5.17ȱ Theȱsecondȱpossibilityȱisȱthatȱtheȱliabilityȱisȱmeasuredȱbasedȱonȱaȱbestȱestimateȱorȱexpectedȱvalue,ȱ reflectingȱtheȱprobabilityȱofȱtheȱdifferentȱoutcomes.ȱȱSomeȱwouldȱconsiderȱtheȱfirstȱpossibilityȱtoȱbeȱ counterȬintuitiveȱandȱatȱoddsȱwithȱrepresentationȱofȱtheȱeconomicȱreality.ȱȱIfȱitȱisȱtheȱnatureȱofȱtheȱcurrentȱ termsȱandȱconditionsȱ(providedȱbyȱcontractȱand/orȱlaw)ȱthatȱemployeesȱhaveȱvariousȱsettlementȱoptions,ȱ someȱbelieveȱthatȱreflectingȱassumptionsȱaboutȱtheȱprobableȱoutcomeȱisȱpartȱandȱparcelȱofȱtheȱ
assumptionsȱusedȱinȱestimatingȱtheȱfutureȱcashȱoutflowsȱandȱdoesȱnotȱinvalidateȱtheȱprincipleȱsetȱoutȱinȱ paragraphȱ5.14ȱthatȱtheȱmeansȱofȱsettlementȱisȱcurrentlyȱavailableȱtoȱtheȱemployer.ȱȱInȱthisȱcaseȱtheȱmeansȱ ofȱsettlementȱthatȱisȱcurrentlyȱavailableȱisȱtoȱsettleȱtheȱliabilityȱaccordingȱtoȱhowȱemployeesȱchooseȱtoȱ receiveȱtheirȱpromisedȱbenefits.ȱȱȱȱ
ȱ
byȱtransferringȱaȱspecifiedȱbundleȱofȱassets.ȱȱAnȱappropriateȱmeasurementȱobjectiveȱshouldȱleadȱtoȱtheȱ mostȱusefulȱmeasureȱinȱtheseȱandȱotherȱcircumstancesȱinȱwhichȱdiscountingȱfutureȱcashȱoutflowsȱmayȱnotȱ beȱtheȱrightȱtechnique.ȱ
6.6ȱ ItȱwasȱnotedȱinȱSectionȱ5ȱthatȱtheȱmainȱcandidatesȱforȱsettlementȱthatȱareȱlikelyȱtoȱbeȱcurrentlyȱ availableȱareȱ(a)ȱrunningȱoffȱtheȱliabilityȱandȱ(b)ȱbuyingȱoutȱtheȱbenefitsȱwithȱaȱsuitableȱinsuranceȱentity.ȱȱ Beforeȱdiscussingȱthoseȱfurther,ȱweȱshouldȱdiscussȱaȱthirdȱalternative,ȱmeasuresȱthatȱareȱderivedȱfromȱ regulatoryȱrequirementsȱwhenȱentitiesȱareȱsubjectȱtoȱpensionȱregulation,ȱbecauseȱregulatoryȱmeasuresȱ oftenȱformȱtheȱbasisȱofȱemployers’ȱobligationsȱtoȱpayȱcash,ȱandȱcouldȱbeȱviewedȱasȱanotherȱsettlementȱ amount.ȱȱȱ
Regulatoryȱmeasuresȱofȱliabilitiesȱ
Backgroundȱ
6.7ȱ Inȱmanyȱarrangementsȱforȱtheȱprovisionȱofȱpensionȱbenefits,ȱassetsȱareȱsetȱasideȱ(oftenȱinȱlegallyȱ separateȱentities)ȱtoȱprovideȱsecurityȱforȱpromisedȱbenefitsȱandȱfundsȱforȱtheirȱpayment.ȱȱOneȱareaȱ particularlyȱaddressedȱbyȱpensionȱregulationȱisȱfundingȱrequirementsȱofȱdefinedȱbenefitȱplans8.ȱȱFundingȱ regulationȱisȱlikelyȱtoȱfocusȱonȱensuringȱthatȱfundingȱofȱpensionȱplansȱisȱadequateȱandȱtherebyȱ
minimisingȱtheȱriskȱofȱpensionȱplansȱnotȱhavingȱsufficientȱfundsȱtoȱfulfilȱtheirȱpensionȱpromises.ȱȱ Thereforeȱregulationȱwillȱseekȱtoȱprovideȱaȱframeworkȱwithinȱwhichȱplansȱareȱfundedȱtoȱaȱlevelȱtoȱ provideȱsomeȱsecurityȱthatȱtheȱliabilitiesȱwillȱbeȱmetȱasȱtheyȱfallȱdue.ȱ
6.8ȱ Regulatorsȱareȱfacedȱwithȱtheȱchallengeȱofȱsettingȱaȱregulatoryȱregimeȱthatȱmonitorsȱfundingȱatȱanȱ adequateȱlevelȱsuchȱthatȱtheȱriskȱofȱaȱpensionȱplanȱbeingȱunableȱtoȱpayȱpensionȱliabilitiesȱisȱreducedȱtoȱanȱ acceptableȱlevel.ȱȱInȱtheȱEU,ȱforȱexample,ȱlegislationȱhasȱbeenȱenactedȱthatȱrequiresȱpensionȱplansȱtoȱholdȱ assetsȱtoȱcoverȱtheirȱ‘technicalȱprovisions’9.ȱȱȱ
TechnicalȱprovisionsȱinȱtheȱEUȱ
6.9ȱ Technicalȱprovisionsȱareȱtheȱamountsȱrequired,ȱbasedȱonȱactuarialȱcalculation,ȱtoȱmakeȱprovisionsȱ forȱtheȱplan’sȱliabilities.ȱȱAȱtechnicalȱprovisionȱhasȱbeenȱdescribedȱbyȱaȱregulatorȱasȱtheȱamountȱofȱmoneyȱ that,ȱifȱinvestedȱatȱtheȱvaluationȱdate,ȱisȱexpectedȱtoȱbeȱsufficientȱtoȱpayȱoutȱfutureȱpensionȱbenefitsȱthatȱ haveȱbeenȱearnedȱbyȱpastȱservice.ȱ
8 The term ‘defined benefit’ is used here because it is often used in legislation to determine which plans fall within the scope of funding regulations.
