A bunch of foreign corporations likely are starting to reevaluate their pension plans’ asset allocations, thanks to the International Accounting Standards Board.
In June the IASB, whose accounting rules are used by about 120 countries that include all European Union members, published its amendments to IAS 19 Employee Benefits, which cover how defined benefit plan sponsors handle pensions in their financial statements. The final rules diverge from some of IASB’s more controversial earlier proposals, such as requiring all actuarial gains and losses to go through a company’s P&L, says Ken Stoler, a PricewaterhouseCoopers LLP partner. Instead, that will show up in the less-prominent OCI (other comprehensive income) statement. “They did back off of a number of things that they were going to require,” he says.
The IASB changes do not directly impact most U.S.-based companies, says Jim Verlautz, a principal at consultant Mercer, but they do apply to U.S. subsidiaries of foreign companies. Still, the new rules that take effect in January 2013 may indicate some future direction as IASB and the US-based FASB (Financial Accounting Standards Board) continue trying to harmonize their rules.
The biggest deal is taking away the income statement credit for a plan’s expected return on assets. Under today’s IASB rules, a company can take credit through its net income for that expected return, which the company itself sets based on what it assumes the invested assets will earn in the market. “The new rule is that credit will be based on the same interest rates used to discount their obligations, which are current high-quality corporate bond rates,” Stoler says. The new, considerably lower credit could translate into a big drop in reported income for some companies.
And the shift could influence pension sponsors’ asset-allocation strategies. “If we are going to see any real changes made by companies, this is probably where it is going to happen,” Stoler says. “Some companies may say, ‘If we are not going to get credit through income for having invested in riskier stuff, then maybe it is not worth it.’ Maybe they will move more into fixed income, because that is all they are going to get credit for anyway. It is something that companies are really thinking about.”
Verlautz also expects to see some companies go to a de-risking strategy, but mentions a couple of other possibilities. IASB’s decision not to have actuarial fluctuations immediately go through the P&L will lead some sponsors to get more aggressive, he thinks. “Those companies will say, ‘I will go and get the biggest return where I can, and if I gamble and lose, it does not go through P&L,’” he says. And other companies will not want accounting rules to drive their investment decisions, so they will opt not to change their portfolios in response.
The new rules also eliminate the ‘corridor approach’ that allows deferred recognition of changes in the value of plan assets or liabilities. Current rules allow companies to smooth changes over time or recognize them immediately; many already do the latter. “They are getting rid of the smoothing option, so everybody will have to play by the same rules,” Stoler says. But this will not impact the actual cash requirement for funding, he says, since funding rules are not based on numbers used for financial reporting.
