For further information please contact Jeroen Koopmans or Johan van Soest in our Utrecht office. View a full list of our services at

Transcription

1 LCP NETHERLANDS PENSIONS ACCOUNTING BRIEFING 2011 AEX and AMX companies have 200 billion of employee benefit liabilities in their 2010 accounts. This report gives an insight into the financial implications of the new pensions accounting standard and the upcoming reforms in the Dutch pension system. Lane Clark & Peacock Netherlands B.V. Pension Fund Consulting ALM Consulting Actuarial Services Corporate Consulting Training Communication

2 2 We would like to thank those from LCP who have made this report possible: Tom van Beek Nick Bunch Tricia Gulliver Colin Haines Linda van Houten Stephen Hunt Gillian Kearney Jeroen Koopmans Stuart Levy Evert van Ling Tim Marklew Emma Mitton Rebeccah Robinson Bob Scott Johan van Soest Alex Waite For further information please contact Jeroen Koopmans or Johan van Soest in our Utrecht office. This report may be reproduced in whole or in part, without permission, provided prominent acknowledgement of the source is given. The report is not intended to be an exhaustive analysis of IAS19. Although every effort is made to ensure that the information in this report is accurate, LCP accepts no responsibility whatsoever for any errors, or the actions of third parties. Information and conclusions are based on what an informed reader may draw from each company s annual report and accounts. None of the companies have been contacted to provide additional explanation or further details. View a full list of our services at Lane Clark & Peacock Netherlands B.V. September 2011

3 3 LCP Netherlands Pensions Accounting Briefing 2011 p4 1. Executive summary p4 1.1 Introduction p4 1.2 Key findings p6 2. Accounting standards for pensions p6 2.1 Introduction p6 2.2 Reduced profit for most companies p6 2.3 Removal of corridor will hit most balance sheets p7 2.4 Numerous changes to accounting rules p8 2.5 Strengthening of disclosure requirements p9 2.6 Further changes still possible p10 3. The Dutch Pensions Deal and its consequences p Introduction p Background to the Dutch Pensions Deal p What are the major changes being proposed under the Dutch Pensions Deal? p Consequences of the Dutch Pensions Deal p Consequences for IAS19 accounting p14 4. Risk sharing under the revised IAS19 p Introduction p Intergenerational risk sharing p Risk sharing between employer and employees p Value of risk sharing according to IAS19 p Conclusions p18 5. Defined Benefit Schemes of the AEX and AMX p Introduction p Key findings p Analysis of results p Key assumptions p29 Appendix AEX and AMX accounting disclosure listing

4 4 LCP Netherlands Pensions Accounting Briefing Executive summary 1.1 Introduction This LCP Netherlands pensions accounting briefing provides an insight into Dutch companies costs and liabilities with respect to pension schemes and other employee benefits, compares the different practices adopted by the largest Dutch companies and highlights the financial implications. This report covers 44 of the 50 AEX and AMX companies listed on the Amsterdam stock exchange. By analysing their pension disclosures, we aim to measure the exposure that companies have to their pension liabilities. 1.2 Key findings Accounting changes will mean lower headline profits for companies Changes to IAS19, which will come into force in 2013, have been in the pipeline for some time now. In June 2011 the International Accounting Standards Board published its final version of the new pensions accounting standard. Removal of the corridor method will increase balance sheet liabilities by 17 billion, based on 2010 figures. Jeroen Koopmans Partner LCP Netherlands All Dutch pension schemes will need to be amended in 2012 at the latest. Companies and pension funds have started to reconsider their pension promises. The expected return on assets will be aligned with interest cost items. Had the new rules been in force for 2011, we estimate the impact across the AEX and AMX companies for this change alone, could have been a 1.5 billion reduction in profits for We note that this reduction would be offset by companies not having to recognise unrecognised actuarial losses in their 2011 P&L. Many companies will need to beef up their pensions disclosures, as current disclosures are insufficient under the new version of IAS19. All Dutch pension schemes must be amended in 2012 at the latest The Dutch pension system is about to change radically, with or without the consent of the unions on the so-called Dutch Pensions Deal. The most important change is that the pensionable age in 2nd pillar (company sponsored) pension schemes will be raised from 65 to 66 in 2013 and (probably) to 67 in The Dutch Pensions Deal forces every company and pension fund to reconsider their pension promises. All Dutch pension schemes will need to be amended in 2012 at the latest.