9
6.10ȱ Aȱtechnicalȱprovisionȱisȱalsoȱdescribedȱasȱaȱfundingȱtarget.ȱȱCharacteristicsȱofȱitsȱmeasurementȱ includeȱtheȱfollowing:ȱ
x itȱisȱspecificȱtoȱanȱindividualȱplanȱ x itȱisȱaȱprudentȱmeasureȱȱ
x itsȱmeasurementȱisȱlessȱprescriptiveȱthanȱtheȱrequirementsȱforȱmeasuringȱpensionȱliabilitiesȱinȱ presentȱaccountingȱstandardsȱ
x itȱmayȱtakeȱintoȱaccountȱtheȱstrengthȱofȱtheȱemployer’sȱcovenant,ȱi.e.ȱreflectingȱtheȱabilityȱofȱtheȱ employerȱtoȱstepȱinȱandȱcontributeȱmoreȱcashȱifȱtheȱplan’sȱassetsȱareȱinsufficientȱtoȱmeetȱitsȱ obligationsȱ
x theȱdiscountȱrateȱmayȱassumeȱanȱelementȱofȱexpectedȱreturnsȱonȱequitiesȱifȱitȱisȱconsideredȱ prudentȱ(e.g.ȱifȱtheȱemployer’sȱcovenantȱisȱsufficientlyȱstrong).ȱ
6.11ȱ Aȱconsequenceȱofȱtheȱaboveȱisȱthatȱaȱsponsoringȱemployerȱwithȱaȱweakȱcovenantȱwill,ȱallȱotherȱ thingsȱbeingȱequal,ȱbeȱsubjectȱtoȱaȱhigherȱtechnicalȱprovisionȱthanȱanȱemployerȱwithȱaȱstrongȱcovenant.ȱ 6.12ȱ Legislationȱinȱdifferentȱcountriesȱresultsȱinȱdifferentȱlevelsȱofȱtechnicalȱprovisionsȱ(someȱrequireȱ greaterȱmarginsȱforȱprudenceȱthanȱothers).ȱȱHowever,ȱtheȱconsequencesȱofȱaȱplan’sȱassetsȱfallingȱshortȱofȱ itsȱtechnicalȱprovisionsȱareȱcommon:ȱaȱrecoveryȱplanȱmustȱbeȱputȱinȱplaceȱthatȱcommitsȱtheȱemployerȱtoȱ makeȱgoodȱtheȱshortfall,ȱi.e.ȱthisȱisȱinȱeffectȱaȱdebtȱonȱtheȱemployer.ȱ
6.13ȱ Regulatorsȱcanȱsetȱaȱframeworkȱforȱfundingȱwhichȱresultsȱinȱfundingȱtargetsȱeitherȱaboveȱorȱbelowȱ theȱlevelȱofȱliabilitiesȱasȱcalculatedȱforȱfinancialȱreportingȱpurposesȱunderȱpresentȱaccountingȱmeasuresȱofȱ liabilities.ȱȱItȱwouldȱseemȱthatȱdivergenceȱisȱinevitableȱunlessȱtheȱregulatorȱhasȱtheȱsameȱexpectationȱaboutȱ theȱacceptableȱlevelȱofȱsecurityȱasȱisȱimplicitȱinȱtheȱlevelȱcalculatedȱforȱfinancialȱreportingȱpurposes.ȱ Shouldȱtechnicalȱprovisionsȱ(orȱotherȱfundingȱmeasures)ȱbeȱusedȱasȱfinancialȱreportingȱmeasuresȱofȱ liabilities?10ȱ
6.14ȱ Sponsoringȱemployersȱthatȱoperateȱunderȱtheȱtechnicalȱprovisionȱregimeȱareȱcommittedȱtoȱ fundingȱonȱthatȱbasis.ȱȱTheȱamountȱofȱtechnicalȱprovisionȱthatȱisȱdeterminedȱforȱanyȱplanȱwillȱthereforeȱ haveȱaȱdirectȱimpactȱonȱtheȱlevelȱandȱtimingȱofȱfutureȱcashȱoutflowsȱofȱtheȱemployer.ȱȱSomeȱwouldȱ thereforeȱargueȱthatȱtechnicalȱprovisionsȱ(orȱotherȱcomparableȱfundingȱmeasures)ȱareȱmostȱrelevantȱinȱ assessingȱtheȱentity’sȱfutureȱcashȱoutflowsȱrelatingȱtoȱitsȱpensionȱobligationsȱandȱshouldȱbeȱusedȱasȱanȱ appropriateȱmeasureȱofȱtheȱliabilityȱinȱtheȱsponsoringȱemployer’sȱfinancialȱstatements.ȱ
10 This Chapter is concerned with the sponsoring employer’s financial statements. Chapter 11 discusses the same issue from the perspective of the pension plan’s financial statements.
6.15ȱ Thisȱpaperȱdoesȱnotȱsupportȱtheȱideaȱthatȱregulatoryȱmeasuresȱofȱliabilitiesȱtoȱpayȱbenefitsȱshouldȱ replaceȱmeasuresȱderivedȱfromȱgeneralȱaccountingȱprinciples,ȱbecauseȱtheirȱprincipalȱpurposeȱconcernsȱ theȱsolvencyȱofȱpensionȱplans,ȱbyȱspecifyingȱaȱlevelȱofȱassetsȱthatȱmustȱbeȱsetȱasideȱinȱseparateȱfundsȱtoȱbeȱ availableȱtoȱmeetȱtheȱobligationȱtoȱpayȱbenefits.ȱȱThusȱtheyȱdoȱnotȱpurportȱtoȱprovideȱfinancialȱstatementȱ usersȱwithȱdecisionȬusefulȱinformationȱperȱseȱaboutȱtheȱamountȱofȱtheȱunderlyingȱobligationȱtoȱpayȱ benefits.ȱ
6.16ȱ Regulatoryȱmeasuresȱthatȱareȱusedȱtoȱdetermineȱaȱprescribedȱlevelȱofȱfundingȱclearlyȱgiveȱriseȱtoȱ cashȱoutflowsȱfromȱtheȱentity’sȱgeneralȱresourcesȱintoȱtheȱresourcesȱthatȱareȱsetȱasideȱtoȱprovideȱseparateȱ fundsȱforȱtheȱpaymentȱofȱbenefits.ȱȱButȱtheȱfollowingȱpointsȱmayȱbeȱnotedȱinȱsupportȱofȱtheȱviewȱthatȱ regulatoryȱmeasuresȱmayȱnotȱprovideȱtheȱmostȱappropriateȱaccountingȱvaluesȱofȱtheȱobligationȱtoȱpayȱ benefits:ȱ
x regulatoryȱmeasuresȱdoȱnotȱreflectȱtheȱfullȱextentȱofȱtheȱunderlyingȱobligationȱbecause,ȱasȱnotedȱ above,ȱtheyȱmayȱunderstateȱtheȱpotentialȱliabilityȱofȱtheȱsponsorȱbecauseȱofȱtheȱwayȱtheȱ
employer’sȱcovenantȱisȱreflected;ȱ
x ifȱsuchȱmeasuresȱwereȱusedȱtoȱreportȱtheȱemployer’sȱliability,ȱanȱemployerȱwithȱaȱweakȱcreditȱ ratingȱwouldȱreportȱaȱlargerȱliabilityȱthanȱanȱemployerȱwithȱaȱstrongȱcreditȱratingȱforȱtheȱsameȱ underlyingȱbenefitȱobligation,ȱwhichȱhasȱtheȱoppositeȱeffectȱtoȱthatȱwhenȱcreditȱriskȱisȱreflectedȱinȱ theȱmeasurementȱofȱotherȱliabilities,ȱbecauseȱreflectingȱgreaterȱcreditȱriskȱconventionallyȱleadsȱtoȱ smallerȱliabilitiesȱ(seeȱSectionȱ7);ȱȱ
x regulatoryȱmeasuresȱinȱdifferentȱcountriesȱmayȱnotȱbeȱcomparableȱbecauseȱdifferentȱ governmentsȱprescribeȱdifferentȱfundingȱtargets.ȱȱȱ
