6 SEPTEMBER 2010 IASB EXPOSURE DRAFT (ED/2010/3) DEFINED BENEFIT PLANS PROPOSED AMENDMENTS TO IAS 19 EFRP RESPONSE

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1 6 SEPTEMBER 2010 IASB EXPOSURE DRAFT (ED/2010/3) DEFINED BENEFIT PLANS PROPOSED AMENDMENTS TO IAS 19 EFRP RESPONSE

2 2 1. Identification of response The European Federation for Retirement Provision (EFRP) represents the various national associations of pension funds and similar institutions for supplementary/occupational pension provision. Its membership at large consists of institutions for workplace (2nd pillar) retirement. Some of them are also operating purely individual pension schemes (3rd pillar). The EFRP has 26 members associations in most EU-15 Member States and other European countries that have a significant in size and relevance workplace pension system 1. Within EFRP the Central & Eastern European Countries Forum (CEEC Forum) has been established (26 October 2006) to discuss issues common to pension systems in that region. 83 million EU citizens are covered for their workplace pension plan by EFRP Members. Through its Member Associations the EFRP represents approximately 3.5 trillion of assets (2009) managed for future occupational pension payments. EFRP Members are large institutional investors representing the buy-side on the financial markets. They are specialised financial institutions dedicated to the sole objective of accumulating and decumulating assets over a long period of time with the aim of providing a supplement to the State pension to avoid old-age poverty. Contact: Ms. Chris VERHAEGEN, Secretary General Koningsstraat Brussels Tel: / Fax: efrp@efrp.eu 1 EU Member States: Austria, Belgium, Finland, France, Germany, Hungary, Ireland, Italy, Netherlands, Portugal, Romania, Spain, Sweden, UK. Non-EU Member States: Croatia, Guernsey, Iceland, Norway, Switzerland.

3 3 2. General comments 2.1 EFRP is grateful for the opportunity to respond to the IASB s Exposure Draft Defined Benefit Plans: Proposed amendments to IAS We welcome the Board s decision not to go ahead with its earlier proposals for Contribution Based promises. The proposals represented a fundamental change in pensions accounting in general and were clearly incompatible with the regulations applying to defined benefit promises, specifically. 2.3 We also welcome the Board s decision not to require in all cases that multiemployer schemes account for individual employer s liabilities, as this raises a number of fundamental issues which we do not believe can be resolved in what is intended as an interim amending standard. 2.4 The views of the different national associations within the EFRP are divided on immediate recognition. The extent to which companies make use of the corridor option differs between countries and between industries. In some countries - notably the UK, Germany and Ireland - limited use is made of the corridor option. In a number of other countries, including France, the Netherlands, Sweden and Portugal, extensive use is made of it. 2.5 IAS 19 distinguishes between DC plans, in which all risks are borne by the plan members, and DB plans, in which most or all risks are borne by the plan sponsor. However, in some countries, the risks in pension plans are shared between employers and employees. Consequently, it is important to recognise the arrangements for risk sharing between employees and employers and in some cases within industries for multi-employer plans. 2.6 EFRP is concerned that the withdrawal of the corridor option may, in countries where its use is prevalent, contribute to the ever growing pressure on DB plans to close. This may lead to social consequences in many European countries, as occupational DB plans represent a significant part of those countries social and pension arrangements. 2.7 We are attracted to the simple and pragmatic net interest approach but are concerned that this could lead to a systematic misstatement of the net of actual investment performance and interest accrual over the lifetime of the plan. The IASB s proposal that pension income (or expense) should be measured by the application of the discount rate on the scheme liabilities to the pension surplus (or deficit), may not reflect the reality of actual investment models applied. For

4 4 example, it may be that some plans have significantly de-risked their investment strategy and are unable to achieve the returns on high quality corporate bonds.

5 5 3. Answers to specific questions Recognition Q1 The exposure draft proposes that entities should recognise all changes in the present value of the defined benefit obligation and in the fair value of plan assets when they occur. (Paragraphs 54, 61 and BC9 BC12) Do you agree? Why or why not? There are different opinions amongst EFRP members. A number of member countries have experience of the immediate recognition approach and agree with the Board s proposal. Others believe that immediate recognition should be deferred until the upcoming fundamental review has been completed and a measurement model has been developed that properly takes into account the risks borne by the employer, the long term nature of the pension liabilities and the fact that the liabilities will only change gradually, in line with scheme demographics. Q2 Should entities recognise unvested past service cost when the related plan amendment occurs? (Paragraphs 54, 61 and BC13) Why or why not? On the assumption of immediate recognition of changes in plan assets and liabilities we agree that unvested past service cost should be recognised when the related plan amendment occurs. Disaggregation Q3 Should entities disaggregate defined benefit cost into three components: service cost, finance cost and remeasurements? (Paragraphs 119A and BC14 BC18) Why or why not? We agree that defined benefit cost for the amount recognised should generally be disaggregated into three components: service cost, finance cost and remeasurements. Defining the service cost component Q4 Should the service cost component exclude changes in the defined benefit obligation resulting from changes in demographic assumptions? (Paragraphs 7 and BC19 BC23) Why or why not? We agree that the service cost should exclude changes in the defined benefit obligation resulting from changes in demographic assumptions, which should