5 LCP Netherlands Pensions Accounting Briefing Executive summary 5 We expect the consequences of the Dutch Pensions Deal, together with the new IAS19 standard, to be that many companies decide to de-risk their pension scheme further, for example into a (Collective) Defined Contribution scheme, eliminating IAS19 liabilities from the balance sheet. During the de-risking process, companies will need to find a proper solution to benefits already accrued. Companies must manage substantial liabilities Over 2010, the employee benefit liabilities of AEX and AMX companies increased from 179 billion to 200 billion. Companies combined 2010 deficit equalled 25 billion (2009: 24 billion), of which only 8 billion is recognised in the balance sheet. LCP Netherlands estimates that the combined IAS19 deficit of AEX and AMX companies has since reduced to just over 20 billion at the end of August bn AEX and AMX companies face the challenge of managing 200 billion of pension and other employee benefit liabilities. Executive summary Risk sharing under new IAS19 standard expected to have significant effects Risk sharing has always been generally accepted in the Netherlands. This includes risk sharing between young and old employees as well as risk sharing between employer and employees. The new IAS19 standard acknowledges this risk sharing. Under the new IAS19 it will be possible to take mandatory employee contributions and any maximum limit on employer contributions into account when calculating the companies past service pension liabilities. In addition, the new IAS19 changes the classification of schemes between defined benefit and defined contribution. This may have surprisingly far reaching implications in the Netherlands, especially if the Dutch Pensions Deal is approved by the unions. Companies will want to continue to de-risk their pension arrangements In the last few years, some companies, including Heijmans and Nutreco, have transferred all or part of their pension risks to insurance companies or into industry-wide arrangements. This has resulted in reduced pension liabilities on their company balance sheet. However, the level of interest in these types of transactions is not the same as in some other countries, particularly compared to the UK. In the next couple of years we would expect companies to want to de-risk their arrangements further, particularly in the light of the Dutch Pensions Deal and IAS19 reforms. If insurers can offer attractive prices then more insurance transactions could well take place in the future.

6 6 LCP Netherlands Pensions Accounting Briefing Accounting standards for pensions 2.1 Introduction In June 2011 the International Accounting Standards Board (IASB) published a new version of the international pensions accounting standard IAS19. The new standard will come into force in 2013, although companies are likely to have the option to adopt the new standard earlier. The main changes for defined benefit pension schemes are described below. 2.2 Reduced profit for most companies A significant change is the removal of the expected return on assets. At present, the return the company expects to earn on its pension investments is credited to profit. In future, the credit to profit will be calculated using the discount rate, which is based on the yields on AA-rated corporate bonds, and is usually lower. Due to this particular change, based on the 2010 disclosures, the majority of AEX and AMX companies that sponsor defined benefit pension schemes would report lower profits had the new standard applied for Under the new standard, which removes the expected return on assets, we estimate the total impact to 2011 profits for these companies would be a reduction of around 1.5 billion. We expect the removal of the expected to return on assets to have the biggest impact for Shell. We estimate that the decrease in disclosed profits due to this change alone would have been between 400 million and 500 million had the rules applied in We note that this reduction in profits would be offset by Shell not having to recognise unrecognised actuarial losses in its P&L (see section 2.3 for further details). Other companies that face big changes in their profits under the new standard include Philips and Air France/KLM, with decreases for each company of up to 200 million, had the rules applied in Removal of corridor will hit most balance sheets Under the current international accounting standard companies have two options for dealing with unexpected actuarial gains and losses (such as lower than expected asset returns leading to a higher than expected deficit): recognise all gains and losses immediately outside profit and loss; or recognise actuarial gains and losses that exceed a specified level (often called the corridor ), in profit and loss over an extended period. The new version of IAS19 removes the second of these options.

7 LCP Netherlands Pensions Accounting Briefing Accounting standards for pensions 7 This particular change is likely to have a big impact in the Netherlands, where the corridor option is widely used. Of the 44 companies in the AEX and AMX with defined benefit pension arrangements, 30 used the corridor method. For these companies the total effect would be substantial and we estimate the increase to 2010 year-end balance sheet liabilities would have been 17 billion had the new rules applied. Similar figures can be expected to apply at the date of transition to the new IAS19 rules, namely 31 December 2011 (for prior year comparative figures). The table below shows the effect for some individual companies had the new rules applied at the end of The liability figures include both pension and other long-term employee benefits. Asset/(Liability) recognised at 2010 year-end ( million) Company Current New IAS19 Difference Shell 3,037 (4,969) (8,006) ArcelorMittal (5,362) (7,701) (2,339) ING 2,743 1,013 (1,730) 17bn The removal of the corridor method could increase AEX and AMX companies balance sheet liabilities by 17 billion, based on 2010 disclosures. Accounting standards for pensions Air France/KLM 1, (1,449) The removal of the corridor method will, however, act as an amnesty for companies who have unrecognised actuarial losses. These losses would otherwise have been recognised over future years as a reduction in profits, but the abolition of the corridor will now mean those losses will never hit profits. This may encourage some of the companies using the corridor method to adopt the new standard ahead of Numerous changes to accounting rules As well as the headline changes, there are numerous changes to the detail of the rules in the new, rewritten IAS19. In particular, there are changes to the rules in how to value schemes which share risks between employees and employers. Many schemes in the Netherlands have risk sharing features, and companies will need to decide how to apply the new rules to their schemes. We expect that in some cases, companies liabilities will be reduced. Examples of the changes to the rules include: Where employees pay mandatory contributions, new rules clarify the scheme may be able to take the contributions into account when calculating its defined benefit obligations. Where a deficit is to be made up by both employer and employee contributions, the company will only need to show its own share of the deficit in future. Where employer contributions are subject to a maximum level, it may be possible that the defined benefit obligation can also be limited.