6.17 Theȱdebateȱaboutȱregulatoryȱmeasuresȱhasȱsimilaritiesȱtoȱtheȱdebateȱaboutȱactuarialȱmeasuresȱofȱ liabilitiesȱthatȱprecededȱtheȱpresentȱpensionsȱaccountingȱstandards.ȱȱSuchȱmeasuresȱtendȱtoȱassumeȱthatȱ partȱofȱtheȱliabilityȱwillȱbeȱmetȱoutȱofȱfutureȱcashȱflowsȱfromȱassetsȱandȱignoreȱtheȱemployer’sȱobligationȱ toȱpayȱmoreȱcontributionsȱifȱtheȱassetsȱdoȱnotȱperformȱasȱexpected.ȱȱTheȱviewȱthatȱsuchȱmeasuresȱdoȱnotȱ provideȱcurrentȱvaluesȱofȱtheȱliabilityȱisȱarticulatedȱinȱtheȱfollowingȱextract:ȱ
ȱ “Itȱisȱimportantȱtoȱappreciateȱthatȱvaluationȱisȱnotȱtheȱfinalȱobjectiveȱofȱaȱfundingȱmethodology.ȱȱ Instead,ȱtheȱultimateȱrequirementȱisȱtoȱcomeȱupȱwithȱaȱfundingȱplan,ȱconfirmingȱthat,ȱunderȱ plausibleȱbusinessȱassumptions,ȱtheȱassetsȱareȱsufficientȱtoȱpayȱbenefitsȱorȱthatȱassetsȱplusȱfutureȱ contributionsȱwillȱbeȱenoughȱtoȱpayȱfutureȱbenefits.ȱȱIfȱtheȱassetsȱareȱexpectedȱtoȱearnȱaȱhighȱ return,ȱforȱexample,ȱonȱaccountȱofȱtheirȱriskiness,ȱitȱcouldȱbeȱarguedȱthatȱitȱisȱappropriateȱtoȱtakeȱ thisȱintoȱaccountȱwhenȱdrawingȱupȱaȱfundingȱplan,ȱparticularlyȱgivenȱtheȱspecialȱcircumstancesȱ ofȱhavingȱanȱunderlyingȱpromiseȱtoȱpayȱfromȱtheȱemployer….ȱȱInȱotherȱwords,ȱalthoughȱtheȱ fundingȱbasisȱisȱweakȱandȱtheȱpensionȱfundȱassetsȱmayȱnotȱbeȱsufficientȱtoȱmeetȱtheȱpromisedȱ benefits,ȱtheȱadditionalȱsecurityȱaffordedȱbyȱtheȱemployerȱresultsȱinȱanȱoverallȱacceptableȱlevelȱofȱ risk.ȱȱTheȱliabilitiesȱareȱnotȱbeingȱ‘valued’ȱbutȱratherȱbudgetedȱfor.”ȱ
ȱ (Exley,ȱMehtaȱandȱSmithȱ1997ȱ‘Theȱfinancialȱtheoryȱofȱdefinedȱbenefitȱpensionȱschemes’,ȱparaȱ 3.2.5)ȱ
6.18ȱ Althoughȱthisȱpaperȱtakesȱtheȱpositionȱthatȱregulatoryȱmeasuresȱareȱforȱfunding,ȱnotȱaccounting,ȱ usersȱmayȱbeȱinterestedȱinȱknowingȱwhatȱsuchȱregulatoryȱmeasuresȱare,ȱbecauseȱofȱtheȱcloseȱrelationshipȱ betweenȱthemȱandȱcontributionȱrequirementsȱ(includingȱrecoveryȱplans).ȱȱTheȱcaseȱforȱdisclosureȱofȱ alternativeȱmeasuresȱofȱliabilities,ȱincludingȱregulatoryȱmeasures,ȱisȱdiscussedȱinȱChapterȱ9.ȱ
6.19ȱ Thisȱpaperȱconcludesȱthatȱregulatoryȱmeasuresȱofȱliabilitiesȱtoȱpayȱpensionsȱshouldȱnotȱreplaceȱ measuresȱderivedȱfromȱgeneralȱaccountingȱprinciples.ȱȱȱ
‘RunȬoff’ȱandȱ‘buyȬout’ȱmeasuresȱ
6.20ȱ Weȱuseȱtheȱtermȱ‘runȬoff’ȱasȱshorthandȱforȱtheȱsituationȱwhereȱtheȱemployerȱcontinuesȱtoȱ administerȱtheȱliabilitiesȱandȱpaysȱbenefitsȱwhenȱtheyȱfallȱdue,ȱeitherȱfromȱitsȱinternalȱresourcesȱorȱfromȱ assetsȱthatȱhaveȱpreviouslyȱbeenȱsetȱaside.ȱ
6.21ȱ Inȱtheȱpresentȱstateȱofȱmarketsȱforȱsuchȱliabilities,ȱtheȱpriceȱofȱbuyingȱoutȱisȱoftenȱhigherȱthanȱaȱ
‘runȬoff’ȱmeasureȱ(asȱcalculatedȱunderȱpresentȱpensionsȱaccountingȱstandards)ȱbecauseȱaȱpotentialȱ transfereeȱwouldȱfactorȱthingsȱintoȱtheȱpriceȱthatȱtheȱentityȱwouldȱnot.ȱȱIfȱtheȱpricesȱwereȱtheȱsame,ȱtheȱ entityȱshouldȱbeȱindifferentȱasȱtoȱwhetherȱtoȱtransferȱtheȱliabilityȱorȱcontinueȱtoȱholdȱit.ȱ
6.22ȱ Reasonsȱwhyȱtheȱmeasuresȱmightȱbeȱdifferentȱincludeȱtheȱfollowing:ȱ
(a)ȱ Theȱtransfereeȱentityȱwouldȱtypicallyȱbeȱanȱinsuranceȱentity.11ȱȱPensionsȱandȱinsuranceȱactivitiesȱ mayȱbeȱsubjectȱtoȱdifferentȱregulatoryȱregimes.ȱȱIfȱanȱinsuranceȱentityȱisȱsubjectȱtoȱstricterȱ regulatoryȱcapitalȱrequirements,ȱaȱliabilityȱtransferredȱtoȱitȱwillȱhaveȱlessȱcreditȱriskȱafterȱitsȱ
transfer.ȱȱThisȱwouldȱaddȱvalueȱtoȱtheȱliabilityȱ(and,ȱfromȱtheȱemployee’sȱperspective,ȱaddȱvalueȱtoȱ hisȱorȱherȱrightȱtoȱreceiveȱbenefits).ȱȱȱ
(b) Participantsȱinȱtheȱmarketȱmakeȱdifferentȱriskȱassessmentsȱrelatingȱtoȱtheȱliabilityȱthanȱtheȱentity.ȱȱ Forȱexample,ȱriskȱappetitesȱmayȱdifferȱbetweenȱtheȱentityȱandȱanyȱpotentialȱtransfereeȱinȱrelationȱ toȱmortalityȱriskȱ(theȱtransfereeȱisȱlikelyȱtoȱbeȱmoreȱriskȱaverse),ȱwhichȱwouldȱbeȱreflectedȱinȱtheȱ compensationȱthatȱtheȱtransfereeȱwouldȱrequireȱforȱassumingȱthatȱrisk.ȱȱ(Thisȱreasonȱisȱprobablyȱ linkedȱtoȱtheȱpointȱinȱ(a)ȱ–ȱtoȱsustainȱaȱhighȱcreditȱrating,ȱaȱtransfereeȱwouldȱbeȱlikelyȱtoȱmakeȱ moreȱconservativeȱassumptionsȱaboutȱmortalityȱrisk.)ȱȱ
(c) Participantsȱinȱtheȱmarketȱdemandȱaȱpremiumȱforȱtheȱriskȱthatȱtheȱinformationȱprovidedȱbyȱtheȱ entityȱisȱincompleteȱorȱmisleadingȱ–ȱinȱotherȱwords,ȱaȱpurchaserȱmayȱbeȱlessȱsureȱthanȱtheȱsellerȱ exactlyȱwhatȱrisksȱitȱisȱtakingȱon.ȱȱȱ
11 That is, on a going concern basis. The transferee entity could be a statutory protection fund, but that would typically come into play in an insolvency situation.
