The imminent European Union endorsement of a new international accounting standard covering defined benefit pensions is likely to prompt an increased focus on the risks involved in pension plans, Mercer said yesterday.
EU approval of the revised International Accounting Standard 19 (IAS 19 rev 2011) is due in the next couple of months. It includes footnote disclosures that are aimed at giving equity analysts and credit ratings agencies a better insight into scheme sponsors' approach to DB risk management.
In particular, they must outline any unusual plan-specific risks - such as trustees having powers over contributions or plan termination - as well as explaining the amount, timing and uncertainty of the plan sponsor's future cash flows to the scheme.
Mercer said this was likely to increase the focus on DB plan risk transfer. Companies that are looking to transfer scheme risk to an insurance company and are willing to lock in to current low bond yields could find a buy-in more attractive for their accounts than undertaking a full transfer via a buy-out, it said.
By removing the subjective 'expected return on asset' assumption from accounts, companies that have previously used 'bullish' predictions of rates of return on assets to improve their reported profit could face a significant change to their key performance indicators. Mercer said this could lead to sponsors reviewing how KPIs are affected by action that reduces DB plan risk.
It also expects a 'step change' in the balance sheet position for companies that have traditionally deferred recognition of losses due to the removal of the option to do so for gains and losses. However, for some companies, this could lead to an improvement in future reported profits - making early adoption of the new IAS 19 an attractive option.
IAS 19 could also make a pension increase exchange - where a pensioner is offered a higher pension in the short-term but gives up some or all of their future pension increases - a more attractive way for firms to manage longevity risk.
As well as providing more certainty in future cash-flows, this approach can also immediately reduce the DB plan risk reflected in financial statements, Mercer said.
Mercer's UK head of pension accounting, Warren Singer, suggested equity analysts were already expecting IAS 19 to increase focus on DB plan risk.
'Questions are being asked about the impact on cash contributions of the next round of funding valuations, especially if there is any further adverse market experience in the current low bond yield environment,' he said.
'Given that reported profits will no longer be automatically rewarded for holding equities rather than bonds, the new IAS 19 and the footnote disclosures may cause plan sponsors to re-evaluate their approach to DB plan risk management.'
Companies that failed to prepare for the disclosures of DB risk management required under the standard could be viewed negatively by analysts compared to peers who had adapted to the new rules, he added.