8 8 LCP Netherlands Pensions Accounting Briefing Accounting standards for pensions The new standard clarifies the classification of defined benefit schemes. This clarification means that it may be possible for schemes previously classified as defined benefit to now be classified as defined contribution. This is most likely to impact insured schemes and those schemes where the scheme participants bear substantial actuarial and investment risk due to the possibility that a pension fund can decrease its liabilities in the event of a funding deficit. Further details on risk sharing can be found in section Strengthening of disclosure requirements The headline profit and balance sheet figures, based on the corporate bond based accounting measure, are only a starting point in understanding pension liabilities investors who seek to understand a company s pension exposure need to dig deeper. The new disclosure requirements will help by providing the answers to a number of key questions: The new disclosure requirements What would be the effect of using alternative assumptions? When will cash be paid out of the scheme? How much cash will be paid in to the scheme? What are the risks? Where are the assets invested? Comment Requirement to give a sensitivity analysis on assumptions; in their 2010 disclosures some, but not all, AEX and AMX companies gave this. A new requirement to disclose the average time until pensions are paid. A description of funding arrangements, and contributions for the next year. A general requirement to explain the characteristics of pension schemes and the risks associated with them, and specific requirements to disclose concentrations of risks and unusual risks to the company. New disclosure requirements will take into account all of the significant asset classes and liability matching strategies. This will be much more useful than the existing requirements, which focus on the basic asset classes of equities, bonds and property. From our analysis, it appears that companies will need to beef up their pensions disclosures when the new standard comes into force - only 5% of the companies in our survey showed sensitivities for both the discount rate

9 LCP Netherlands Pensions Accounting Briefing Accounting standards for pensions 9 and mortality assumptions used in their 2010 accounts. Around 27% of the companies did disclose a sensitivity analysis on the discount rate, split into 39% of the AEX companies and only 14% of the AMX companies. Strangely, there are several companies that do not provide all the disclosure items we would expect to see based on the current IAS19, for example where the annual reports are lacking reconciliations of the opening and closing balances of the liabilities and the scheme assets. It appears that companies will need to beef up their pensions disclosures when the new standard comes into force. The new disclosure rules will mean a real change for companies. Instead of specifying what companies should tell investors about their pension schemes with a set of detailed rules, the IASB is setting out principles and objectives alongside a list of requirements to help meet those objectives. Companies will need time to prepare the information required. If this is to be done for the December 2011 year-end, by way of an exploratory test run, processes will need to be thought about in the final quarter of Multi-employer plans Companies operating multi-employer plans will also face new reporting requirements. In the Netherlands there are many industry wide pension funds that are typically seen as multi-employer plans. Their affiliated companies currently disclose very little information because the companies are not able to obtain details relating to their share of the assets and liabilities in the scheme. The new IAS19 could require companies to provide more financial information and set out the risks that they are exposed to as participating employers. Accounting standards for pensions One of the analysed companies, Ahold, has a significant number of employees in the US that are covered by multi-employer plans. Ahold has already opted to disclose an estimated proportionate share in these schemes. It also identifies their risks of increased contributions and socalled withdrawal liabilities. 2.6 Further changes still possible The new standard will not necessarily be the end of the line for changes in the way in which companies account for their pension obligations. The IASB will soon be starting its next project to re-examine pensions accounting, which will be a more comprehensive, root and branch review. It is possible that in a few years time, we could see proposals for radically different pensions accounting potentially in line with Solvency II type requirements, which will shortly apply for insurance company reserving. If companies were required to value liabilities on a minimum-risk basis, the increase in value of pension liabilities disclosed on AEX and AMX companies balance sheets could run to 50 billion.

