IAS 19 changes to drive derisking

The final draft of International Accounting Standard 19 Employee Benefits (IAS 19) has removed a past accounting benefit for investment returns, incentivising less risky asset allocations.

Schemes wishing to derisk will now find sponsors more focused on the volatility of their funds than their asset allocations, and the two parties could save money by combining their risk monitoring activities.

Ultimately, schemes which derisk effectively provide greater security for their members’ retirement income, and sharing costs with sponsors leaves more in the pot.

And more requirements on companies to understand the detail and regulatory framework of their schemes and disclose specific costs will bring greater scrutiny on the money spent by the latter.

Charles Rodgers, senior consultant at Towers Watson, said the changes had created a “separation” between investment strategy and accounting.

“You might well expect to see some risk reduction, some investment strategy changes coming through,” he said.

Employers who may have been minded to encourage schemes towards return-seeking assets such as equities may now be keen to de-risk in order to avoid balance sheet volatility, he added.

Paragraph 139 of the standard requires a company to disclose information about its defined benefit (DB) plan including the nature of the benefits provided, its regulatory framework and governance requirements.

Warren Singer, a principal at Mercer, said the changes should “generally be helpful” in the relationship between sponsor and scheme.

He said: “They will have a shared interest in understanding the risks and managing them effectively. Sometimes sponsors and plans seek efficiencies and try and do it in one go.”

Schemes wishing to share resources with sponsors when managing risk need to make sure they first establish a common framework as to how the risks will be modelled, said Rodgers.

Catch-up

There are three key changes to IAS 19 which affect schemes.

1. Removing the option to defer movements in the deficit, an option called a “corridor”. This will affect only a small number of schemes.

2. Expected returns from investment can no longer be recorded as a profit on the account. This is expected to drive employer interest in derisking, as they no longer benefit from riskier investments.

3. Separating investment costs from administration costs. This should create greater transparency of scheme costs.

Mike Smedley, a partner at KPMG, said the changes removed a “modest incentive” for companies to aim for higher investment returns.

He added: “You might find companies now saying, we can afford to derisk the investments.”

The change added to the ongoing shift among UK pension schemes to safer asset allocations, he said. Schemes which had been encouraged to pursue return-seeking, higher risk assets such as equities may find that pressure removed.

Video: Owen Walker sits down with Deloitte audit director Matthew Coulson and Pitmans Trustees' Andy Agathangelou to discuss the impact of new accounting standards.

The changes to IAS 19 are being interpreted as further removing the wedge between schemes and their sponsors which had been driven in with the advent of scheme-specific funding requirements with the Pensions Act 2004.

In the last few years, the rise of contingent asset deals and the drive to derisk has demonstrated scheme and sponsor working together to secure the benefits of scheme members for the future.

Smedley said: “If you say to the average trustee and company, here’s something that will reduce your risk, does not cost much money and makes everything more secure, they would both bite your hand off.”

Small print

One much-overlooked IAS 19 change is to the scheme costs which companies must disclose, separating administrative and investment spending.

This requirement was watered down in the final version of the report, but could still serve to increase scrutiny of how schemes spend their money.

“It will be part of the net income charge, there will be an allowance for administration costs,” said Rogers.

“It is not entirely clear at this stage quite how you are going to be able to disclose the information you are required to disclose without including that item, either explicitly or implicitly.”

Companies seeking best practice will start to separate the running costs of their funds in the accounting process, according to the consultants.

Schemes should therefore be ready for greater scrutiny by their employers on their separate costs.

Smedley said: “That’ll be interesting, when one company with a £1bn scheme discloses its costs for £1m that year, and another company discloses theirs for £3m."

This could provide an impetus to schemes to seek efficiencies in order to maintain good relations with their sponsor, and maximise their members’ retirement income.

He added: “You might find schemes being asked, are you being efficient?”