The International Accounting Standards Board (IASB) has rejected calls to fundamentally change the way pension scheme liabilities are calculated, saying they should continue to “reflect economic reality” rather than attempt to eliminate or reduce deficits.
Speaking at a conference in Rotterdam in the Netherlands today, IASB chairman Hans Hoogervorst said he accepted that some refinement of pension accounting is necessary, but believed the arguments given by schemes against the current model are flawed.
At present, the IAS 19 standard requires pension liabilities to be measured based on the characteristics of that liability, irrespective of how the obligation is funded. This is typically based on the yield on gilts or high quality corporate bonds.
But many investors believe the low interest rate environment and central bank monetary policy has artificially suppressed gilt yields and pushed up liabilities. This has led to more schemes using a discount rate based on the expected return of the assets in the portfolio, which is usually higher.
Hoogervorst said these arguments have some intuitive appeal, but are not related to the central tenet of the standard that liabilities that do not depend on asset returns should not be discounted at the expected asset return.
He added the expected asset return method fails to properly take account of risk which a central and key feature of finance; it suggests scheme sponsors can reduce deficits by switching from low-risk, low-return bonds to higher-risk, higher-expected-return equities; and is inconsistent with prudent financial management.
He said: “Of course I am not saying that the current IAS 19 on pensions is perfect. We recognise that our standard is a bit out of date in that it does not cater for recent developments in pension scheme design. This is especially the case here in the Netherlands, where pure defined benefit schemes have largely made place for hybrid schemes in which the pension liability is defined more flexibly. I accept this and the International Accounting Standards Board is looking at whether improvements can be made. However, such problems are not related to the central tenet of the standard that liabilities that do not depend on asset returns should not be discounted at the expected asset return.”
He added: “For these reasons the IASB rejects calls to fundamentally change pension accounting to eliminate or reduce pension deficits. Our approach to liability measurement in accounting is well accepted. The same or similar approaches are being used in other areas of accounting, such as insurance and environmental liability measurement. It is also the basis of prudential regulation and is consistent with how markets measure such liabilities and with the advice of the actuarial profession.”
