DASB Statement *): Guidance for the application of IAS 19R in the Dutch pension environment

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1 PREFACE: DASB Statement *): Guidance for the application of IAS 19R in the Dutch pension environment The IASB issued the revised IAS 19 Employee Benefits (IAS 19R) in June IAS 19R includes various amendments to the existing standard, including the elimination of the corridor approach and the presentation of changes in the net defined benefit liability (or asset). The Dutch Accounting Standards Board (DASB) was among the parties whose efforts resulted in amendments to IAS 19R that have a major influence on reporting in the Dutch pension environment. The aforementioned amendments concern classification of post-employment benefit plans and measurement of defined benefit obligations. Given the DASB s close involvement in realising these amendments and because Dutch Accounting Standard (DAS) allows application of IAS 19 for post-employment benefits, as a result of which and contrary to the other IFRS Standards IAS 19R is effectively part of these standards, the DASB considers it desirable to publish this Guidance. The DASB has issued this Guidance in order to support Dutch practice in applying IAS 19R concerning the classification of post-employment benefit plans and the measurement of defined benefit obligations. The Guidance is not an interpretation of IFRS and, therefore, contains no authoritative statements or recommendations. The Guidance uses the main IAS 19R principles to determine the classification of post-employment benefit plans based on the characteristics and risks typical to post-employment benefit plans in the Netherlands. The clarifications included in IAS 19R and the possibilities under IAS 19R to classify a plan as defined contribution (DC) are explained in more detail. The Guidance also considers the IAS 19R provisions with respect to risk-sharing and shared-funding when measuring defined benefit obligations. In relation to Dutch defined benefit plans there are circumstances where the aforementioned circumstances may significantly reduce the defined benefit obligations in the financial statements. It should be noted that the Netherlands Financial Assessment Framework [Financieel Toetsingskader] (FAF), which applies to Dutch defined benefit plans, may affect the measurement under IAS 19R. The DASB emphasises the support function of this Guidance for financial reporting. It does not contain authoritative statements or recommendations, as risk-sharing and shared-funding are by nature very complex, and the guidance included in IAS 19R is very limited. Furthermore, the practical application of this Guidance will need to further develop itself. Each legal entity will have to assess for itself whether the measurement method selected complies with IAS 19R. When opportune, the Guidance may possibly be adapted. Dutch legal entities may apply IAS 19R once the European Commission has endorsed this amended standard. 1

2 The DASB invites you to communicate responses and comments on this Guidance, preferably by to the DASB secretarial department. The DASB will treat them as public information and publish them on the DASB website, unless respondents have specifically stated their comments should be regarded as confidential, either in whole or in part. Amsterdam, 30 January 2012 *) This document is a translation of the original DASB Statement on the application of IAS 19R in the Dutch pension environment 2

3 SUMMARY General Each post-employment benefit plan must be classified and measured according to its specific facts and circumstances. The changes in IAS 19R as compared to IAS 19 may lead to different classification or measurement of Dutch defined benefit plans. IAS 19R clarifies the conditions for classification of post-employment benefit plans as either a DC or a DB plan. These clarifications are particularly relevant for industry-wide pension plans. Futhermore, IAS 19R contains new provisions to account for risk-sharing and shared-funding, when measuring defined benefit obligations. When applied to Dutch defined benefit plans, this may in certain circumstances, significantly reduce the defined benefit obligations in the financial statements. It is important to consider how the Netherlands Financial Assessment Framework [Financieel Toetsingskader] (FAF), which applies to Dutch defined benefit plans, affects the measurement under IAS 19R. The DASB emphasises the support function of this Guidance for Dutch financial reporting practice. It does not contain authoritative statements or recommendations, as risk-sharing and shared-funding are by their nature very complex. The guidance included in IAS 19R is very limited and its practical application will need to further develop itself. Application of specific approaches for measuring the defined benefit obligation where DB plans are involved have still to be developed. Each legal entity will have to assess for itself whether the measurement method selected complies with IAS 19R. Classification IAS 19R currently stipulates that if an employer wants a classification as a DC plan, it is not necessary for the employer not to run any actuarial risk whatsoever. The Guidance contains examples of such risks. For example it is explained that a formula in which post-employment benefits are based on salary/years of service, will not lead to classification as a DB plan, if there is no obligation for the legal entity to provide further contributions if the fund does not hold sufficient assets. Classification of industry-wide pension plans A legal entity that is a member of an industry-wide pension plan will usually not have an obligation to provide further contributions, in the event of a deficit in the fund. As a result Dutch legal entities may usually classify their industry-wide pension plans as DC plans under IAS 19R. There are, however, exceptions. An industry-wide pension plan is classified as a DB plan if the legal entity s obligation is not limited to paying the fixed contribution relating to the current period. The Guidance describes situations in which that may be the case. 3