(d) Futureȱexpensesȱofȱadministeringȱtheȱliabilityȱwouldȱbeȱfactoredȱintoȱtheȱpriceȱthatȱaȱtransfereeȱ wouldȱrequireȱ–ȱcurrentlyȱtheyȱareȱusuallyȱexcludedȱfromȱtheȱmeasurementȱofȱtheȱliabilityȱonȱanȱ ongoingȱbasis.ȱ(However,ȱthisȱpaperȱproposesȱthatȱexpensesȱofȱsettlingȱtheȱliabilityȱshouldȱbeȱ includedȱinȱbothȱmeasuresȱ–ȱseeȱSectionȱ8.)ȱ
(e) Theȱtransfereeȱwillȱonlyȱacceptȱaȱtransferȱatȱaȱpriceȱthatȱincludesȱsomeȱprofitȱ–ȱevenȱwhenȱallȱofȱtheȱ aboveȱ(andȱanyȱotherȱfactors,ȱsuchȱasȱtheȱcostȱofȱservicingȱregulatoryȱcapital)ȱhaveȱbeenȱtakenȱintoȱ account.ȱȱȱ
6.23ȱ Someȱhaveȱsuggestedȱthatȱtheȱgapȱbetweenȱ‘runȬoff’ȱandȱ‘buyȬout’ȱmeasuresȱwillȱbecomeȱsmallerȱ asȱmoreȱentitiesȱenterȱtheȱtransferȱmarket,ȱincludingȱentitiesȱthatȱareȱnotȱsubjectȱtoȱtheȱmoreȱstringentȱ insuranceȱregulations.ȱȱȱ
6.24ȱ TheȱmeasurementȱbasisȱinȱIASȱ37ȱ(andȱitsȱproposedȱrevision)ȱforȱprovisions12ȱprovidesȱaȱusefulȱ startingȱpoint.ȱȱItȱreflectsȱtheȱlowestȱamountȱthatȱanȱentityȱwouldȱrationallyȱpayȱonȱtheȱbalanceȱsheetȱdateȱtoȱ beȱrelievedȱofȱtheȱobligation.ȱȱTheȱobjectiveȱwouldȱthereforeȱbeȱtoȱreportȱaȱcurrentȱsettlementȱamount,ȱbutȱ itȱwouldȱappearȱtoȱruleȱoutȱaȱbuyȬoutȱmeasureȱthatȱtheȱentityȱwouldȱnotȱrationallyȱpay.ȱȱȱThereȱwillȱoften,ȱ therefore,ȱbeȱnoȱrationalȱalternativeȱtoȱrunningȱoffȱtheȱliability.ȱȱ
6.25ȱ Aȱcurrentȱvalueȱmeasureȱofȱfutureȱpaymentsȱofȱpensionȱbenefitsȱreflectsȱtoday’sȱvalueȱofȱtheȱfutureȱ cashȱoutflowsȱexpectedȱtoȱsettleȱtheȱliabilityȱwhenȱitȱfallsȱdue.ȱȱThisȱwouldȱusuallyȱbeȱtheȱamountȱthatȱfulfilsȱtheȱ objectiveȱinȱparagraphȱ5.14,ȱbecauseȱaȱbuyȬoutȱamountȱwouldȱusuallyȱbeȱhigher.ȱȱHowever,ȱifȱtheȱliabilityȱ couldȱbeȱtransferredȱforȱaȱlowerȱamount,ȱreportingȱtheȱliabilityȱatȱthatȱlowerȱamountȱwouldȱfulfilȱtheȱ objective.ȱ
IASB’sȱproposalsȱforȱinsuranceȱliabilitiesȱ
6.26ȱ Itȱisȱusefulȱtoȱreadȱacrossȱfromȱtheȱapproachȱtoȱmeasurementȱofȱinsuranceȱliabilitiesȱthatȱisȱ advocatedȱinȱIASB’sȱDiscussionȱPaperȱ‘PreliminaryȱViewsȱonȱInsuranceȱContracts’ȱ(Mayȱ2007).ȱȱThatȱ paperȱsetsȱoutȱthreeȱbasicȱ‘buildingȱblocks’ȱforȱmeasuringȱinsuranceȱliabilitiesȱwhenȱaȱpresentȱvalueȱ measurementȱisȱrequired:ȱ
(a)ȱ explicit,ȱunbiased,ȱmarketȬconsistent,ȱprobabilityȱweightedȱandȱcurrentȱestimatesȱofȱtheȱ contractualȱcashȱflowsȱ
(b)ȱ currentȱmarketȱdiscountȱratesȱthatȱadjustȱtheȱestimatedȱfutureȱcashȱflowsȱforȱtheȱtimeȱvalueȱofȱ moneyȱ
(c)ȱ aȱriskȱmarginȱreflectingȱtheȱmarginȱthatȱmarketȱparticipantsȱrequireȱforȱbearingȱriskȱ(andȱaȱserviceȱ marginȱinȱrespectȱofȱotherȱservicesȱprovided,ȱifȱany).ȱ
12
6.27ȱ Theȱaboveȱapproachȱtoȱmeasurementȱisȱdescribedȱasȱcurrentȱexitȱvalue,ȱalthoughȱitȱmayȱbeȱnotedȱ thatȱtheȱIASBȱhasȱstatedȱthatȱitȱhasȱnotȱidentifiedȱsignificantȱdifferencesȱbetweenȱthatȱapproachȱandȱfairȱ value.ȱȱTheyȱbothȱpurportȱtoȱreflectȱtheȱamountȱanȱentityȱwouldȱhaveȱtoȱpayȱtoȱtransferȱaȱliabilityȱtoȱ anotherȱentityȱatȱtheȱreportingȱdate.ȱȱ(Aȱdescriptionȱofȱtheȱcharacteristicsȱofȱaȱfairȱvalueȱmeasurementȱforȱ liabilitiesȱinȱtheȱIASB’sȱDiscussionȱPaperȱ‘FairȱValueȱMeasurements’ȱ(Novemberȱ2006)ȱisȱgivenȱinȱ
AppendixȱD.)ȱȱCurrentȱexitȱvalueȱ(orȱfairȱvalue)ȱdiffersȱsignificantlyȱfromȱtheȱmeasurementȱapproachȱinȱ IASȱ19ȱandȱitȱisȱclearȱthatȱtheȱIASȱ19ȱapproachȱgenerallyȱproducesȱaȱlowerȱmeasureȱofȱaȱliability:ȱ
Insuranceȱliabilitiesȱ(IASBȱDP)ȱ Pensionȱliabilitiesȱ(IASȱ19)ȱ
Expectedȱvalueȱofȱcashȱflowsȱ(marketȬ consistentȱestimates)ȱ
Expectedȱvalueȱofȱcashȱflowsȱ(entity’sȱ bestȱestimates)ȱ
DiscountȱatȱriskȬfreeȱrateȱ Discountȱatȱhighȱqualityȱcorporateȱbondȱ rateȱ
Addȱaȱmarketȱmarginȱ Noȱmarginȱaddedȱ
6.28ȱ Someȱdisagreeȱwithȱcertainȱimplicationsȱofȱusingȱfairȱvalueȱ(orȱcurrentȱexitȱvalue)ȱasȱaȱ measurementȱobjectiveȱforȱpensionȱliabilities.ȱȱViewsȱincludeȱtheȱfollowing:ȱ
(a)ȱ Someȱconsiderȱfairȱvalueȱ(orȱmarketȬbasedȱexitȱvalueȱasȱitȱisȱdescribedȱinȱtheȱIASB’sȱFairȱValueȱ DiscussionȱPaper)ȱtoȱbeȱanȱinappropriateȱmeasurementȱobjectiveȱwhenȱ(asȱisȱusuallyȱtheȱcase)ȱ pensionȱliabilitiesȱareȱnotȱtradedȱinȱactiveȱmarkets,ȱbecauseȱextensiveȱuseȱwouldȱbeȱmadeȱofȱ valuationȱtechniquesȱusingȱinputsȱinȱtheȱ‘Levelȱ2’ȱandȱ‘Levelȱ3’ȱcategories.ȱ
(b)ȱ Marketsȱtoȱwhichȱanȱentityȱmightȱhaveȱaccessȱ(e.g.ȱtransferȱofȱaȱliabilityȱtoȱanȱinsuranceȱcompany,ȱ orȱ‘buyȱout’)ȱdoȱnotȱgiveȱriseȱtoȱtransactionsȱthatȱareȱcomparableȱtoȱtheȱhypotheticalȱtransactionsȱ envisaged.ȱȱThatȱcouldȱleadȱtoȱanȱentityȱhavingȱtoȱreportȱaȱprohibitivelyȱexpensiveȱtransferȱ amountȱwhenȱitȱwouldȱnotȱrationallyȱpayȱthatȱamountȱtoȱdischargeȱitsȱobligation.ȱȱȱ