10 10 LCP Netherlands Pensions Accounting Briefing The Dutch Pensions Deal and its consequences 3.1 Introduction The Dutch pension system is about to change radically. A possible future of our pension system has been worked out in the so-called Dutch Pensions Deal, a provisional document drawn up by social partners united in the Labour Foundation (STAR). The Dutch Pensions Deal has far-reaching consequences for employees, employers, pension funds and insurers. All Dutch pension schemes will need to be amended in 2012 at the latest, with or without the consent of the unions on the Dutch Pensions Deal. 3.2 Background to the Dutch Pensions Deal Recent years have revealed that the Dutch pension system is vulnerable. Typical Dutch pension schemes, with nominal guaranteed defined benefits that are conditionally indexed, have been under heavy attack by low interest rates, rapidly increasing life expectancy and volatile asset returns. In the Dutch Pensions Deal, social partners (ie the association of employers and trade unions) have set out adjustments they agreed were necessary for occupational pensions. Related proposals were made for the future sustainability of the Old Age Pensions Act (AOW) in the first pillar (ie the government-backed pension). Several unions are dissatisfied with its contents and some of them, amongst others the two largest Dutch unions, FNV Bondgenoten and AbvaKabo, rejected it. The board of the FNV federation, which represents 19 unions, should have decided on the Dutch Pensions Deal on 12 September However, the FNV federation could not take a joint view. After further concessions from the government, there is a greater chance that the voting majority of the FNV federation will be in favour of the Dutch Pensions Deal. The two largest unions still reject it, and not all parties in the Dutch government are convinced of the Dutch Pensions Deal as well. The outcome of further discussions was still unclear at the time this report was drafted. However, the Dutch Minister of Social Affairs has already announced that he will draw up his own plan if the unions decide to vote down the Dutch Pensions Deal, which also means that several concessions will be revoked. In the Dutch Lower Chamber there seems to be a majority in favour of the proposed agreement, although amendments are requested on a number of topics. 3.3 What are the major changes being proposed under the Dutch Pensions Deal? The most significant items of the Dutch Pensions Deal are the following. Amendments in the Old Age Pensions Act (AOW) Raising the pensionable age to 66 in 2020 and (probably) to 67 in 2025.

11 LCP Netherlands Pensions Accounting Briefing The Dutch Pensions Deal and its consequences 11 Thereafter, the pensionable age will be amended every 5 years in the event that life expectancy has changed more than 1 year since the latest adjustment. Amendments in the employment-related pension schemes Automatic pension cost increases must be avoided for both employers and employees. Target pensions must conform to the maximum (company specific) contribution limit achieved in recent years and allowances must be made for exogenous developments regarding life expectancy and the financial markets. In the pension scheme, an explicit choice should be made between hard and soft benefits. Hard benefits are guaranteed nominal pension benefits with a minimal chance of cut backs on accrued benefits, but also with only a small chance of indexation. Soft benefits will be more index-linked, but reductions in accrued benefits in the event of poor investment returns are part of the deal. Raising the pensionable age to 66 in 2013 and (probably) to 67 in Thereafter, the pensionable age will be amended every five years in the event that life expectancy has changed more than one year since the latest adjustment. If increasing life expectancy or turmoil on the financial markets leads to additional costs, then expected indexations would be adjusted or possibly the accrued benefits would be cut back. 3.4 Consequences of the Dutch Pensions Deal The Dutch Pensions Deal forces every company and pension fund to reconsider their accrued and future pension promises. The pensionable age needs to be adjusted and with that, also the retirement date in the employment contracts. The Dutch Pensions Deal and its consequences It should be emphasised that the Dutch Pensions Deal sketches the outlines of the new pension arrangements in the Netherlands. The increase in the pensionable age will be mandatory by fiscal legislation, but almost all other items should be arranged through local consultations between employers and employees. The major consequences for pension arrangements administered by pension funds as well as insured benefit schemes are summarised below. Pension arrangements with a pension fund A pension fund is a separate legal entity to the sponsoring employer(s). Therefore, the employer(s) cannot solely influence any decisions made relating to the pension fund. Nevertheless, the board of a pension fund consists of employer and member representatives. Therefore, the topics drawn up here are also addressed to companies who have representatives in the pension fund board, which is especially the case for company pension funds.

12 12 LCP Netherlands Pensions Accounting Briefing The Dutch Pensions Deal and its consequences Johan van Soest Senior Consultant LCP Netherlands Directly insured pension contracts should be amended as well. Companies should be careful and examine the conditions of the new insurance contract closely to avoid unnecessary surprises. Items that companies and pension funds need to consider and have on their agenda as a result of the Dutch Pensions Deal include: choice between hard and soft pension benefits; level of risk acceptance; internal and external communication; increasing governance requirements; and transparency and level of costs. Insured contracts The Dutch Pensions Deal appears to be written for pension funds. Nevertheless, directly insured pension contracts must also be amended in 2012 at the latest. These changes could result in an increase of premium rates. Employers can consider in line with the Dutch Pensions Deal to change a current insured Defined Benefit scheme into a Collective Defined Contribution scheme (CDC), a scheme in which the employers contribution is fixed at an agreed level. The funding risk is transferred to the employees, but, contrary to the case with a pension fund, amendments will only influence future pension accrual. By lowering the accrual rate slightly, a bigger portion of the CDC premium can be used for riskier investments, possibly resulting in higher returns. The potential indexation can then be set higher. Of course such an amendment will require close consultations with works councils and unions. 3.5 Consequences for IAS19 accounting All Dutch pension schemes should be amended in 2012 at the latest. The required scheme changes will influence the accounting figures of companies. The size of the total impact will of course depend on the new pension arrangements. Transfer to CDC or DC It can be expected that many companies will amend the current Defined Benefit scheme into a Collective Defined Contribution scheme or even a standard Defined Contribution scheme. After all, one of the fundamental principles of the Dutch Pensions Deal is that automatic future cost increases should be avoided. In other words: the total contributions into a pension scheme will be fixed, where the pensionable age and accrual rate will become variable and even cut backs on accrued benefits are expected to be possible. A well designed CDC scheme can be treated as a DC scheme under the current IAS19. In future, we expect the criteria needed to be satisfied for a CDC scheme to be treated as a DC scheme to be easier under the new version of IAS19.