4 Classification of company pension plans A company pension plan may only be classified as a DC plan if an employer runs no or hardly any actuarial risk. This may, for example, be the case with CDC plans. The Guidance describes conditions for classification as a (C)DC plan. Similarly, the Guidance provides examples of situations that lead to classification as a DB plan. Classification of insured plans If a legal entity pays insurance premiums to a life insurance company to fund a post-employment benefit plan, the plan may technically be recognised as a DC plan, unless the legal entity effectively still runs an actuarial risk relating to employee service in the current and prior periods. The Guidance describes examples of situations that lead or may lead to classification as a DB or a DC plan. Measurement of DB plans This section of the Guidance discusses the IAS 19R provisions for considering risk-sharing and shared-funding when measuring defined benefit obligations and is solely relevant for plans that are classified as DB plans. The elements of risk-sharing and shared-funding with respect to Dutch defined benefit plans concern: - conditional status of indexations and benefits; - restriction of employer contributions (also referred to as liability ceiling ); - employee contributions. The Guidance deals separately with the particular details of these elements. They should however, be considered in totality when measuring the defined benefit obligation. A major basic assumption in this respect is the defined benefit plan s funding status, which influences both the future contributions and the benefits paid. In the Netherlands the financial solvency of the fund is determined on the basis of the FAF. The FAF has its own financial and actuarial assumptions and these deviate from the assumptions under IAS 19R. It is therefore important in the Dutch pension environment, to take account of the influence of the FAF on the measurement under IAS 19R. Conditionality of indexations and benefits Calculation of the defined benefit obligation incorporates expected conditional indexations based on the fund s current and future funding status according to FAF principles. This is based on the market expectations applicable at balance sheet date for the period in which the obligations will be settled. In this manner the best estimate of the expected indexations based on market expectations is included in the measurement (including the possibility to recover any forfeited indexations in later years), even though the expected indexation is conditional. Note that the market expectations may deviate from the assumptions applied by the defined benefit plan. Similarly, this applies to expected reductions of benefits. 4

5 Restriction of the employer contributions (liability ceiling) If employer contributions are limited to a certain maximum amount and result in a restriction of the cost of the benefits for the employer, then this will be taken into account when measuring the defined benefit obligation. IAS 19R does not, however, contain guidance or examples on how the effect of the liability ceiling must or can be determined. A reduction caused by the liability ceiling may not result in a net defined benefit asset. Employee contributions Employee contributions are a form of shared-funding. Furthermore, employee contributions may also lead to risk-sharing. One of the amendments of IAS 19R relates to the inclusion of employee contributions in measuring the defined benefit obligation. The basic assumption is that the best estimate is made of the cost of the benefits that will be for the account of the employer, which cost is then allocated to the related periods. 5

6 Guidance for the application of IAS 19R in the Dutch pension environment General Introduction 101 The IASB issued the amended IAS 19 Employee Benefits (IAS 19R) in June IAS 19R includes both provisions relating to the classification of post-employment benefit plans and relating to the measurement of defined benefit obligations. These provisions will have a major effect on financial reporting in the Dutch pension environment. The Dutch Accounting Standards Board considers it recommendable to provide supportive guidance on how the amended standard is applied in the Dutch pension environment. Especially as DAS allows the application of IAS 19 for post-employment benefits. As a result, IAS 19R, contrary to the other IFRS Standards, effectively forms part of the Dutch standards. With this Guidance, the DASB endeavours to offer Dutch practice guidance for the application of the provisions on classification of post-employment benefit plans and measurement of defined benefit obligations as prescribed in IAS 19R, based on the specific features and characteristics of the most common post-employment benefit plans used in the Netherlands. 102 It goes without saying that each post-employment benefit plan should be classified and measured on the basis of specific facts and circumstances surrounding it. The changes in IAS 19R compared to IAS 19 may lead to a different classification or measurement. Furthermore, changes in the specific facts and circumstances may, over time, result in an amended classification or measurement. Classification Main provisions in IAS 19R 201 The appendix includes the most important, relevant provisions relating to classification in IAS 19R (the changes compared with IAS 19 are included in the appendix). Concepts in the Dutch pension environment 202 If a legal entity which is active in the Netherlands, makes legally-enforceable pension commitments to its employees, including employees seconded abroad, then pursuant to the Pension Act, the resulting defined benefit obligations must be transferred (with a few exceptions) to: a. an industry-wide pension plan; or b. a company pension plan; or c. a life insurance company. 203 Other than national State plans such as the General Old Age Pension Act [Algemene Ouderdomswet, or AOW], industry-wide pension plans are funds in which plan assets are held to eventually pay benefits to (former) employees, of more than one legal entity that do not have or have had a joint management (not being a multi-company pension plan) and with which the 6