6 6 instead go through remeasurements, as these changes are of a non-recurring nature. Defining the finance cost component Q5 The exposure draft proposes that the finance cost component should comprise net interest on the net defined benefit liability (asset) determined by applying the discount rate specified in paragraph 78 to the net defined benefit liability (asset). As a consequence, it eliminates from IAS 19 the requirement to present an expected return on plan assets in profit or loss. Should net interest on the net defined benefit liability (asset) be determined by applying the discount rate specified in paragraph 78 to the net defined benefit liability (asset)? Why or why not? If not, how would you define the finance cost component and why? (Paragraphs 7, 119B, 119C and BC23 BC32) We are attracted to the simplicity and pragmatism of this approach but are of the opinion that it could systematically misstate the net of actual investment performance and interest accrual over the lifetime of the plan. We would view the proposed approach as a short-term fix that should be a subject of the upcoming fundamental review of IAS 19. Presentation Q6 Should entities present: (a) service cost in profit or loss? (b) net interest on the net defined benefit liability (asset) as part of finance costs in profit or loss? (c) remeasurements in other comprehensive income? (Paragraphs 119A and BC35 BC45) Why or why not? We agree with the Board s proposal that entities should present service cost in the profit and loss account, net interest on the net defined benefit liability or asset as part of finance cost in profit and loss, and remeasurements in other comprehensive income. However, until such time as the Board s review of financial statements has been concluded, we would ask the Board to consider continuing to permit a choice for consolidated financial statements whereby net interest may be included with service cost in operating cost rather than reported separately in financing cost, where this better reflects the type of plan (e.g. unfunded plans) or the way the plan is managed.

7 7 Settlements and curtailments Q7 (a) (b) (c) Do you agree that gains and losses on routine and non-routine settlement are actuarial gains and losses and should therefore be included in the remeasurement component? (Paragraphs 119D and BC47) Why or why not? Do you agree that curtailments should be treated in the same way as plan amendments, with gains and losses presented in profit or loss? (Paragraphs 98A, 119A(a) and BC48) Should entities disclose (i) a narrative description of any plan amendments, curtailments and non-routine settlements, and (ii) their effect on the statement of comprehensive income? (Paragraphs 125C(c), 125E, BC49 and BC78) Why or why not? We agree that: (a) gains and losses on routine settlement (and this term needs to be defined clearly) are actuarial gains and losses and should therefore be included in remeasurements. However effects from non-routine settlements (again this needs to be defined), which typically result from singular management decisions or actions, are often very similar to curtailments (or are connected to them) and should therefore be included in the profit and loss. (b) curtailments should be treated the same way as plan amendments, with gains and losses presented in profit and loss. (c) entities should disclose (i) a narrative description of plan amendments, curtailments and non-routine settlements, and (ii) their effect on the statement of comprehensive income. Disclosures Defined benefit plans Q8 The exposure draft states that the objectives of disclosing information about an entity s defined benefit plans are: (a) to explain the characteristics of the entity s defined benefit plans; (b) to identify and explain the amounts in the entity s financial statements arising from its defined benefit plans; and (c) to describe how defined benefit plans affect the amount, timing and variability of the entity s future cash flows. (Paragraphs 125A and BC52 BC59) Are these objectives appropriate? Why or why not? If not, how would you amend the objectives and why? We agree in general that the objectives listed are appropriate. However, we are worried about the possibility of excessive disclosures, which can be burdensome for preparers of accounts and confusing for users. We would therefore