13 LCP Netherlands Pensions Accounting Briefing The Dutch Pensions Deal and its consequences 13 Classification as a DC scheme eased Under the current IAS19 rules, CDC schemes are often still classified as a DB scheme. This is partly because auditors are very cautious of treating a scheme as DC when there is a benefit formula in place, and partly because the legal documents of pension promises are not always fully compliant with all DC requirements currently stated in IAS19. In this case, even if there is only a small hypothetical chance that not all actuarial and investment risk will fall on the employee, the pension scheme is classified as DB. In the new IAS19, which will be in force from 1 January 2013, the classification of pension schemes seems to have met Dutch wishes. According to the new IAS19, a pension scheme can be classified as DC where actuarial and investment risks fall in substance on the employee. This means that a pension scheme can still be classified as DC, even if a small (non-material) risk falls on the employer. Together with the consequence of the Dutch Pensions Deal, that actuarial and investment risks are transferred further to employees, a lot of Dutch companies are expected to de-risk their pension scheme in such a manner that the scheme will be classified as DC, although a benefit formula can still be in place. This will of course influence the balance sheet as well as the P&L of those companies. Pay attention to accrued benefits Some caution is in order, however, because the Dutch Pensions Deal only holds for future pension accrual. Separate arrangements should be made for accrued benefits. A company that wants to de-risk will probably aim to do so for the entire pension promise, which means that the accrued benefits are made soft. Unions and works councils will have their own ideas about this kind of de-risking of accrued benefits, and they are expected to ask for a fair compensation for the transfer of these risks. The Dutch Pensions Deal and its consequences

14 14 LCP Netherlands Pensions Accounting Briefing Risk sharing under the revised IAS Introduction From an international point of view, one of the main characteristics of the Dutch pension scene is the risk sharing element. Risk sharing can be divided into two parts: intergenerational risk sharing; and risk sharing between employer and employees. 4.2 Intergenerational risk sharing Intergenerational risk sharing is also known as risk solidarity between old and young participants. Pensioners benefits are to some extent protected against shocks on the financial markets, because their benefits will not be cut back instantly when the pension fund is in deficit. These shocks can be better absorbed by younger participants due to their longer investment horizon. Furthermore, the rate of contributions payable to a pension fund is equal for all participants despite their age, which means that there is a premium trade-off between young and old. This is generally seen as a fair trade-off as well, since the young participants of today will be the older participants in the future. Although a lot can be written about intergenerational risk sharing, and its survival chances for the future, for accounting purposes this kind of risk sharing is the least important one. 4.3 Risk sharing between employer and employees Typical Dutch risk sharing possibilities between employer and employees include combined funding of contributions, conditional indexation and even cut backs on accrued benefits. Jeroen Koopmans Partner LCP Netherlands Due to the classification possibilities in the new IAS19, we expect that many more Dutch pension schemes will be classified as Defined Contribution. Combined funding In most Dutch pension schemes 30-50% of the contributions due to a pension fund or insurance company are paid by the employees, and consequently 50-70% is paid by the employer. As a result, both employer and employees have an interest in low and stable pension premiums and both parties will try to avoid cost increases. Conditional indexation Although there are pension schemes that provide for unconditional indexation of accrued benefits (and in most of these schemes the unconditional indexation is restricted to the benefits of active members), almost all pension schemes in the Netherlands only have conditional indexation. A major part of the investment risks in a pension scheme is therefore with the (former) employees. When investment returns are sufficient, the accrued benefits will be indexed. On the other hand, poor investment returns will cause smaller or no indexation. As a result of the last credit crisis, hardly any indexation increases were granted as from 2009.

15 LCP Netherlands Pensions Accounting Briefing Risk sharing under the revised IAS19 15 Cut backs In severe circumstances, accrued benefits can even be decreased due to long-term underfunding of a pension fund. Some pension funds in the Netherlands have used this emergency measure in 2011, and it is not unthinkable that more pension funds will cut back on accrued benefits in Value of risk sharing according to IAS19 In most countries, risks relating to pensions are shared between the employer and employees. According to some experts, the current IAS19 rules do not take this risk sharing into account properly, although, in our opinion, that can be questioned for the Dutch situation. Either way, after extensive lobbying, the new IAS19 acknowledges that part of the risks are shared between employer and the pension scheme participants. The new IAS19 allows, amongst others, for the following risk sharing elements. Employee contributions Currently employee contributions are only taken into account when calculating the pension expense over a year. Future employee contributions cannot be used in the determination of the Defined Benefit Obligation (DBO). Under the new IAS19 rules it will be possible to take mandatory employee contributions into account when calculating the DBO. However, it should be noted that this only concerns employee contributions with respect to past service liabilities. The new rules clarify that, where a deficit is to be made up by both employer and employee contributions, the company will only need to show its own share of the deficit in future. However, in our opinion, most Dutch pension schemes will not benefit from this amendment of IAS19. That is because, in nearly every pension scheme in the Netherlands employee contributions are only due with respect to future service. As the DBO only reflects past service liabilities, future employee contributions have no impact on the calculation of the DBO. Risk sharing under the revised IAS19 Employer contribution limits: liability ceiling Where employer contributions are subject to a maximum level, it may be possible that the DBO can also be limited. This liability ceiling is based on the funding arrangements of the pension scheme, for example, if it is agreed that employer contributions will never exceed a certain percentage of the pensionable salary.

