Administration April 29, 2010

New IASB Proposal Could Increase Scrutiny of Risks Taken by DB Plans

April 29, 2010 (PLANSPONSOR.com) - The International Accounting Standards Board (IASB) on Thursday issued its exposure draft on accounting for defined benefit (DB) pension plans.
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The proposed changes to international accounting standards (IAS 19) could encourage greater scrutiny of the risks taken by defined benefit plans and the way in which these risks are rewarded, according to Mercer. In particular Mercer believes the proposal, which places both the upside and downside of risks taken by DB plans outside of the profit or loss account, could affect company behavior if finalized in its current form.

Elements of the proposal, according to a Mercer news release, include:

  • Profit or loss would no longer include the expected risk premium for investing in risky assets;
  • Buyouts and settlements would no longer affect profit or loss; and
  • Administration costs could materially increase net defined benefit liabilities.
At present, the expected reward from taking investment risk with plan assets is presented as profit, even if it is not actually achieved, while under the IASB proposal, the actual reward or loss from taking investment risk would be recognized immediately in the balance sheet but presented outside of the profit or loss account. “This change aims to improve the decision-usefulness of the profit or loss account for analysts and other users of those accounts,” commented Warren Singer, UK Head of Pension Accounting at Mercer, in the press release. “The proposal is a balance between using actual return on assets, which may introduce too much volatility for the profit or loss account to be useful, or using the expected return on assets, which has been criticized for creating artificial profits.”

Similarly under the proposal, the cost of settling liabilities with an insurance company (compared to the accounting reserve) would be presented outside of the profit or loss account, as this type of settlement does not affect the expected future benefit cash flows to be provided by a DB plan. At present, this cost would reduce a company’s profits. “Again, this proposal would make it easier from an accounting perspective for companies to reduce risks and settle defined benefit liabilities with an insurer,” Singer said.

Mercer views the IASB’s clarification of the intended treatment of administration costs as another important development. “The IASB feels there is some diversity in the treatment of administration costs and they are clarifying that entities should not include costs that have nothing to do with plan assets in the return on plan assets,” commented Singer. “For those companies who currently allow for administration costs in the expected return on asset assumption and who are not currently granting additional benefits, Mercer estimates that this clarification could add around up to 5% to the Defined Benefit Obligation and possibly result in a material change in disclosed deficit or surplus positions.”

The IASB’s exposure draft – IAS 19 “Defined benefit plans” – is available from http://www.iasb.org.

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