8 8 emphasise the particular importance that we attach to adequate disclosure of how defined benefit plans affect the amount, timing and variability of an entity s future cash flows. Q9 To achieve the disclosure objectives, the exposure draft proposes new disclosure requirements, including: (a) information about risk, including sensitivity analyses (paragraphs 125C(b), 125I, BC60(a), BC62(a) and BC63 BC66); (b) information about the process used to determine demographic actuarial assumptions (paragraphs 125G(b) and BC60(d) and (e)); (c) the present value of the defined benefit obligation, modified to exclude the effect of projected salary growth (paragraphs 125H and BC60(f)); (d) information about asset-liability matching strategies (paragraphs 125J and (e) BC62(b)); and information about factors that could cause contributions to differ from service cost (paragraphs 125K and BC62(c)). Are the proposed new disclosure requirements appropriate? Why or why not? If not, what disclosures do you propose to achieve the disclosure objectives? We would emphasise the importance of appropriate disclosures on the predictability of future cash flows as far as these are related to current and prior pension accruals and would stress the need for information about the factors that could cause contributions to differ from service costs [Q 9(e)]. We believe the proposed sensitivity disclosures will be too complex for users to understand and expensive and difficult for preparers to provide [Q 9(a)]. Multi-employer plans Q10 The exposure draft proposes additional disclosures about participation in multiemployer plans. Should the Board add to, amend or delete these requirements? (Paragraphs 33A and BC67 BC69) Why or why not? We believe that 33A (d) needs clarification to make clear that amount means a description of how the amount is arrived at, rather than a wind-up figure for each employer. In addition, we find that the disclosure in 33A (f) (iii) of the next five years expected contributions is going to be difficult and expensive for multiemployer plans and entities to comply with, and we would suggest that this requirement is deleted. Q11 The exposure draft updates, without further reconsideration, the disclosure requirements for entities that participate in state plans or defined benefit plans that share risks between various entities under common control to make them consistent with the disclosures in paragraphs 125A 125K. Should the Board add to, amend or delete these requirements? (Paragraphs 34B, 36, 38 and BC70) Why or why not?

9 9 We agree that this is not the time to reconsider the disclosure requirements for the state plans and plans sharing risks under common control beyond updating them for consistency. Other comments Q12 Do you have any other comments about the proposed disclosure requirements? (Paragraphs 125A 125K and BC50 BC70) As stated before, we are concerned about the burden on preparers of the increased disclosures, as well as the complexity for the users of financial statements, in particular we are concerned about the amount of sensitivity analysis that would need to be provided, and the cost of providing such analysis. Other issues Q13 The exposure draft also proposes to amend IAS 19 as summarised below: (a) The requirements in IFRIC 14 IAS 19 The Limit on a Defined Benefit Asset, Minimum Funding Requirements and their Interaction, as amended in November 2009, are incorporated without substantive change. (Paragraphs 115A 115K and BC73) (b) Minimum funding requirement is defined as any enforceable requirement for the entity to make contributions to fund a post-employment or other long-term defined benefit plan. (Paragraphs 7 and BC80) (c) Tax payable by the plan shall be included in the return on plan assets or in the measurement of the defined benefit obligation, depending on the nature of the tax. (Paragraphs 7, 73(b), BC82 and BC83) (d) The return on plan assets shall be reduced by administration costs only if those costs relate to managing plan assets. (Paragraphs 7, 73(b), BC82 and BC84 BC86) (e) Expected future salary increases shall be considered in determining whether a benefit formula expressed in terms of current salary allocates a materially higher level of benefits in later years. (Paragraphs 71A and BC87 BC90) (f) The mortality assumptions used to determine the defined benefit obligation are current estimates of the expected mortality rates of plan members, both during and after employment. (Paragraphs 73(a)(i) and BC91) (g) Risk-sharing and conditional indexation features shall be considered in determining the best estimate of the defined benefit obligation. (Paragraphs 64A, 85(c) and BC92 BC96) Do you agree with the proposed amendments? Why or why not? If not, what alternative(s) do you propose and why? (a) We agree that the requirements in IFRIC 14 should be incorporated but they should be made symmetric: the current limit on the defined benefit asset to the realisable amount should be mirrored to the liability side: a similar limit on the defined benefit liability to the maximum payable amount calculated in the same way should be applied where entities have an agreed or specified cap on their liability to contribute to a plan.