(c)ȱ Aȱfairȱvalueȱmeasurementȱexplicitlyȱrequiresȱtheȱcreditȱ(orȱnonȬperformance)ȱriskȱrelatingȱtoȱthatȱ liabilityȱtoȱbeȱreflected.ȱȱThusȱitȱseemsȱclearȱthatȱifȱtheȱmeasurementȱobjectiveȱisȱfairȱvalueȱ(orȱ currentȱexitȱvalue),ȱfundingȱorȱcollateralisationȱofȱtheȱliabilityȱwillȱincreaseȱitsȱfairȱvalueȱandȱ shouldȱbeȱtakenȱintoȱaccountȱinȱitsȱmeasurement.ȱȱSomeȱbelieveȱitȱisȱinappropriateȱtoȱincludeȱ creditȱ(orȱnonȬperformance)ȱriskȱinȱtheȱmeasurementȱofȱpensionȱliabilitiesȱ(differentȱviewpointsȱ areȱconsideredȱinȱSectionȱ7).ȱ
(d)ȱ Aȱtransfereeȱwouldȱonlyȱacceptȱaȱtransferȱatȱaȱpriceȱthatȱincludesȱsomeȱprofit.ȱȱSomeȱbelieveȱthatȱ theȱinclusionȱofȱsomeoneȱelse’sȱprofitȱmarginȱinȱtheȱmeasurementȱofȱanȱentity’sȱownȱliabilitiesȱ doesȱnotȱnecessarilyȱprovideȱusefulȱinformationȱaboutȱtheȱamount,ȱtimingȱandȱuncertaintyȱofȱcashȱ outflowsȱfromȱtheȱliabilityȱthatȱtheȱentityȱholds.ȱȱSomeȱbelieveȱthatȱthisȱpointȱappliesȱmoreȱ
generallyȱtoȱtheȱassumptionsȱthatȱunderlieȱaȱhypotheticalȱtransferȱprice,ȱparticularlyȱwhenȱnoȱ
marketȱexistsȱtoȱtransferȱtheȱliability.ȱȱ(Othersȱdoȱnotȱbelieveȱthisȱisȱaȱvalidȱargumentȱbecauseȱtheȱ entityȱholdingȱtheȱliabilityȱalsoȱrequiresȱaȱprofitȱtoȱachieveȱaȱreturnȱonȱitsȱownȱequity;ȱinȱtheirȱ view,ȱthisȱprofitȱrequirementȱ–ȱor,ȱmoreȱcorrectly,ȱcompensationȱtoȱtheȱequityȱforȱriskȱwhenȱ holdingȱriskyȱassetsȱandȱliabilitiesȱ–ȱisȱtheȱsameȱasȱaȱbuyerȱwouldȱrequire.ȱȱHence,ȱinȱtheirȱview,ȱ thereȱwouldȱbeȱnoȱdifferenceȱinȱpricingȱbetweenȱaȱtransfereeȱandȱtheȱvalueȱtheȱentityȱowningȱtheȱ liabilityȱwouldȱcalculateȱbasedȱonȱthisȱargument.)ȱȱ
(e)ȱ Someȱbelieveȱthatȱtheȱobjectiveȱonȱinitialȱrecognitionȱ–ȱtoȱmeasureȱtheȱliabilityȱincurredȱinȱ exchangeȱforȱtheȱservicesȱrenderedȱ(asȱdiscussedȱinȱSectionȱ4)ȱ–ȱsuggestsȱthatȱanȱentryȱvalueȱ measurementȱobjective,ȱreflectingȱtheȱpriceȱthatȱwouldȱbeȱreceivedȱtoȱassumeȱtheȱliability,ȱisȱmoreȱ appropriateȱthatȱanȱexitȱvalueȱmeasurementȱobjective,ȱwhichȱreflectsȱwhatȱtheȱentityȱwouldȱhaveȱtoȱ payȱtoȱtransferȱtheȱliability.ȱ
(f)ȱ Untilȱfurtherȱworkȱisȱdoneȱonȱdefiningȱtheȱingredientsȱofȱfairȱvalueȱforȱliabilitiesȱgenerally,ȱitȱ wouldȱbeȱdifficultȱtoȱdetermineȱwhetherȱtheȱapproachȱtakenȱinȱChapterȱ2ȱinȱrelationȱtoȱdefiningȱaȱ pensionȱliabilityȱwouldȱbeȱaffectedȱbyȱaȱfairȱvalueȱmeasurementȱobjective.ȱȱForȱexample,ȱthisȱpaperȱ hasȱapproachedȱtheȱissueȱofȱwhetherȱfutureȱsalaryȱincreasesȱshouldȱbeȱreflectedȱinȱtheȱ
measurementȱofȱaȱliabilityȱasȱanȱinterpretationȱofȱtheȱdefinitionȱofȱaȱliability,ȱandȱisȱnotȱdependentȱ onȱconclusionsȱonȱhowȱtheȱliabilityȱshouldȱbeȱmeasured.ȱ
6.29ȱ Onȱtheȱotherȱhand,ȱsomeȱbelieveȱthatȱanyȱapproachȱshouldȱbeȱconsistentȱwithȱusingȱfairȱvalueȱifȱ deepȱandȱliquidȱmarketsȱinȱtheȱtransferȱofȱpensionȱliabilitiesȱwereȱtoȱdevelopȱinȱtheȱfuture.ȱȱTheyȱwouldȱ thenȱbeȱmoreȱcomfortableȱthatȱanȱexitȱvalueȱapproachȱ(interpretedȱinȱthisȱcaseȱasȱtheȱcurrentȱmarketȱprice)ȱ wouldȱgiveȱtheȱmostȱappropriateȱmeasureȱofȱtheȱliabilityȱatȱtheȱbalanceȱsheetȱdate.ȱȱȱ
6.30ȱ Asȱdiscussedȱabove,ȱitȱisȱtheȱabsenceȱofȱanȱactiveȱmarketȱforȱtransferringȱpensionȱliabilitiesȱthatȱ causesȱmanyȱtoȱdoubtȱthatȱfairȱvalueȱ(asȱdescribedȱinȱtheȱmostȱrecentȱliterature)ȱisȱtheȱmostȱappropriateȱ measurementȱobjective.ȱȱTheyȱbelieveȱinȱanȱapproachȱthatȱdoesȱnotȱincludeȱanotherȱparty’sȱprofitȱmarginȱ orȱriskȱmarginȱinȱtheȱmeasurementȱofȱanȱentity’sȱownȱliabilities.ȱȱThisȱapproachȱmightȱbeȱviewedȱasȱanȱ
‘entityȬspecific’ȱmeasurement,ȱbecauseȱitȱaimsȱtoȱreflectȱnotȱonlyȱtheȱpropertiesȱofȱtheȱliabilityȱitselfȱbutȱ alsoȱtheȱrelationshipȱtoȱitsȱowner.13ȱȱSomeȱbelieveȱanȱentityȬspecificȱmeasurementȱisȱappropriate,ȱ particularlyȱwhenȱthereȱisȱnoȱtransferȱmarketȱforȱtheȱliabilityȱ(exceptȱperhapsȱaȱtransferȱtoȱanȱinsuranceȱ entity).ȱȱWeȱmightȱexpectȱmarketȬbasedȱmeasuresȱandȱentityȬspecificȱmeasuresȱtoȱconverge,ȱhowever,ȱasȱ theȱtimeȱhorizonȱofȱtheȱliabilityȱdecreasesȱandȱuncertaintyȱisȱreduced.ȱȱȱȱ
EntityȬspecificȱvalueȱcomparedȱwithȱcurrentȱexitȱvalue/fairȱvalueȱ
6.31ȱ Ifȱanȱ‘entityȬspecific’ȱmeasurementȱwereȱusedȱforȱpensionȱliabilities,ȱhowȱmightȱitȱdifferȱfromȱtheȱ proposedȱcurrentȱexitȱvalueȱmodelȱforȱinsuranceȱliabilities?ȱ
13 IASB’s Glossary of Terms describes an entity-specific value of a liability as “the present value of the