16 16 LCP Netherlands Pensions Accounting Briefing Risk sharing under the revised IAS19 We expect that in some cases companies liabilities can be reduced, especially when mandatory employee contributions are a major part of the total contributions and the pension scheme is in a considerable deficit. The new accounting standard allows for more interaction between funding and accounting, which could make the disclosure figures less transparent and comparable. In theory it will therefore be possible that the DBO can be limited, although the actual implications are unclear and will strongly depend on the features of the pension agreement. Moreover, we wonder if this interaction between funding and accounting could make the ultimate disclosure figures less transparent and comparable. Conditional indexation Typically in the Netherlands, benefit increases are dependent on the financial situation of the pension fund or the excess interest generated in an insured contract. The DBO of these pension schemes should be determined by projecting expected benefits based on the current funded status and current economic assumptions. If the current financial position of a pension scheme is not sufficiently adequate to grant indexations and future excess interest is expected to be limited, then only nominal benefits should be taken into account when determining the DBO. In our opinion, the new IAS19 is not materially different to IAS19 with respect to coping with conditional indexation. 4.5 Conclusions The new IAS19 provides for more risk sharing features than the current IAS19 does. We expect this acknowledgement of risk sharing in the accounting principles to have in some cases significant consequences for Dutch pension schemes. There might be pension schemes that could benefit from the new rules concerning mandatory employee contributions and the liability ceiling. In our opinion, however, the most important effect the new IAS19 will have on Dutch pension schemes is to increase the classification possibilities. Schemes previously classified as Defined Benefit may now be classified as Defined Contribution. This is most likely to impact insured schemes and those schemes where the scheme participants bear substantial actuarial and investment risk due to the possibility that a pension fund can decrease its liabilities in the event of a funding deficit. With the Dutch Pensions Deal in the waiting room, this will probably influence a vast majority of the pension schemes in the Netherlands.

17 Jeroen Koopmans Partner LCP Netherlands A small number of companies have disclosed steps taken during 2010 to control pension risks and reduce pension deficits in the Netherlands. We expect this number to increase considerably in 2012 when the effects of the Dutch Pensions Deal and IAS19 reforms will influence the annual accounts. Defined Benefit Schemes of the AEX and AMX

18 18 LCP Netherlands Pensions Accounting Briefing Defined Benefit Schemes of the AEX and AMX 5.1 Introduction We have analysed 44 AEX and AMX companies reporting in companies were excluded as they did not appear to sponsor a material defined benefit scheme. For Crucell, no annual account was available, which is probably due to the acquisition by Johnson & Johnson in February A full listing can be found in the Appendix. 25bn The 2010 annual reports of AEX and AMX companies show a combined 25 billion deficit for pension and other employee benefits. We have concentrated on the financial position of the Defined Benefit schemes in which the companies employees and former employees participate. Some companies offer post-retirement healthcare and other employee benefits, which we have included in our analysis as other liabilities as far as these figures were part of the employee provisions on the balance sheet. The pension arrangements in other countries than the Netherlands have also been included, although this was often dictated by the reports because detailed geographical splits were hardly disclosed. 5.2 Key findings We estimate that the combined deficit of AMX and AEX companies has increased from 24 billion for companies reporting in 2009 to 25 billion for companies reporting in Pension liabilities are significant for both AEX and AMX companies. We estimate that the combined 2010 pension liabilities for 44 AEX and AMX companies equal 188 billion. When other long-term employee benefits are also taken into account the combined liabilities of those companies total 200 billion (in 2009: 179 billion). A small number of companies have disclosed steps taken during 2010 to control pension risks and reduce pension deficits in the Netherlands. We expect this number will increase considerably in 2012 when the effects of the Dutch Pensions Deal and IAS19 reforms will influence the annual accounts. Recent changes to the mortality tables adopted in the Netherlands have acted to increase pension liabilities in Although exact figures were rarely disclosed, we estimate that liabilities have increased by between 4% and 8%. 5.3 Analysis of results IAS19 takes a snapshot of the accounting surplus or deficit at the company s year-end and, if the company has not chosen to spread gains and losses via the corridor option, this is generally the number that appears on the balance sheet.

