Pensions Accounting: Prisoners of time

The International Accounting Standards Board (IASB) has concluded its latest agenda consultation exercise and added a research project to address what it calls “Pension Benefits that Depend on an Asset”. Despite the impressive title, the research is unlikely to cause a flurry of activity on pensions.

In part, this is because the board has allocated the project to its research pipeline, rather than its workplan. In practical terms, this means that the IASB will devote resources as and when it can. It will not, however, commit to developing any formal proposals, meaning that pensions could surface again at the IFRS Foundation’s next consultation in five years’ time.

As for this research effort, during its July meeting, the board signalled it would consider a solution to the accounting challenges presented by certain types of hybrid-risk plans – those that seek to balance the trade-off in risk between defined benefit (DB) and defined contribution (DC) plans.

This approach – which staff refer to as the ‘capped’ ultimate-costs-adjustment model – could apply to pension promises that vary according to the level of returns on specified assets. Staff say it operates by capping the cashflows included in the measurement of the liability. The selling point of this approach is that it does not require the board to revisit plan classification under IAS 19 – the graveyard of previous attempts on pensions.

What the development does underscore is the extent to which the IASB sees pensions as largely prisoners of time because events run ahead of the accounting. 

Nowhere is this more apparent than in the UK, where a toxic combination of low yields, high deficits and ballooning contribution burdens have pushed some DB schemes and sponsors to breaking point. Added to this brew are concerns around distributable reserves. 

Much attention has been focused in the UK on the legality of IFRS accounts and the availability of distributable profits for distribution to shareholders as dividends. However, in the run-up to the reporting year-end, the issues with distributable reserves typically appear in three guises, says Alex Waite, head of corporate consulting with Lane Clark & Peacock

First, he explains, given a large deficit, a company’s directors might decide that they cannot pay a dividend. “I would call that affordability,” says Waite. “There is no technical phrase for it. I am seeing that conversation happening.”

A second scenario is where both the legal and accounting worlds collide to say that because of the way the group structure works, the distributable reserves are being wiped out on the balance sheet by the pension deficit. Third, he adds, the way in which companies pay a dividend is often through a complicated group structure where they pay dividends higher up the group structure to the parent company. 

Waite explains: “You could end up with this issue about distributable reserves biting anywhere in the corporate structure – depending on where the pension commitment is lodged and how distributable reserves are moved around. He adds that even if you have the money at group level, but nonetheless have a sub-entity level that traps the dividend, you have the dividend locked in. This allocation of the pension liability can be arbitrary. It might not be obvious where the deficit is.”

“The currently proposed draft includes words that would potentially be a major issue for most UK pension schemes and their sponsors.  However, the wording is still evolving”

Alex Waite

Meanwhile, the IFRS Interpretations Committee’s work on its asset-ceiling guidance, IFRIC 14, risks putting those schemes for which it is a factor facing yet more pressure. Back in 2015, the IFRS IC proposed an amendment to IFRIC 14 to deal with the accounting when parties can wind up a plan or affect benefits for plan members without an entity’s consent.

Broadly speaking, the amendment clarifies that where a scheme’s trustees, for example, can wind up a plan without the sponsor’s consent, the sponsoring entity will not have an unconditional right to a refund of any surplus on winding-up. Furthermore, the changes prevent sponsors from recognising any surplus where another party can use it for other purposes. 

Finally, the committee has attempted to clarify that a decision by trustees to purchase an annuity as a plan asset does not affect the sponsor’s ability to claim a refund. This proposal has proved controversial with some who have argued that it creates an artificial distinction between a buy-in and a buy-out. 

Simon Robinson, a consultant actuary with Aon Hewitt, says he has concerns about how the amendments will play out – especially in light of the committee’s decision to edit their wording at their September meeting. 

“People have generally taken comfort from being able to adopt a more relaxed approach, mainly because most trustees don’t have the powers to stop companies recognising a surplus. But this tweaked wording could affect companies.” There are estimates that over half of sponsors will be affected. This leaves them with a situation where trivial differences in the wording of a trustee agreement dating back decades could make a difference.

Robinson explains: “The IFRIC included some wording which when the project first started sounded like it had the potential to be a major issue. But then they turned around and said that buy-ins are different [from] buyouts. This meant that the changes appeared to suggest that very few companies would be affected because a buy-in is treated as an investment decision under the revised wording.

“People have generally taken comfort from being able to adopt a more relaxed approach, mainly because most trustees don’t have the powers to stop companies recognising a surplus. But this tweaked wording could affect companies”

Simon Robertson

“But, having pored over the meeting papers for the September IFRIC meeting, I was left with the impression that they have changed the wording slightly. Pension scheme trustees rarely have the unilateral right to commence windup but I believe that, much more frequently, they do have the unilateral right to buy annuity policies in the names of the members. This could, again, have an enormous impact on UK corporate balance sheets.” 

The issue is one that Waite has spotted. “There is currently a review being undertaken by the IASB over the wording of IFRIC 14, and one possibility is that the wording will change to be a lot more draconian,” he says. “Indeed, the currently proposed draft includes words that would potentially be a major issue for most UK pension schemes and their sponsors.  However, the wording is still evolving so we will be feeding back out concerns and then watch carefully for what happens next.”

As for the UK end game, Waite thinks the answer lies in Europe. “The Netherlands has a similar-sized pensions industry to us. They do that with 300 pensions schemes. We have 6,000. There has been huge consolidation in the Netherlands and I think we will see the same in the UK. The economy in the Netherlands is a quarter of the UK, it is not 20 times smaller.

“There is some overlap with the experience in Europe. They had lower interest rates earlier and so they have already gone through a lot of the painful processes that we are about to go through. For example, the closures of plans, the removal of pension indexation, mergers of plans to reduce costs. This is a lot more fundamental than any reconsideration of the IAS 19 discount rate.”

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