6.32ȱ Inȱmanyȱcases,ȱexceptȱforȱtheȱinclusionȱofȱcreditȱriskȱinȱcurrentȱexitȱvalue,ȱweȱwouldȱnotȱexpectȱtheȱ twoȱapproachesȱtoȱdiffer.ȱȱForȱexample:ȱ
x forȱbenefitsȱthatȱdependȱonȱtheȱvalueȱofȱaȱpoolȱofȱassetsȱ(actualȱorȱnotional),ȱtheȱliabilityȱwouldȱ beȱmeasuredȱunderȱeitherȱapproachȱbyȱreferenceȱtoȱtheȱcurrentȱmarketȱvaluesȱofȱthoseȱassetsȱ x forȱbenefitsȱthatȱdependȱonȱtheȱvalueȱofȱaȱpoolȱofȱassetsȱandȱinclude,ȱadditionally,ȱaȱguaranteeȱ
givenȱbyȱtheȱemployerȱrelatedȱtoȱtheȱassets’ȱinvestmentȱperformance,ȱtheȱliabilityȱinȱrespectȱofȱ theȱguaranteeȱwouldȱbeȱmeasuredȱlikeȱaȱderivativeȱfinancialȱinstrument.ȱ
6.33ȱ Forȱotherȱtypesȱofȱbenefits,ȱsuchȱasȱpensionsȱthatȱdependȱonȱlengthȱofȱserviceȱandȱsalary,ȱaȱcurrentȱ valueȱmeasureȱwillȱbeȱderivedȱfromȱdiscountingȱexpectedȱfutureȱcashȱflows.ȱȱReturningȱtoȱtheȱthreeȱ
‘buildingȱblocks’ȱsetȱoutȱinȱparagraphȱ6.26ȱabove,ȱtheȱfollowingȱpointsȱmayȱbeȱnoted.ȱ Expectedȱvalueȱofȱcashȱflowsȱ
6.34ȱ Inȱgeneral,ȱtheȱmeasuresȱofȱcashȱoutflowsȱinȱbuildingȱblockȱ(a)ȱunderȱtheȱtwoȱapproachesȱwouldȱ notȱbeȱexpectedȱtoȱdifferȱsignificantly.ȱȱWhilstȱanȱentityȬspecificȱapproachȱwouldȱallowȱanȱentityȱtoȱfactorȱ itsȱownȱbestȱestimatesȱintoȱmeasurements,ȱitȱwouldȱnotȱentitleȱmanagementȱtoȱignoreȱmarketȱevidenceȱofȱ value.ȱȱInȱotherȱwords,ȱanȱentityȱshouldȱuseȱmarketȬconsistentȱinformationȱwhenȱitȱisȱavailableȱandȱ relevantȱtoȱtheȱentity.ȱȱThoseȱwhoȱsupportȱanȱentityȬspecificȱapproachȱneverthelessȱbelieveȱitȱwouldȱbeȱ wrongȱtoȱuseȱinformationȱthatȱisȱinconsistentȱwithȱinformationȱthatȱisȱavailableȱinȱtheȱmarket.ȱȱȱ
6.35ȱ Onȱtheȱotherȱhand,ȱifȱanȱentityȱhasȱbetterȱinformationȱaboutȱspecificȱattributesȱofȱitsȱliability,ȱsomeȱ believeȱitȱshouldȱuseȱthatȱbecauseȱinȱtheirȱviewȱitȱisȱmoreȱrelevantȱtoȱunderstandingȱtheȱentity’sȱfinancialȱ position.ȱȱForȱexample,ȱitȱmightȱnotȱbeȱappropriateȱtoȱinsistȱonȱmarketȬbasedȱmeasuresȱforȱmortalityȱ assumptions,ȱsinceȱmortalityȱratesȱcanȱbeȱspecificȱtoȱanȱentityȱ(suchȱasȱwhenȱanȱentityȱknowsȱthatȱtheȱ longevityȱofȱitsȱworkforceȱisȱnotȱasȱgoodȱasȱtheȱmarketȱview).ȱȱSimilarly,ȱfutureȱexpensesȱofȱadministeringȱ theȱliabilityȱareȱlikelyȱtoȱbeȱentityȬspecificȱestimatesȱunderȱthisȱapproach.ȱ
6.36ȱ Discussionȱconcerningȱtheȱdefinitionȱofȱliabilitiesȱ(inȱChapterȱ2)ȱhasȱsetȱoutȱdifferentȱviewsȱonȱ whetherȱtheȱlevelȱofȱfutureȱpensionableȱsalariesȱorȱestimatesȱofȱfutureȱdiscretionaryȱpensionȱincreasesȱ shouldȱbeȱfactoredȱintoȱtheȱmeasurementȱofȱtheȱliability.ȱȱIfȱeitherȱofȱthoseȱpossibleȱfutureȱbenefitsȱwereȱ reflected,ȱitȱseemsȱthatȱunderȱeitherȱapproachȱanȱentity’sȱownȱbestȱestimatesȱwouldȱbeȱrequiredȱofȱtheȱcashȱ outflowsȱneededȱtoȱsettleȱthoseȱelementsȱofȱtheȱliability,ȱbecauseȱitȱwouldȱnotȱbeȱpossibleȱtoȱtransferȱsuchȱ aȱliabilityȱtoȱanotherȱentityȱandȱnoȱotherȱ‘marketȱconsistent’ȱestimateȱcouldȱbeȱmade.ȱ
Currentȱmarketȱdiscountȱratesȱforȱtheȱtimeȱvalueȱofȱmoneyȱ
6.37ȱ Theȱdiscountȱrateȱinȱbuildingȱblockȱ(b)ȱwouldȱunderȱeitherȱapproachȱbeȱpurelyȱforȱtheȱtimeȱvalueȱ ofȱmoney,ȱi.e.ȱaȱriskȬfreeȱrate.ȱȱThereȱisȱlittleȱguidanceȱinȱtheȱinsuranceȱdiscussionȱpaperȱonȱdeterminingȱ thisȱrate,ȱexceptȱthatȱitȱisȱnotȱderivedȱfromȱexpectedȱreturnsȱonȱactualȱassetsȱheld.ȱȱContributorsȱtoȱthisȱ discussionȱpaperȱconcurȱwithȱthatȱview.ȱȱThereȱis,ȱhowever,ȱsomeȱdebateȱaboutȱwhetherȱaȱriskȬfreeȱrateȱisȱ
derivedȱfromȱaȱyieldȱcurveȱforȱgovernmentȱbondsȱorȱfromȱanȱinterestȱrateȱswapsȱcurveȱ(asȱaȱmoreȱliquidȱ alternativeȱwithȱlongerȱmaturitiesȱavailable),ȱandȱitȱisȱsuggestedȱthatȱfurtherȱconsiderationȱshouldȱbeȱ givenȱtoȱthis.ȱȱȱ
6.38ȱ Inȱcontrast,ȱIASȱ19ȱrequiresȱpensionȱliabilitiesȱtoȱbeȱdiscountedȱbyȱreferenceȱtoȱmarketȱyieldsȱatȱtheȱ balanceȱsheetȱdateȱonȱhighȱqualityȱcorporateȱbondsȱ(or,ȱinȱcountriesȱwhereȱthereȱisȱnoȱdeepȱmarketȱinȱsuchȱ bonds,ȱgovernmentȱbonds)ȱofȱaȱcurrencyȱandȱtermȱconsistentȱwithȱtheȱcurrencyȱandȱtermȱofȱtheȱ
obligation.ȱȱTheȱrelevantȱparagraphsȱfromȱtheȱIASC’sȱBasisȱforȱConclusionsȱtoȱIASȱ19ȱareȱincludedȱinȱ AppendixȱE.ȱ