19 LCP Netherlands Pensions Accounting Briefing Defined Benefit Schemes of the AEX and AMX 19 Changes over 2010 The chart below shows how worldwide funding levels have changed over the year for the 42 AEX and AMX companies in our report which have December 2010 year-ends (the other two have year-ends in March and June). Ratio of assets to accounting liabilities (%) Number of companies under to to to to or over Source: LCP analysis The average reported IAS19 funding level for companies with December year-ends increased by only 1% from 85% in 2009 to 86% in No spectacular movements were observed for any of the companies. Sources of deficits and surpluses For the AEX and AMX companies worldwide deficits increased by just over 1 billion over Unfortunately, positive investment returns ( 19 billion) have been more than offset by a combination of increased IAS19 values placed on projected benefits ( 13 billion) and interest charges ( 10 billion). Aggregate contributions paid ( 6 billion) have exceeded the IAS19 cost of extra benefits accrued over the year ( 3 billion). The overall effect was a net increase in deficit of 1 billion. 19bn Despite high combined investment returns of 19 billion, the overall 2010 deficit of AEX and AMX companies increased by 1 billion. IAS19 sources of deficits and surpluses for companies ( billion) New assumptions and experience Changes in liabilities Changes in assets Interest charged Benefits earned Investment returns and exchange rate differences Contributions Defined Benefit Schemes of the AEX and AMX Overall movement in the deficit Source: LCP analysis

20 20 LCP Netherlands Pensions Accounting Briefing Defined Benefit Schemes of the AEX and AMX 20bn The estimated deficit at 31 August 2011 of the AEX and AMX companies stood at just over 20 billion, compared with 69 billion in August Pension scheme deficits Through much of August 2011 investment markets have been showing great volatility, with significant declines in equities and gilt yields. Nevertheless, LCP Netherlands estimates that the aggregate pension deficit for the AEX and AMX companies analysed improved, and stood at just over 20 billion as at 31 August 2011, when compared to the 31 December 2010 position. The position at the end of August 2011 compares to an estimated position of 69 billion a year earlier. The chart below highlights how the position has developed over the past year and half. Projected aggregate pension deficit 0 Dec 2009 Feb 2010 Apr 2010 Jun 2010 Aug 2010 Oct 2010 Dec 2010 Feb 2011 Apr 2011 Jun 2011 Aug Surplus / Deficit bn AEX companies AMX companies -80 Note: All data is at month ends. Data is for the Dutch pension arrangements of 23 AEX companies and 21 AMX companies from pension disclosures in company accounts. Source: LCP analysis

21 LCP Netherlands Pensions Accounting Briefing Defined Benefit Schemes of the AEX and AMX 21 Pension schemes in relation to their sponsoring companies The chart below shows the size of accounting liabilities relative to companies market capitalisations for 44 companies of the AEX and AMX. The average AEX and AMX accounting liability was 42% of market capitalisation in both 2010 and Market capitalisation increased by 13%, largely due to the continued recovery of the investment markets over On the other hand, liabilities increased by around 12% mainly due to lower discount rates and increasing life expectancies. Despite this, some pension schemes still pose a very significant risk for certain companies. For example, Air France/KLM s accounting liabilities were over three and a half times the size of its market capitalisation in 2010, an improvement compared with approximately five and a half times at its accounting date in Other companies with higher accounting liabilities than their market capitalisation include AkzoNobel, BAM, Heijmans and Philips. Accounting liabilities as a proportion of market capitalisation (%) Number of companies under 5 5 to to to to to to to or over Defined Benefit Schemes of the AEX and AMX Source: LCP analysis

22 22 LCP Netherlands Pensions Accounting Briefing Defined Benefit Schemes of the AEX and AMX 5% On average, employee benefit deficits are 5% of market capitalisation. The chart below shows the size of accounting deficit relative to companies market capitalisations. Employee benefit deficits averaged over 5% of market capitalisation, compared to almost 6% in However, for some companies, the size of the IAS19 pension scheme deficit is significant to the value of the company itself. For example, SNS Reaal s accounting deficit was over 45% the size of its market capitalisation at its 2010 accounting year-end and for Delta Lloyd this figure was over 70%. Also, Aegon and AMG show relatively high ratios, over 30% for 2010 as well as For the three insurance companies Aegon, Delta Lloyd and SNS Reaal, these figures are slightly distorted because part of the assets held for the pension liabilities cannot be disclosed as scheme assets under IAS19 because these assets are held by the companies themselves. Accounting deficits as a proportion of market capitalisation (%) 35 Number of companies under 5 or in surplus 5 to 9 10 to to to or over Source: LCP analysis

