Actuarial Valuation of Employee Benefits under IFRS

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Actuarial Valuation of Employee Benefits under
IFRS

• 12 June 2009

• Arvind Gopalakrishnan, Head of South India
  Operations, Mercer Retirement Consulting
• Harshad Salaskar, Senior Consultant, Mercer
  Retirement Consulting
• 91 80 4185 7700Arvind.Gopalakrishnan_at_mercer.
  com

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Agenda

• IFRS Coverage
• IAS19 Employee Benefits Scope
• Disclosures
• Assumptions
• Actuarial Losses / (Gains)
• Likely changes in IAS19

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IFRS Coverage
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IFRS

• Prior to IFRS, International Accounting Standards
  were used
• Broadly, IFRSs refers to the entire body of IASB
  pronouncements, including standards and
  interpretations approved by the IASB
• IAS 19 prescribes the scope of Employee
  Benefits
• IAS 26 provides information on Accounting and
  Reporting by Retirement Benefit Plans.

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IAS19 Employee Benefits Scope
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IAS 19 Employee Benefits - Scope

• The Standard prescribes the accounting and
  disclosure by employers for employee benefits
• This standard does not apply to benefits which
  needs to cover under the IFRS2 share-based
  payment
• This Standard does not deal with reporting by
  employee benefit plans (covered under IAS 26)
  e.g. accounting and reporting by trust plans
• The Standard identifies following categories of
  employee benefits to be covered
• Short term employee benefits
• Post-employment benefits
• Other long term employee benefits
• Termination benefits
• Will cover formal plans, state plans,
  constructive obligation (informal practices)

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IAS 19 Short Term Benefits

• Short-term employee benefits are employee
  benefits (other than termination benefits) that
  are due to be settled within twelve months after
  the end of the period in which the employees
  render the service
• Examples could be wages, salaries and social
  security contributions, paid annual / sick leave,
  bonuses, non-monetary benefits (housing, cars)
• No actuarial valuation is required and hence
  there would no possibility of any actuarial loss
  or (gain)
• Obligation is measured on undiscounted basis

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IAS 19 Post-employment benefits

• Post-employment benefits (whether funded or not)
  include
• Retirement benefits such as pension benefit
• Post-employment life insurance, death benefit,
  medical benefit
• Post-employment benefits can be of two types
• Defined Benefit (DB)
• Defined Contribution (DC)

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Defined Benefit Plans

• A retirement plan where employee benefits are
  sorted out based on a formula, using factors such
  as salary history and duration of employment
• A defined benefit scheme fixes the benefit in
  advance - usually as a proportion of the members
  earnings when they exit
• E.g. DB scheme might provide at retirement a
  pension of 1 of salary for each year of service.
  If an employee retires after 30 years of service,
  employee would receive pension of 30 of salary
  before retirement
• Actuarial valuation will be required for DB plans
  based on actuarial assumptions

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Defined Contribution Plans

• A retirement plan wherein a certain amount or
  percentage of money is set aside each year by a
  company for the benefit of the employee.
• A defined contribution scheme has a set
  contribution for the employer and a set
  contribution for the employee
• As contribution rates are predetermined,
  employers know what they have committed to and
  employer is no longer obliged to add more to the
  fund
• E.g. In DC scheme, employer and employee each
  contributes 5 of eligible salary

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Combination of Defined Benefit and Defined
Contribution

• Plans where employers obligation is not limited
  to contributions to the fund but has legal or
  constructive obligation such as
• Scheme having benefit formula that is not linked
  solely with accumulation (hybrid schemes)
• Scheme providing guarantee, either indirectly
  through a plan or directly, of a specified return
  on contributions
• For privately managed provident funds, the
  employer must provide for the fund return
  declared by the Government

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Other Long Term Benefits

• Other long-term benefits are employee benefits
  (other than post-employment benefits and
  termination benefits) that are not due to be
  settled within twelve months after the end of the
  period in which the employees render the related
  service
• Examples could be long-service leave, jubilee or
  long service award, profit sharing (payable
  twelve months or more after the end of the
  period)
• The Standard requires a simpler method of
  accounting for other long-term employee benefits
  than for post-employment benefits
• Actuarial gains and losses are recognized
  immediately and no corridor is to be applied
• Past service cost are recognized immediately
• IAS19 does not require specific disclosures about
  other long-term employee benefits

