Pensions Accounting: A history lesson
In order to understand why the IASB and the IFRS Interpretations Committee will struggle to identify a principle behind the IAS19 discount-rate objective, let us delve into the history of how the board’s predecessor, the International Accounting Standards Committee, arrived at the AA-corporate bond rate ‘rule’.
As IASB director Wayne Upton explained during IASB’s recent 21 February meeting: “To my mind, the problem with risk-free rates is they exist in finance theory, [but it is] kind of hard to find one in nature.
“In all honesty, as well, I think they had a lot of push-back [along the lines of] a government rate might well be ‘too low’ and that high-quality corporates was a population that got you a little bit higher but still captured a lot of the notion.”
It is, at best, unfortunate that IASB staff failed to sit down with either Ian Macktosh, IASB vice-chairman, or even Peter Clark, the IASC’s IAS 19 project manager, ahead of the 21 February meeting and take soundings on the IASC’s likely mindset at the time.
Mackintosh, formerly the chairman of the UK Accounting Standards Board, revealed at the meeting: “When we did the research paper for the ASB, we went back through the records and it was discussed at a few meetings, I guess.… The recollection I have was there never was actually any real justification [for the choice]. They had to get to something and this was something that looked about right. So there was no great theoretical underpinning of the decision.”
And Peter Clark recalled: “To declare an interest, I was a project manager at the time .… and there was never a discussion about how they arrived at the decision [to use] high-quality corporate bonds. Most of the discussion about the discount rate was about whether you would use an asset-backed rate or something else.”
It remains hard to see how the project as currently framed will solve the IAS19 discount-rate dilemma. As IASB implementations director Michael Stewart explained: “The objective of today is to get your input and direction that we can take back to the interpretations committee for them to progress further with it and to produce or provide you with a recommendation for amending IAS19.”
Before the IASB wastes any further time on its discount-rate navel gazing, it could do worse than read the Association of British Insurer’s March 2007 research paper, Understanding Companies’ Pension Deficits.
Although the analysis in chapter four of that document focuses on FRS17, the UK GAAP equivalent of IAS19, it suggested that rather than tinkering at the edges, IASB would do well to stop, think, and mount a considered review of the IAS19 discount rate requirements.
“The move to the FRS17 regime was partly driven by a desire to reduce subjectivity in the valuation of pension assets and liabilities. Yet there is till room for further improvement. It is important to understand that no single discount rate will be ‘appropriate’ in all circumstances,” explained the 2007 report.
“Rates cannot reflect firms’ risk-breaking capability under a one-size-fits-all approach like FRS17. One question is whether creditworthy sponsors should be allowed to discount obligations with a higher rate and pursue riskier asset allocations than weaker ones.”
The ABI did recognise that its solution is not without difficulties: “While allowing companies to use different discount rates might represent a first step towards solving the problem, it is unlikely that regulatory bodies will accept this solution. Yet it would be helpful to know the discount rate that closes the pensions deficit, so as to facilitate cross-cutting comparisons.”
And if the European Securities and Markets Authority is wondering what role it might play, the ABI noted: “Alternatively, regulators could produce clear valuation guidelines and allow sponsors to use predetermined discount rates so long as the scheme clears certain robust, carefully crafted solvency hurdles.” We live in hope.