Swiss Accounting Standards: Swimming against the tide
When it comes to Swiss second-pillar pensions, the IAS19 accounting approach has so many holes in it that some Swiss sponsors have ditched international standards in favour of local GAAP – Stephen Bouvier asks why
Swiss retirement provision is typically built around either final-salary plans or, more commonly, cash-balance plans that convert on retirement into a guaranteed lifetime pension and which also includes long-term disability and widows benefits (see panel). The legal framework for second-pillar retirement provision means that more or less all Swiss plans are classified as defined-benefit (DB) plans for accounting purposes under International Accounting Standard 19, Employee Benefits (IAS19).
As for the pressure points, Willi Thurnherr, the head of Mercer’s Swiss retirement practice, notes that discounting is an area where the IAS19 approach sits awkwardly within the Swiss system. “The statutory discount rate is now in the range of 1% whereas the statutory one is typically between 2% and 3%. This tends to result in a position of underfunding against both US General Accepted Accounting Principles [GAAP] and International Financial Reporting Standards [IFRS]. Nonetheless, according to Swiss law, most schemes are adequately funded.”
Under IFRS, the discount rate is determined by applying a high-quality corporate bond rate or proxy at the balance sheet date. The Swiss discount rate, however, is based on an expected return on plan assets, although it has a longer-term focus than a market-based valuation. Some experts believe the statutory liability measure understates a Swiss company’s true pension funding position.
And valuation challenges, says Olivier Vaccaro, a Swiss-based partner with Aon Hewitt, have pushed some Swiss sponsors to explore de-risking. “The valuation of Swiss plans under IAS19 is sometimes not as straightforward as it should be,” he says. “Many clients are looking for de-risking opportunities either by making adjustments to the plan design or by attempting to review valuation principles.”
Swiss cash balance plans
• The employer contributes a percentage of the employee’s salary which increases with age.
• Each year, interest is credited at a minimum, legally fixed rate of 1.75% to build up an account balance.
• Discount rates under Swiss law are 2-3%.
• On retirement a Swiss pensioner can take either a lump sum and/or a pension.
• The conversion rate for the mandatory part of the account balance is 6.8% assuming a retirement age 64 for women and 65 for men.
• Individual members receive a minimum annuity of 6.8% of the mandatory part of the account balance with a linked spouse’s pension fixed at 60% of the member’s annuity.
• Individual schemes can offer higher benefits.
Another approach has been to insure the DB liability, although this has created problems, according to Vaccaro: “There have always been challenges when a sponsor transfers risk to an insurer. Auditors have concluded in the past that this risk transfer does not change the fact that even fully insured plans are DB under IAS19.”
Auditors in particular have challenged the assertion that sponsors have managed to insure away their obligations. There have been a number of sticking points in these conversations with auditors, among them the fact that insurance premiums can be adjusted, meaning that benefits accrued through past service might be subject to premium adjustments, or even that the insurer might cancel the insurance contract.
Another key difference between the Swiss statutory model and the IAS19 model is the calculation of a liability for active scheme members. Over 95% of Swiss plans are cash-balance plans with guarantees. Swiss law requires sponsors to account for each individual scheme member and their account balance. IAS19, however, forces sponsors to apply the projected unit credit approach to all DB schemes.
“The valuation of Swiss plans under IAS19 is sometimes not as straightforward as it should be”
This, argues Willi Thurnherr, presents a challenge for Swiss plans because employer contributions increase with age, whereas IAS19 requires you to attribute future contribution increases equally over time in order to avoid a back-end loading effect. For example, an employer might make a contribution of 7% for an employee aged up to 34 years of age, increasing to 18%, on a sliding scale, from age 54 to retirement.
Assuming that this averages out at 12.5% over the lifetime of the employee’s scheme membership, employers end up with a large overstatement of pension cost versus cash contribution in the early years of a future pensioner’s scheme membership. Thurnherr believes, for roughly 90% of Swiss plans, that the IAS19 approach creates deficits that reflect nothing more than the IAS19 approach per se.
So what measurement approach would be preferable to IAS19? Thurnherr suggests that there is no answer. “I think the statutory discount rate in Switzerland is probably too high and has lagged the market-based measure in IAS19. Given low bond yields, IAS19 has responded to these circumstances much faster.”
He points out that when an employee leaves service in Switzerland, they receive their accrued benefits in the form of the account balance. So the liability of the employer, when winding down a scheme, is simply that balance, which allows it to rid itself of all future liabilities.
Given the levels of discontent with IAS19 and other aspects of IFRS within Switzerland, it is perhaps unsurprising that some quoted Swiss companies have ditched IFRS as their reporting basis in favour of local GAAP. From a political perspective, Switzerland is swimming against the tide of the global flow to IFRS.
This is despite the fact that the vision of a globally applicable single set of accounting standards is shared by the G20, the World Bank, the IMF, the Basel Committee, IOSCO, and IFAC. A recent IFRS Foundation analysis of 138 jurisdictions revealed that Switzerland is one of ten nations that has not made public commitment to support a single set of global accounting standards.
Indeed, the Swiss stock exchange SIX offers various listing regimes to suit the business and requirements of the issuer. The two most relevant to listed commercial enterprises are the Main Standard and the Domestic Standard. In order to list on SIX under the Main Standard regime, a company must have a three-year trading track record.
An entity reporting under IFRS would typically report under the Main Standard. Alongside these sits the Domestic Standard. This is in essence a route by which companies applying Swiss GAAP FER can secure an equity listing. Indeed, the decision by Siegfried Holding in 2012 to move from IFRS to Swiss GAAP FER as its new financial reporting regime saw the pharmaceutical move its listing from the Main Standard into the Domestic Standard of the SIX Swiss Exchange.
Explaining the move, Siegfried said: “With the change, Siegfried adopts a standard that provides a comparable informative value while corresponding to the company’s size and causing less complexity and costs. Swiss GAAP FER continues to ensure a transparent financial reporting of Siegfried Holding.” Others, sources hint, are tipped to follow.