6.39ȱ TheȱIASBȱdecidedȱ(paragraphȱ31ȱinȱtheȱBasisȱforȱConclusionsȱinȱAppendixȱE)ȱthatȱtheȱdiscountȱ rateȱshouldȱreflectȱtheȱtimeȱvalueȱofȱmoneyȱbutȱshouldȱnotȱattemptȱtoȱcaptureȱtheȱrisksȱassociatedȱwithȱaȱ definedȱbenefitȱobligationȱorȱanȱentityȇsȱownȱcreditȱrating.ȱȱTheyȱconsideredȱtheȱrateȱthatȱbestȱachievesȱ theseȱobjectivesȱisȱtheȱyieldȱonȱhighȱqualityȱcorporateȱbonds.ȱȱ(TheȱguidanceȱinȱSFASȱ87/SFASȱ106ȱalsoȱ takesȱratesȱofȱreturnȱonȱhighȬqualityȱfixedȬincomeȱinvestmentsȱasȱreflectingȱonlyȱtheȱtimeȱvalueȱofȱmoney).ȱȱ 6.40ȱ Onȱtheȱotherȱhand,ȱFRSȱ17ȱrelatesȱtheȱyieldȱonȱaȱhighȱqualityȱcorporateȱbondȱtoȱtheȱobjectiveȱofȱ reflectingȱaȱriskȬadjustedȱrate,ȱi.e.ȱaȱrateȱthatȱreflectsȱbothȱtheȱtimeȱvalueȱofȱmoneyȱandȱtheȱcharacteristicsȱofȱ theȱliability.ȱȱTheȱASB’sȱrationaleȱforȱtheȱaboveȱdiscountȱrateȱisȱsetȱoutȱinȱAppendixȱIVȱtoȱFRSȱ17.ȱȱTheȱ relevantȱparagraphsȱareȱincludedȱinȱAppendixȱFȱtoȱthisȱChapter.ȱȱItȱisȱnoteworthyȱthatȱaȱhigherȱthanȱriskȬ freeȱrateȱisȱjustifiedȱhereȱonȱtheȱgroundsȱofȱtheȱvariousȱoptionsȱavailableȱtoȱanȱemployerȱtoȱreduceȱ benefits,ȱorȱtoȱrefrainȱfromȱincreasingȱthem.ȱȱInȱeffect,ȱthatȱdiscountȱrateȱisȱintendedȱtoȱreflectȱtwoȱ offsettingȱfactors:ȱ(a)ȱaȱpriceȱforȱtheȱuncertaintyȱofȱfutureȱcashȱoutflowsȱ(whichȱincreasesȱtheȱvalueȱofȱtheȱ liability)ȱandȱ(b)ȱtheȱaforementionedȱoptionsȱ(whichȱreduceȱtheȱvalueȱofȱtheȱliability).ȱ
6.41ȱ Theȱfollowingȱpointsȱmayȱbeȱnotedȱinȱrelationȱtoȱthatȱrationale:ȱ
(a)ȱ TheȱdiscussionȱaboutȱliabilitiesȱinȱChapterȱ2ȱofȱtheȱdiscussionȱpaperȱisȱinȱtheȱcontextȱofȱ
determiningȱwhichȱcashȱoutflowsȱshouldȱbeȱreflectedȱinȱtheȱmeasurementȱofȱaȱpensionȱliability.ȱȱ Theȱviewȱthatȱemergesȱisȱthatȱtheȱeffectȱofȱdiscretionaryȱbehaviourȱwouldȱbeȱexcluded,ȱalongȱwithȱ possibleȱfutureȱchangesȱinȱbenefitsȱthatȱareȱnotȱpresentȱoptionsȱofȱtheȱemployer.ȱȱAlso,ȱifȱfutureȱ salaryȱlevelsȱwereȱnotȱreflectedȱinȱtheȱliability,ȱtheȱquestionȱofȱhowȱtoȱreflectȱtheȱemployer’sȱ discretionȱoverȱfutureȱincreasesȱinȱpensionableȱsalariesȱwouldȱnoȱlongerȱbeȱrelevant.ȱȱȱ
(b)ȱ Accruedȱbenefitsȱthatȱhaveȱbeenȱearnedȱbyȱemployeesȱcannotȱbeȱreducedȱbyȱtheȱemployerȱ(atȱleastȱ inȱtheȱpresentȱenvironmentȱinȱtheȱUKȱandȱmostȱotherȱcountriesȱthatȱweȱhaveȱcanvassed)ȱandȱ cannotȱbeȱavoidedȱbyȱclosingȱdownȱaȱplan.ȱ
(c)ȱ Forȱliabilitiesȱinȱrespectȱofȱbenefitsȱthatȱhaveȱnotȱvested,ȱassumptionsȱunderlyingȱtheȱestimatesȱofȱ cashȱflowsȱwouldȱalreadyȱreflectȱtheȱprobabilityȱthatȱvestingȱconditionsȱwillȱnotȱbeȱfulfilled.ȱȱȱȱ
Risksȱinȱpensionȱliabilitiesȱ
6.42ȱ Anȱimportantȱissueȱthatȱmightȱdivideȱtheȱtwoȱapproachesȱisȱwhetherȱtheȱmeasurementȱresultingȱ fromȱapplyingȱbuildingȱblocksȱ(a)ȱandȱ(b)ȱshouldȱbeȱadjustedȱforȱaȱriskȱmarginȱ(asȱinȱbuildingȱblockȱ(c))ȱ and,ȱifȱso,ȱhowȱshouldȱitȱbeȱmeasuredȱforȱaȱpensionȱliability.ȱ
6.43ȱ Asȱisȱdemonstratedȱinȱtheȱdiscussionȱbelow,ȱsolvingȱtheȱissueȱofȱaȱriskȱmarginȱisȱprovingȱelusive.ȱȱ Itȱhasȱbeenȱnotedȱthat,ȱinȱtheȱdebateȱaboutȱinsuranceȱliabilities,ȱsomeȱbelieveȱthatȱanȱ‘entryȱprice’ȱriskȱ marginȱshouldȱbeȱusedȱratherȱthanȱanȱestimateȱofȱtheȱmarginȱthatȱotherȱmarketȱparticipantsȱwouldȱrequireȱ forȱbearingȱrisk.ȱȱButȱifȱthatȱviewȱwereȱappliedȱtoȱpensionȱliabilities,ȱthereȱremainsȱaȱbigȱquestionȱ
regardingȱhowȱtoȱmeasureȱthatȱmarginȱbecauseȱ(unlikeȱinsuranceȱcontracts)ȱthereȱisȱusuallyȱnoȱobservableȱ entryȱorȱtransactionȱpriceȱforȱassumingȱtheȱliabilities.ȱȱ
6.44ȱ Itȱmightȱbeȱhelpfulȱtoȱconsiderȱaȱpensionȱliabilityȱasȱgivingȱriseȱtoȱtwoȱtypesȱofȱrisks:ȱ
1. Risk/variabilityȱofȱtheȱsizeȱofȱtheȱpensionȱclaim.ȱ
2. Riskȱthatȱthereȱisȱinsufficientȱcashflow/assetsȱinȱtheȱcompanyȱtoȱpayȱtheȱpensionsȱ(creditȱrisk).ȱ 6.45ȱ Theȱfirstȱisȱtheȱriskȱthatȱtheȱactualȱpensionȱpaymentsȱwillȱdifferȱfromȱtoday’sȱexpectations,ȱwhenȱ assumptionsȱhaveȱbeenȱmadeȱaboutȱtheȱuncertaintiesȱthatȱwillȱaffectȱtheȱamountȱofȱbenefitsȱtoȱbeȱpaid,ȱ suchȱasȱmortalityȱratesȱandȱ(forȱthoseȱwhoȱbelieveȱtheyȱshouldȱbeȱtakenȱintoȱaccount)ȱfutureȱsalaryȱlevels.ȱ 6.46ȱ Theȱsecond,ȱcreditȱrisk,ȱisȱdiscussedȱinȱSectionȱ7ȱwhereȱitȱisȱconcludedȱthatȱitȱisȱinappropriateȱforȱ anȱemployer’sȱliabilityȱforȱpensionsȱtoȱbeȱreducedȱtoȱreflectȱtheȱemployer’sȱownȱcreditȱrisk.ȱ
6.47ȱ Theȱapproachȱinȱtheȱinsuranceȱdiscussionȱpaperȱtoȱtheȱriskȱofȱtheȱsizeȱofȱtheȱclaimȱisȱsimilarȱtoȱ adjustingȱtheȱexpectedȱvalueȱofȱtheȱcashȱoutflowsȱtoȱaȱ‘certaintyȱequivalent’.ȱȱTheȱthinkingȱisȱthatȱaȱ liabilityȱwithȱanȱuncertainȱcashȱoutflowȱthatȱhasȱanȱexpectedȱvalueȱofȱ100ȱisȱusuallyȱmoreȱonerousȱthanȱaȱ liabilityȱwithȱaȱcertainȱcashȱoutflowȱofȱ100.ȱȱInȱotherȱwords,ȱanȱentityȱwouldȱwantȱtoȱbeȱcompensatedȱforȱ theȱuncertaintyȱandȱwouldȱthereforeȱdemandȱtoȱbeȱpaidȱmoreȱtoȱassumeȱtheȱuncertainȱliabilityȱthanȱtoȱ assumeȱtheȱcertainȱliabilityȱ(basedȱonȱtheȱassumptionȱthatȱinvestorsȱareȱriskȱaverse)ȱ
6.48ȱ SomeȱhaveȱsuggestedȱthatȱaȱriskȱpremiumȱshouldȱonlyȱincludeȱtheȱsystematicȱorȱnonȬdiversifiableȱ risks.ȱȱTheseȱareȱheldȱtoȱbeȱrisksȱthatȱcannotȱbeȱdiversifiedȱawayȱfromȱbyȱholdingȱaȱlargeȱportfolioȱofȱ pensionȱliabilitiesȱorȱsimilarȱassetsȱandȱincludeȱinȱparticularȱtheȱriskȱthatȱmortalityȱratesȱinȱtheȱfutureȱwillȱ beȱdifferentȱfromȱtoday’sȱestimatesȱandȱtheȱriskȱthatȱrealȱsalaryȱincreasesȱinȱtheȱfutureȱwillȱbeȱdifferentȱ fromȱtoday’sȱestimatesȱ(theȱlatterȱassumes,ȱofȱcourse,ȱthatȱfutureȱsalaryȱlevelsȱareȱreflectedȱinȱsomeȱ pensionȱliabilities,ȱwhichȱasȱdiscussedȱinȱChapterȱ2,ȱisȱaȱtreatmentȱthatȱmanyȱdoȱnotȱagreeȱwith).ȱȱTheȱ theoryȱisȱthatȱinȱefficientȱmarkets,ȱonlyȱnonȬdiversifiableȱriskȱwillȱbeȱpricedȱbecauseȱtheȱmarketȱwillȱnotȱ chargeȱforȱotherȱrisksȱthatȱitȱcanȱoffsetȱbyȱdiversification.ȱȱȱ
6.49ȱ Furthermore,ȱdifferentȱviewsȱareȱheldȱonȱwhetherȱtheȱvalueȱofȱaȱpensionȱliabilityȱisȱincreasedȱorȱ decreasedȱwithȱnonȬdiversifiableȱriskȱsuchȱasȱtheȱmortalityȱriskȱthatȱcannotȱbeȱhedged.ȱȱForȱexample,ȱsomeȱ claimȱthatȱaȱriskyȱliabilityȱcouldȱbeȱdischargedȱmoreȱefficientlyȱbyȱtheȱcashȱflowsȱarisingȱfromȱaȱportfolioȱ thatȱincludesȱsomeȱriskyȱassetsȱthanȱtheȱcashȱflowsȱfromȱaȱportfolioȱofȱriskȬfreeȱassetsȱ(becauseȱtheȱrisksȱ areȱoffsetting)ȱandȱthatȱtheȱliabilityȱshouldȱthereforeȱbeȱmeasuredȱwithȱreferenceȱtoȱtheȱvalueȱofȱtheȱmostȱ efficientȱportfolioȱofȱassets.ȱȱȱ
6.50ȱ Itȱmayȱbeȱnotedȱthatȱunderȱtheȱproposalsȱinȱtheȱinsuranceȱdiscussionȱpaper,ȱtheȱdirectionȱofȱanȱ adjustmentȱforȱriskȱofȱtheȱsizeȱofȱtheȱclaimȱisȱtoȱincreaseȱanȱinsuranceȱliability.ȱȱMostȱcontributorsȱtoȱthisȱ paperȱwouldȱagreeȱthatȱtheȱeffectȱofȱconveyingȱtoȱanȱemployerȱtheȱriskȱthatȱitȱwillȱhaveȱtoȱpayȱmoreȱ benefitsȱifȱpeopleȱliveȱlongerȱthanȱexpectedȱisȱtoȱmakeȱaȱpensionȱliabilityȱmoreȱonerousȱthanȱitȱwouldȱbeȱifȱ theȱriskȱwereȱborneȱbyȱothersȱ–ȱitȱhasȱbeenȱlikenedȱtoȱanȱemployerȱwritingȱaȱcallȱoptionȱthatȱcanȱbeȱ
exercisedȱbyȱpeopleȱlivingȱlonger.ȱȱȱ
6.51ȱ Aȱmatterȱonȱwhichȱallȱwouldȱagreeȱisȱthatȱaȱriskȱmarginȱforȱaȱpensionȱliabilityȱisȱveryȱdifficultȱtoȱ measure.ȱȱManyȱwouldȱgoȱfurther,ȱtakingȱtheȱviewȱthatȱsomeȱrisksȱ(forȱexample,ȱthoseȱrelatingȱtoȱfutureȱ changesȱinȱmortality)ȱareȱ‘unknowable’ȱandȱthereforeȱcannotȱbeȱquantified.ȱȱUnderȱthisȱview,ȱitȱwouldȱbeȱ misleadingȱtoȱtryȱandȱreflectȱtheȱfinancialȱeffectȱofȱsuchȱrisksȱinȱreportedȱliabilityȱamounts,ȱsay,ȱbyȱ
attemptingȱtoȱconstructȱaȱtheoreticalȱentryȱprice.ȱȱAccordingly,ȱunderȱthisȱview,ȱusersȱareȱbetterȱservedȱbyȱ disclosureȱaboutȱtheȱassumptionsȱthatȱhaveȱbeenȱusedȱinȱtheȱestimatesȱofȱtheȱcashȱflowsȱandȱtheȱ
sensitivityȱofȱtheȱliabilityȱtoȱchangesȱinȱthoseȱassumptionsȱ(seeȱChapterȱ9).ȱȱ
6.52ȱ Theȱfollowingȱtableȱexpandsȱthatȱinȱparagraphȱ6.27ȱtoȱreflectȱtheȱforegoingȱdiscussion,ȱaddingȱaȱ possibleȱbasisȱforȱmeasuringȱpensionȱliabilitiesȱunderȱanȱentityȬspecificȱviewȱofȱtheȱliability:ȱ
Insuranceȱliabilitiesȱ (IASBȱDP)ȱ
Pensionȱliabilitiesȱ(IASȱ 19)ȱ
Pensionȱliabilitiesȱ (entityȬspecificȱview)ȱ
Expectedȱvalueȱofȱcashȱ flowsȱ(marketȬconsistentȱ estimates)ȱ
Expectedȱvalueȱofȱcashȱ flowsȱ(entity’sȱbestȱ estimates)ȱ
Expectedȱvalueȱofȱcashȱ flowsȱ(entity’sȱbestȱ estimates)ȱ
DiscountȱatȱriskȬfreeȱrateȱ Discountȱatȱhighȱqualityȱ corporateȱbondȱrateȱ
DiscountȱatȱriskȬfreeȱrateȱ
Addȱaȱmarketȱmarginȱ Noȱmarginȱaddedȱ Noȱmarginȱaddedȱ Discloseȱsensitivitiesȱofȱ assumptionsȱ
6.53ȱ Theȱforegoingȱdiscussionȱmayȱbeȱsummarisedȱasȱfollows:ȱ
x Theȱobjectiveȱofȱaȱcurrentȱvalueȱmeasureȱofȱfutureȱpaymentsȱofȱpensionȱbenefitsȱisȱtoȱreflectȱ today’sȱvalueȱofȱtheȱfutureȱcashȱoutflowsȱexpectedȱtoȱsettleȱtheȱliabilityȱwhenȱitȱfallsȱdue.ȱȱThisȱ approachȱmightȱbeȱviewedȱasȱanȱ‘entityȬspecific’ȱmeasurement,ȱbecauseȱitȱaimsȱtoȱreflectȱnotȱ onlyȱtheȱpropertiesȱofȱtheȱliabilityȱitselfȱbutȱalsoȱtheȱrelationshipȱtoȱitsȱowner.ȱȱWhereȱthisȱ measureȱisȱderivedȱfromȱdiscountingȱfutureȱcashȱflowsȱitȱshouldȱreflect:ȱ
expectedȱvalueȱofȱcashȱflowsȱ(entity’sȱbestȱestimates)ȱthatȱwouldȱbeȱadmittedȱunderȱtheȱ proposalsȱinȱChapterȱ2ȱ
currentȱmarketȱdiscountȱrateȱtoȱreflectȱtheȱtimeȱvalueȱofȱmoneyȱonly,ȱi.e.ȱaȱriskȬfreeȱrate.ȱ
x Inȱtheoryȱtheȱliabilityȱshouldȱalsoȱreflectȱaȱmarginȱforȱrisk,ȱbutȱthereȱisȱconcernȱthatȱsomeȱrisksȱ (forȱexampleȱthoseȱrelatingȱtoȱfutureȱchangesȱinȱmortality)ȱareȱ‘unknowable’ȱandȱthereforeȱ cannotȱbeȱquantified.ȱȱAccordingly,ȱusersȱareȱbetterȱservedȱbyȱdisclosureȱaboutȱtheȱsensitivitiesȱ ofȱtheȱliabilityȱtoȱchangesȱinȱtheȱassumptionsȱthatȱhaveȱbeenȱusedȱinȱarrivingȱatȱtheȱbestȱ
estimates.ȱ