Valuing Swiss pension plans under International Financial Reporting Standard (IFRS) IAS19 has been a long-running debate and discussion among experts and companies. IAS19 shapes the assumptions and methods for calculating the income statement and balance sheet entries and different approaches are possible.
An employer’s obligation towards its Swiss pension plan can be hard to define. Under local rules, pension funds are typically considered “fully funded”, with only a subsidised risk of a liability for the employer to fund a shortfall. Under IAS19 though, there is typically a liability – in the IFRS view the employer will have to pay more than just regular contributions to fund pension promises and the guarantees from a Swiss pension plan.
In reality, many steps are taken before a true cash liability emerges. These steps can involve changing benefits of employees. This means the risk is shared between the employer and employees. The question is how to reflect this under IAS19.
Is allowing for “risk sharing” acceptable under IFRS?
The actions a pension fund might take in response to a local funding shortfall include:
- Reducing interest credited to savings capital for employees;
- Changing the conversion rates using to turn retirement capital into a pension; and
- Requiring additional contributions from employees and employer.
The accounting position should be a realistic reflection of the expected future pension obligations and situation of the fund. When valuing the balance sheet it can be acceptable to assess the impact and likelihood of such measures in advance.
How to allow for risk sharing
The impact of risk sharing depends on how the company expects the future of the pension fund to unfold and the actions taken in light of that development. The impact depends on the specific circumstances and rules of the fund, the company and its employee group.
A typical analysis would project the future local funding level based on expected returns on plan assets, developments in interest rates, mortality, plan parameters and funding of technical provisions. The company can then analyse what needs to happen to key plan parameters like the conversion rate and interest credit over time. Any analysis also needs to reflect minimum benefits and within the flexibility allowed in the current plan rules and governing law. The company has to reflect what is allowed and expected to happen.
Important questions to address
Allowing for risk sharing triggers some important questions:
- How will the company really respond to underfunding? How has the company dealt with any underfunding in the past? Did employees pay a proportion of any additional contributions? Or was some aspect of the benefits increased to compensate for a reduction elsewhere? Are some mechanism of change stipulated in the formal terms of the plan?
- Any allowance for risk sharing should reflect the net effect of any future changes and also be consistent with the expectations of employees. What are employees’ expectations and what messages have been sent by the company and fund?
- How will the company disclose the impact? Readers of the accounts must be able to understand what actions are expected, how the company has reached that conclusion and the impact on the accounts and members.
The chamber of pension fund experts in Switzerland has published some general principles for valuation and reporting of the risk sharing features of Swiss pension plans. These features should also be considered when assessing the impact.
Risk sharing debate a sign of rising complexity
Risk sharing is only one aspect of the complexity facing IFRS reporting for companies with a Swiss pension plan. Declining interest rates, rising life expectancy and lower expected investment returns have pushed the financial position of Swiss funds into sharp focus. This is more pronounced under IFRS as it uses market-based assumptions to value the pension position. The IFRS position shows us that if the current economic situation remains, there may be tough choices ahead between further cuts in future actives’ benefits and paying additional contributions to maintain the financial position of Swiss pension plans.
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