Pension fund accounting - what's going on?

UK: Accounting Standards Board
Financial Reporting of Pensions discussion paper issued 31 January 2008, written with European standard-setters to influence the debate on accounting for pensions.

The paper proposed:
• Using a risk-free rate to value liabilities
• The use of actual, not expected, returns in pension fund income statements
• Pension liabilities to be in include in pension scheme accounts
• Multi-employer schemes to be measured in the same way as single-employer schemes
• Consultation period now closed and the results of consultation will be submitted to the IASB.

Global: International Accounting Standards Board
Working with the US Financial Accounting Standards Board to update the existing standard on pensions accounting, IAS 19, but in the interim is working on 'immediate problems':

• Immediate recognition of gains and losses, removing current options for deferral
• Actual, not expected, returns to be shown on the income statement
• New treatment proposed for 'contribution-based' pensions
• Aiming for a revised standard by 2011, with consultation paper expected next year.

It has already been said of the global financial crisis there is enough blame to go around for all those involved. Along with everyone else, the accounting profession can expect to take some criticism for the 'mark to market', or fair value accounting approach, which some see as exacerbating the crisis.

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Mercer principal Phil Turner comments: "It is quite challenging for us working in pensions. Pension liabilities are measured by AA corporate bond rates and bond yields have been all over the shop." But others point out that mark to market is a more transparent and consistent approach than some form of smoothing, which would have hidden problems that needed addressing.

While the principles of mark to market may be here to stay, there is a vigorous debate developing over other aspects of pension scheme accounting. The UK's Accounting Standards Board (ASB), in conjunction with the European accounting standard setters, issued a discussion paper, Financial Reporting of Pensions, in January 2008, which closed for consultation in the summer. The paper has been seen as an attempt to influence the thinking of the International Accounting Standards Board (IASB) on its intended thorough revision of the international accounting standard for employee benefits, IAS 19. The ASB has stirred up plenty of comment, particularly its proposal to move to a risk-free rate to value scheme liabilities, instead of a AA corporate bond rate.

Punter Southall principal Danny Vassilades comments: "This would increase liabilities significantly; given current market conditions liabilities could increase by 30%. There was also feedback from the consultation that a risk-free rate needed to be defined, because it was not immediately obvious what it is." Vassilades adds that the proposal would greatly increase the volatility of defined benefit (DB) liabilities, so incentivising finance directors (FDs) to seek a bulk buy-out of scheme liabilities.

While Turner says: "The use of government bonds as a risk-free rate is all very well in the UK and US, but in less developed countries it could be a higher rate than AA corporate bonds."

The National Association of Pension Funds also raised objections to three other proposals in the discussion paper, although it saw the idea of using a risk-free rate to discount liabilities as the greatest threat to DB pensions.

While the ASB has been putting its ideas forward, the bigger picture, according to Turner, includes greater convergence between the international accounting standards and those used in the US under FAS 87. The US financial regulator, the Securities and Exchange Commission has agreed in principle to adopt the international standard, with this decision to be reviewed in 2011 and therefore with adoption some time after that.

While the IASB and the US standard-setter, the Financial Accounting Standards Board, are planning a fundamentally revised accounting standard for pensions in 2011, the IASB has recently proposed changes to matters it sees as requiring immediate action.

One key proposal is to immediately recognise all gains and losses incurred at DB plans, removing any options for deferred recognition. Turner said this change is certain to happen, as there is plenty of support for it. The IASB has put forward three possible alternatives for immediate recognition of gains and losses. Watson Wyatt international consultant Eric Steedman comments: "One proposal is to be put everything through the profit and loss account (P&L), so if assets fall by 5%, that hits the P&L."

Otherwise, gains and losses could be shown below the line, in the statement of recognised gains and losses (STRGL) in UK accounts, or its IAS 19 equivalent, the statement of recognised income and expense (SORIE). Vassilades comments: "If you run a pension scheme and it has lost money, you have to make good the loss. The potential or actual loss has to be accounted for; you can't just ignore it."

The IASB has also issued proposals for fair value accounting for what it defines as 'contribution-based' pensions. These, it seems, are all forms of hybrid scheme, between pure defined benefit and pure defined contribution plans and the IASB has drawn a largely negative reaction here. For one thing, observers think the IASB has cast its net too widely, bringing in career average schemes and, apparently, many Dutch pension plans.

For FDs following the various standard-setters, in the words of Steedman: "It can be difficult to disentangle and understand what's going on. There are different layers and different levels of proposals going on." FDs could be forgiven for worrying about other matters, but it could be wise to keep a watching brief, with representations made on proposals which could conceivably damage pensions provision in the UK.


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