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Accounting: Ringing up the changes

• The slowdown in UK mortality improvements is continuing
• Sponsors are adjusting discounting approaches
• They are also looking closely at proposals that could affect surpluses
• Insurers have lobbied furiously on IFRS 17

Despite accountancy’s staid reputation, 2017 has been anything but dull. And 2018 is set to be no different. Starting with accounting for defined-benefit plans under International Accounting Standard 19, the overall picture is a slight but noticeable divergence in trends between the UK and the rest of the EU – albeit helpfully. 

Within the UK, Chris Hurry, a partner at Hymans Robertson, says assumptions will paint a “slightly more positive” picture on corporate balance sheets than last year, with net discount rates largely unchanged against a backdrop of rising asset prices and relatively static liabilities.

Moreover, the 2016 figures in the Institute and Faculty of Actuaries’ Continuous Morality Investigation point to a slowing in the pace of longevity improvement. “As a result, sponsors are no longer waiting for their triennial cash-funding valuation to update their assumptions and more of them are updating annually,” Hurry says.

“The trail-off been on the cards for a number of years, driven initially, I suspect, by the effects of harsh winters and ineffective flu vaccines feeding through. There is also evidence this is most evident at the less affluent end of the socio-economic scale.”

And on discounting, UK sponsors have realised that an innovative approach can save billions. There are broadly two discounting approaches. The first is to plot a curve through AA corporate bonds, while the second is to pick up the Gilt curve at the longer end and add on some credit spread. The switch recently helped UK supermarket chain Tesco to live up to the old adage that ‘every little helps’. 

“We expect [sponsors] with significant pension liabilities to start showing more interest in this approach,” says Chris Hurry. “There also seems to be some acceptance from auditors that different sorts of extrapolation are more acceptable.” The overall effect, he notes, is to boost the discount rate by 15-20bps.”

Mercer’s chief actuary for Germany, Thomas Hagemann, has pencilled in a more modest rise. “Looking at the Mercer yield curve right now,” he says, “which is what we use across the euro-zone for discounting purposes, we have seen a drop of around 6bps as a result of the recent downgrade of General Electric from AA to A.

“In other words, we no longer use GE debt to calculate our overall discount rate. Given that discount rates are quite low at the moment, this has had an impact. However, although we will have to wait until year-end for the full picture, discount rates are around 10bps higher than this time last year. They could end the year between and 10 and 20bps up, although there has been very little easing overall in the euro-zone.”

Similarly, Hagemann points to less dramatic longevity trends. “I am aware that there has been some sign of a slowing of the rate of increase in the UK, but in Germany, we are still using the 2005 Heubeck tables. Under this approach, longevity depends on the year of a person’s birth. We can see from the tables that the development is still quite smooth and improving. It is not slowing down.”

Accounting rule changes are also a hot topic on both sides of the Channel. Indeed, it is hard to remember a year-end without some mention of IFRIC 14. Last September, the IASB’s staff recommended that the board should pause for thought on its changes to IFRIC 14 and split it from its changes to plan amendment accounting under IAS 19. 

The project started in 2014 when the IASB’s interpretations committee decided to clarify one aspect of when a defined benefit (DB) scheme sponsor can recognise a balance-sheet surplus.

Although IFRIC 14 had supposedly settled this issue, the problem in front of the committee concerned whether the power of third parties, such as scheme trustees, to wind up a scheme or even augment benefits could affect whether or not the sponsor can book a plan surplus as an asset. 

The stakes are high, as the Royal Bank of Scotland demonstrated in early 2016 when it reported an additional liability of £4.2bn (€4.8bn).

The proposals have caused shockwaves in the UK. Critics say they could saddle sponsors with huge additional liabilities – particularly if a sponsor agrees to a substantial funding commitment as part of a plan revaluation. 

Hurry says: “Effectively this is about accounting for the funding obligation. It will depend on whether you expect to be able to get the surplus back at the end of time. Certainly, a significant proportion of companies take the view that they will be able to run the scheme until the last member exits, and then recover any remaining funds. 

“However, the proposed changes could make people look more closely at their scheme rules, where trustees have specific powers that could prevent this. These proposals could mean more companies could be affected.”

Although non-UK sponsors are unlikely to feel the pinch from the IFRIC 14 changes beyond their UK subsidiaries, of much more interest to German practitioners are the amendments that the IASB released alongside the amendments to IFRIC 14.

Put briefly, these changes require DB sponsors to re-measure the effects of plan amendments not from the next financial year but from the point at which they take effect in the current year. The amendments are expected by the end of 2018 or early 2019. 

Hagemann says: “I have to say that not only Mercer but other actuaries in Germany are unhappy with the board’s project. It will mean that where there is a special effect in the middle of the year, sponsors will have to recalculate both the service and interest costs.”

But it is not only DB plan sponsors who face upheaval and uncertainty during 2018. So, too, do investors and insurers.

In October, IPE laid a freedom of information (FOI) request with the UK Treasury following a tip-off that the IASB’s flagship insurance liabilities standard, IFRS 17, was in trouble. It has emerged that the UK insurance industry has lobbied government furiously behind the scenes to stall or even frustrate the new rules. 

Meanwhile, in Brussels, Insurance Europe has voiced similar reservations. Staggeringly for a standard that was a decade in the making, the trade body complained to the European Commission that “none” of its members had seen a draft of the new IFRS before its release in May. The situation surrounding the beleaguered standard emerged in a second FOI release by the UK business department BEIS. The UK government initially argued that the public interest would be harmed by the release of the information.

And while insurance companies await an outcome on how and if they will eventually account for transactions such as buyouts under the new rules, investors at least have more clarity about the economic reality that banks will be able to gloss over, thanks to a recent vote in the European Parliament.

During a plenary session vote in November, the European Parliament provisionally approved a transitional regime to dilute the effect of IFRS 9’s impairment model. The vote means that five years from this month, banks will have the option to add back up to 90% of impairments on their financial-asset holdings to tier-1 core equity.

Who said accountancy was dull?

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