If the International Accounting Standards Board was looking for praise of its decision to tackle pensions accounting, it found it among members of its recently formed pensions working group at its inaugural 5 June meeting. Although a minority warned the board against creating an era of constant upheaval in pensions accounting, the majority broadly urged the board to be bold.
Having Crispin Southgate of London-based Pentangle Consulting, an equity and a credit investor, on the working group made assessing the majority view a cinch. He wants the IASB to look again at IAS19’s AA corporate bond discount rate. He also wants a debate on how pension obligations are accounted for - on an accumulated or projected benefit obligation basis.
He also wants an end to smoothing, not to mention greater disclosures about defined-benefit scheme liabilities, asset portfolios, and their use of derivatives. Nor does he like IAS19’s focus on expected returns. Why not? Because it leaves scope to “massage earnings”. Not all of these issues figure in Phase I of the IASB’s two-phase pensions project addresses, so Southgate’s summary of the broad mood around the meeting table gives an intriguing peak-ahead of what could figure in Phase II.
Back to Phase I, and Belgium is watching developments keenly, says Régis Renard, a Brussels-based Aon Consulting, and now Crispin Southgate’s colleague on the pensions working group. A change in the law from 1 January 2004 has forced Belgium’s employers to fund a 3.25% investment return guarantee on employer-funded contributions.
With Belgian employers on the hook for the future investment risk attached to benefits earned by their employees in prior or current periods, the IAS19 accounting balance has tipped from defined-contribution accounting to defined-benefit accounting. In a bid to address intermediate risk plans such as the Belgian plans, IASB staff believe that their proposal for a third classification of defined-return plans provides a solution.
At the May IASB meeting, staff unveiled a plan to split employer contributions under plans such as the Belgian ones into a contribution component, and an investment return guarantee, measured at fair value. “Under this approach, there are clear distinctions between the two separate obligations,” says Mr Renard, “and I believe it should address the problems we have had with IAS19. Measuring the guarantee at fair value seems to be the best approach.” It also means that employers who offer a defined-return plan will avoid projected the unit credit method in IAS19.
“The IASB has been quite clever in drawing a tight distinction between trying to account for defined-return plans and defined-benefit plans,” explains Southgate. “If you are going to analyse the cost of a defined-return plan, you will want to refer to market values, which is not going to be done usefully on the basis of a AA-corporate bond rate. You are much more likely to look at market measures, which are priced off LIBOR or swaps. Effectively this is a disconnect, and the IASB is trying to address it.”
But since when was a technically brilliant solution enough to win an argument in the great defined-benefit pension debate? On the evidence of the 5 June meeting, the IAS19 project team is braced for the accusation that their efforts will induce behavioural change among plan sponsors, - whether on investment strategies or on the choice of defined-benefit over a defined-contribution provision.
This, says Southgate, is a case of “blaming the messenger”. All the messenger has done, he points out, is to force plan sponsors “to reveal the true cost to a sponsoring business of making defined-benefit provision”.
Nor, he adds, can anyone presume a causal link between accounting standard setting and behavioural change. “Dutch pension schemes,” he explains, “were until recently heavily exposed to equities and lost quite a bit as a result. But the situation in the UK is far more complex and has evolved over time. Some of the changes go back to the Maxwell scandal.”
Behavioural change in the UK in fact pre-dates Maxwell, a scandal rooted in the 1980s. Government regulation has played a stealthy role, over time, in increasing the cost of defined-benefit provision.
“A key but subtle aspect of behavioural change concerns the consequences of managing something that you don’t fully control,” says Southgate.
“Whether or not you control the funding status of your pension scheme, if you have committed to it, you should show that in your accounts. If people are reducing their commitment to defined-benefit pension schemes, it is because they have realised that the promise they have made is tricky to deliver - unless they are prepared to fund it. The commercial revelation has been one of ‘God, do we have to pay for that?’” The answer from the IASB is: ‘Yes, you do’
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