10 10 (b) We are comfortable with the proposed definition of minimum funding requirement. (c) We agree that whether tax payable should be included in the return on plan assets or in the measurement of the defined benefit obligation should depend on the nature of the tax. (d) We agree that the return on plan assets should be reduced by administration costs only if those costs relate to managing plan assets. (e) The issue of expected future salary increases should be considered in the upcoming fundamental review. We agree that for the purposes of this review that future salary increases should be included in determining whether a benefit formula expressed in terms of current salary allocates a materially higher level of benefits in later years. (f) We agree that mortality assumptions should be current estimates of expected mortality rates of plan members. (g) We agree that risk sharing and conditional indexation features should be considered in determining the best estimate of the defined benefit obligation. The current proposed text in paragraph 85c is in our opinion not clear enough on the specific funding arrangements that can exist between an entity and its employees. In some countries, the discretion to change benefits is with the management of the pension fund. Neither paragraph 85, nor paragraph 85c, itself refer to any funding arrangement that may have been made with the pension fund management. Therefore, we propose adding a paragraph 85 (d) as follows: (d) the formal terms of the plan limit the legal and constructive obligation to pay additional contributions to cover a shortfall in the funds assets. Multi-employer plans Q14 IAS 19 requires entities to account for a defined benefit multi-employer plan as a defined contribution plan if it exposes the participating entities to actuarial risks associated with the current and former employees of other entities, with the result that there is no consistent and reliable basis for allocating the obligation, plan assets and cost to individual entities participating in the plan. In the Board s view, this would apply to many plans that meet the definition of a defined benefit multiemployer plan. (Paragraphs 32(a) and BC75(b))

11 11 Please describe any situations in which a defined benefit multi-employer plan has a consistent and reliable basis for allocating the obligation, plan assets and cost to the individual entities participating in the plan. Should participants in such multi-employer plans apply defined benefit accounting? Why or why not? The problem we have in the current wording of Paragraph 32(a) is the interpretation of the words consistent and reliable basis. It could be argued that an allocation on the basis of the each company s share in the current contributions to the fund might satisfy these consistency and reliability criteria. Others argue that due to the continuously changing population of sponsoring companies multi-employer plans fall by definition under the 32(a) exemption. Therefore, this approach is not very clear and leads to different interpretations. Correspondingly, we would propose that the Board considers issuing further specific clarification of what is meant by a consistent and reliable basis. Transition Q15 Should entities apply the proposed amendments retrospectively? (Paragraphs 162 and BC97 BC101) Why or why not? We agree on applying the proposed amendments retrospectively for the one year comparative figures in the financial statements. Benefits and costs Q16 In the Board s assessment: (a) the main benefits of the proposals are: (i) reporting changes in the carrying amount of defined benefit obligations and changes in the fair value of plan assets in a more understandable way. (ii) eliminating some presentation options currently allowed by IAS 19, thus improving comparability. (iii) clarifying requirements that have resulted in diverse practices. (iv) improving information about the risks arising from an entity s involvement in (b) defined benefit plans. the costs of the proposal should be minimal, because entities are already required to obtain much of the information required to apply the proposed amendments when they apply the existing version of IAS 19. Do you agree with the Board s assessment? (Paragraphs BC103 BC107) Why or why not? We do not accept the Board s cost benefit analysis, which we believe is far too narrow. First, it underestimates the burden imposed on preparers e.g. on additional work required for what used to be called other long term benefits and all the sensitivity analyses required. Also, the Board should consider the wider social and economic costs arising from the behavioural changes that its

12 12 proposals are likely to produce. In particular, the removal of the corridor option will lead to increased pressure on sponsors of DB plans to close them. The Board notes in BC 11(c) that a measure should be volatile if it faithfully represents transactions that are themselves volatile. Conversely, the measure should not be volatile if the transaction that it represents is not volatile. We cannot emphasise too strongly that pension liabilities do not fluctuate widely from one year to the next, but change gradually over time in line with developing plan demographics. In BC 11(d) the Board states its view that it is not the responsibility of accounting standards-setters to encourage or discourage particular behaviour. Removal of the corridor could encourage such behaviour the closure of DB pension plans. Other comments Q17 Do you have any other comments on the proposals? The Board proposes to combine the benefits that IAS 19 currently classifies as other long-term employee benefits and post-employment benefits into one single category: long-term employee benefits. This means that both the changes to presentation and the disclosure requirements proposed will also apply to other long -term employee benefits. In our view this proposal would result in undue additional effort for the reporting entity as it requires additional work to separate the service cost, the remeasurement component and actual payments made. Currently, the cost components are often combined in one single profit and loss line item in operating (employment) expense due to the immediate profit and loss recognition rule for any changes in other long-term employee benefits. A split into profit and loss and OCI-components is currently not required. Furthermore, the proposed changes would also burden the reporting entity with additional disclosure requirements (e.g. detailed reconciliations, sensitivity analyses) for these benefit obligations as the current IAS 19 does not require specific disclosures about other long-term employee benefits. We believe that the current rules for recognition and disclosures of other longterm employee benefits are adequate when taking the materiality of the corresponding obligations into account. They have proven to be both robust and reliable. We are not aware of any problems with the current rules and we take the view that the proposed changes for this kind of benefit are more costly than the

13 13 resulting additional information for users, especially as these obligations are rarely material.