23 LCP Netherlands Pensions Accounting Briefing Defined Benefit Schemes of the AEX and AMX 23 Employer contributions The following chart shows the employer contributions as a percentage of the benefits earned (ie the service costs) for 39 companies for which this information was available. In 2010, 77% of the companies paid more in contributions than the accounting value of benefits earned. Ratio of Employer Contributions to Benefits Earned (%) 77% Of the 44 AEX and AMX companies analysed, 77% paid more contributions to benefits earned Number of companies under to to to to to to or over Source: LCP analysis A number of companies have paid considerably more contributions. In particular Philips paid over 12 times benefits earned as employer contributions in Benefits earned included a negative prior service cost of 119 million reflecting changes to indexation on pension benefits paid in the future and the employer contributions included a 361 million contribution, being the value of the Company s full NXP stake sold in September 2010 to the Philips UK Pension Fund as part of a recovery plan. AkzoNobel was paying over 8 times benefits earned, but also BAM, Heineken, Reed Elsevier, Unilever and Wolters Kluwer have paid more than three times the benefits earned. Part of these high ratios is the result of additional contributions paid by the company for the recovery funding of one or more schemes with a deficit. These recovery contributions are mostly based on other mandatory assumptions. For example, in the Netherlands the pension liabilities of a pension fund should be based on the interest curve published by the Dutch Central Bank. For most pension funds this resulted in an average discount rate lower than 3.5% pa at the 2010 year-end, whereas the average IAS19 discount rate was around 5.0% pa. As a result, the funding deficit of a pension scheme based on these mandatory assumptions is usually higher than the accounting deficit, and additional cash payments are contributed accordingly. Defined Benefit Schemes of the AEX and AMX

24 24 LCP Netherlands Pensions Accounting Briefing Defined Benefit Schemes of the AEX and AMX At the other end of the spectrum, Aegon paid contributions that were only around 40% of benefits earned. As we understand, this low ratio is mainly caused by the fact that assets held by Aegon for the Dutch pension schemes are excluded. Under IAS19, these assets cannot be disclosed as scheme assets and they are therefore recognised elsewhere in the balance sheet as general account assets. Consequently, contributions for this scheme are also excluded and recognised as general income. What have companies done to tackle their deficits? Dutch companies have been looking for ways to reduce the level of risk of their employee benefit schemes. In 2010 we noticed further de-risking of IAS19 liabilities for some AEX and AMX companies. There were three types of de-risking. Changing the pension scheme from DB to DC DSM has carried out multiple changes with respect to their pension scheme in the Netherlands. The scheme has been changed from final pay into average pay as of 1 January Furthermore, as of this date, the funding agreement changes from DB into CDC. As a result of these changes, the Dutch pension scheme of DSM can be classified as Defined Contribution. The Dutch pension liability is removed from the 2010 year-end balance sheet. Furthermore, in anticipation of the Dutch Pensions Deal, the pensionable age will already be raised from 65 to 66 as of 1 January Changing the investment policy to hedge risks The main Dutch pension fund of TNT has changed its strategic asset allocation as a result of an Asset Liability Management study. The objective of this study was to decrease risk of the investment portfolio. As a result, the pension fund decreased its strategic weight of direct equity investments from 42% to around 11% and the proceeds were invested in bonds. To preserve part of the upward potential on equity and at the same time be protected for substantial decreases in equity valuations, the pension fund invested in equity derivatives. In addition the pension fund uses interest rate swaps and swaptions to reduce the net interest exposure. The study and the decisions based on its outcome were probably not mainly driven by de-risking from an IAS19 perspective, but it could have interesting consequences for the IAS19 disclosure figures of the company: -- It probably will contribute to a less volatile balance sheet, especially when the company can no longer defer actuarial results using the corridor method as of 2013.

25 LCP Netherlands Pensions Accounting Briefing Defined Benefit Schemes of the AEX and AMX Besides this, under the current IAS19, we expect new hedging investment policies could reduce companies profits as the expected return on assets would reduce, due to the expectation of a lower level of expected returns on the scheme assets. However, the new IAS19 forces all companies to set the expected return on scheme assets assumption equal to the discount rate. Buy-out of accrued benefits Heijmans and Nutreco have transferred part of their pension benefits from their local Dutch pension funds to an insurance company. The insurer guarantees the payment of these benefits, so the actuarial risks with respect to these benefits are no longer with the company. As a result, the pension liabilities on the balance sheet will decrease. 5.4 Key assumptions We consider below the key assumptions used to place an IAS19 value on pension benefits. Discount rates The discount rate is used to calculate a present value of the projected pension benefits. Under IAS19 the discount rate should be based on high quality corporate bonds and the duration of the corporate bonds should be consistent with the estimated duration of the pension obligations. We have analysed the discount rate in the chart below for companies with December 2010 reporting year-ends for Dutch and non-dutch schemes. Discount rates used in December 2009 and 2010 (% pa) Number of companies under 4.50 Source: LCP analysis 4.50 to to to to to or over The yields on high quality corporate bonds, and hence the discount rates, will fluctuate from day to day in line with market conditions. The discount rate has reduced slightly since December 2009, on average from 5.2% pa to 5.0% pa. Combined with the increased life expectancy this has had the effect of increasing companies reported pension liabilities. Defined Benefit Schemes of the AEX and AMX