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Termination Benefits

• Termination benefits are employee benefits
  payable as a result of
• Employers decision to terminate an employees
  employment
• Employees decision to accept voluntary
  redundancy in exchange for those benefits
• An entity is demonstrably committed to a
  termination when, and only when, the entity has a
  detailed formal plan (with specified minimum
  contents) for the termination and is without
  realistic possibility of withdrawal.
• Where termination benefits fall due more than 12
  months after the balance sheet date, they should
  be discounted. In the case of an offer made to
  encourage voluntary redundancy, the measurement
  of termination benefits should be based on the
  number of employees expected to accept the offer

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Disclosures
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Disclosures Defined Contribution

• Accounting and disclosure for defined
  contribution plans is straightforward
• No actuarial assumptions are required to measure
  the obligation or the expense and there is no
  possibility of any actuarial gain or loss
• The obligations are measured on an undiscounted
  basis, except where they do not fall due wholly
  within twelve months after the end of the period
  in which the employees render the related service

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Disclosures Defined Benefit

• Balance Sheet
• DBO (Defined Benefit Obligation)
• Less Fair value of plan assets
• Less Unrecognized past service cost
• Less Unrecognized actuarial losses / (gains) (in
  case of corridor approach)
• Profit Loss Statement
• Current service cost
• Past service cost
• Interest cost
• Expected return on assets
• Actuarial losses / (gains)
• Effect of any curtailments or settlements

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Actuarial Assumptions
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Actuarial Assumptions

• Assumptions
• Unbiased and mutually compatible
• Based on market expectations over the projection
  period
• Employer to decide on the assumptions
• Demographic
• Mortality
• Employee turnover, disability and early
  retirement
• Claim rates under medical plans
• Financial
• Discount Rate
• Salary escalation rate
• Medical expenses
• Expected return on plan assets

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Effects of Changes in Actuarial Assumptions
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Actuarial Assumptions Discount Rate

• The rate used to discount post-employment benefit
  obligations shall be determined by reference to
  market yields at the balance sheet date on high
  quality corporate bonds
• In countries where there is no deep market in
  such bonds, the market yields (at the balance
  sheet date) on government bonds shall be used
• The currency and term of the corporate bonds or
  government bonds shall be consistent with the
  currency and estimated term of the
  post-employment benefit obligations
• However, AS15 (R) states that only Gilt Rate
  needs to be used without margin for corporate
  bond spread

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Actuarial Losses (Gains)
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Actuarial Losses / (Gains)

• Actuarial Losses / (Gains) arises due to
• Change in liability driven by change of
  assumptions
• Change in liability driven by variation in actual
  experience vis-à-vis assumptions
• Change in fair value of assets driven by actual
  investment return different from the expected
• IAS 19 provides the following options to
  recognize actuarial gains and losses
• Immediate recognition in P L
• Immediately recognition in statement of
  recognised income and expense (SORIE)
• Corridor approach

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Recognition of Actuarial Losses / (Gains)

• AS 15(R) requires immediate recognition of
  actuarial losses / (gains) in Profit Loss
• This results in volatility in profits and losses
  of company especially in case of significant
  change in gilt rate and change in fair value of
  unit-linked fund assets
• IAS19 provides two more approaches to follow as
  compared to AS15 (R)
• Immediately recognition through SORIE enables to
  control volatility of profits and losses

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Recognition of Actuarial Losses / (Gains)

• Corridor approach can be used to delay
  recognition of losses / (gains)
• Corridor Approach amortizes over employees
  future service periods any unrecognized gains or
  losses in excess of 10 of greater of projected
  benefit obligation or fair value of plan assets
• Unrecognized L / (G) 10 Max (DBO, Assets)
  / Average FS

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Recognition of Actuarial Losses / (Gains)

• Corridor Approach requires to reconcile
  Unrecognized Losses / (Gains)
• Opening Unrecognized Losses / (Gains)
• Actuarial loss / (gain) on DBO
• Actuarial loss / (gain) on Assets
• Actuarial loss / (gain) recognized in the
  years P L
• Closing Unrecognized Losses / (Gains) to be
  carried forward

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Likely Changes in IAS19
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Likely Changes in IAS19

• The International Accenting Standards Board is
  discussing changes to the disclosures required
  and expect to come up with an exposure draft in
  the fourth quarter of 2009
• The likely changes would be
• Entities should recognize all changes in the
  value of plan assets and changes in the
  post-employment benefit obligation in the period
  in which they occur (immediate recognition)
• Replacement the term deep market with term
  active market and will define the term
• Requirement of disclosure of the effect of plan
  amendments with a narrative description of the
  amendments
• The requirements under IAS19 will be more clearer
  after circulation of the exposure draft

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Q A
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