7 contribution and benefit levels are determined without distinguishing between the legal entities participating in the plan. This may include plans that have not been transferred to an industry-wide pension plan, provided they have the same characteristics and they meet the definition of an industry-wide pension plan. 204 A company pension plan 1 is a plan whereby plan assets are held to pay benefits to (former) employees of one or more legal entities, which have a joint management. Changes in the general classification provisions of IAS 19R 205 The addition of in substance on the employee in IAS 19R.28 means that it concerns a DC plan if the actuarial risk 2 effectively 3 or in reality falls on the employee 4 (and, as a result, effectively or in reality does not fall on the employer). This means that a DC plan is involved, if an employer effectively has no other obligations, legally or constructively, than the payment of fixed contributions to the fund, predetermined or otherwise, and the benefits effectively depend on the contributions paid and the investment returns arising from these contributions. Therefore, to have a plan classified as DC, it is not necessary for an employer to run no actuarial risk at all (e.g., due to circumstances such as described in paragraph 224). 206 Furthermore, the example included in IAS 19R.29, and the note to this in IAS 19R.BC30 clarify that a benefit formula based on years of service and salary, does not in itself lead to classification as a DB plan, if the legal entity has no obligation to pay further contributions in the event of insufficient plan assets. 1 For the purpose of this Guidance a company pension plan may also include post-employment benefit plans that are transferred to a multi-company pension plan. The Pension Act allows company pension plans to merge into a multi-company pension plan, wherein the multi-company pension plan may carry out the plans of the original company without any changes. A multi-company pension plan applies ringfencing to segregate the assets of the participating company plans. Ringfencing means the assets of each participating pension plan are separated (in a ring) from the other assets contributed. The Decree on the Financial Assessment Framework for pension plans [Financieel Toetsingskader] within the meaning of the Pension Act applies to each ring. The measurement of defined benefit obligations, the determination of the cost-covering contribution levels, the testing of the solvency ratio, and the preparation of a recovery plan, take place for each ring separately. Because the benefit plans and the funding agreements may differ per ring, the classification should be determined for each ring separately or per affiliated legal entity. 2 Actuarial risk covers all risks arising from actuarial results. Actuarial results arise due to differences between the expectations assumed in the demographic and financial assumptions and reality (in respect of e.g. survival rate, salary development, return on the plan assets) and due to changes in the discount rate and in other actuarial assumptions applied. Included herein is the investment risk. 3 This Guidance also refers to a risk that effectively or in reality falls on a party, as a risk that fully or almost fully lies with that party, or (depending on the context) as a risk that does not or hardly lie with other parties. 4 Or another third party, e.g., an insurer. 7

8 Relevant characteristics and risks of post-employment benefit plans in the Dutch pension environment, for classification purposes 207 The classification of a post-employment benefit plan as a DC plan or a DB plan is determined on the basis of the legal entity s legally-enforceable or constructive obligations. This assessment takes place on the basis of the substance of the pension agreement, the formal terms of the plan and the administration agreement 5. This assessment also includes any communications concerning the post-employment benefit plan to the participants. In terms of financial reporting, the characteristics and risks specific to a certain type of pension agreement form an initial indication for the classification as a DC plan or a DB plan. The Pension Act addresses in detail the various characteristics and risks typical to the various types of pension agreements, viewed from the perspectives of the administering pension fund and the employee. Although classification of a post-employment benefit plan, as part of the financial reporting, takes place from the perspective of the employer, these characteristics may offer a good indication of the classification to be adopted. The Act distinguishes three main forms: a defined benefit agreement, a defined capital agreement and a defined contribution agreement. In practice the Collective DC plans (hereinafter: CDC plans ) are a fourth variant. The underlying thought behind a CDC plan is that the legal entity makes available a contribution each year, whereby the pension fund attempts to administer, for the participants collectively, a defined benefit plan from the available funds. If the funds to implement the plan are insufficient the underlying principle is not to revert to the legal entity, but to have the participants bear the deficit collectively, e.g., by reducing the indexation or vested benefits (either immediately or over a period of time). 208 The contents of the pension agreement, the formal terms of the plan on which the benefits to the employees are based, and the administration agreement determine the corresponding obligations incurred by the legal entity. This assessment is not viewed from the employees perspective but is effectively based on the examination of the obligations of the legal entity. For this reason it is possible to have circumstances under which, e.g., in accordance with the example such as described in IAS 19R.29 under a, a defined benefit agreement requiring characterisation pursuant to the Pension Act, is classified as a DC plan. 209 A DC plan s main feature is that the obligation of the legal entity is limited to paying the fixed contributions relating to the current period. This need not be a fixed annual contribution. For example, plans with contributions based on a pre-agreed percentage of the salary or related to age, are also included. The level of benefits that employees receive at or after their retirement depend on the contributions paid by or still outstanding from the legal entity (and any employee contributions) together with the investment returns generated by the fund. In the event of insufficient plan assets the plan deficit will be covered fully or almost fully by reducing the benefits (either by reducing or forfeiting the indexations, or by reducing the benefits already vested) paid to plan participants. 5 For the purpose of this Guidance an administration agreement is considered to include the administration rules of an industry-wide pension plan. 8

9 As a result, the legal entity runs no or hardly any actuarial risk. Consequently, the employees and/or pensioners, or a life insurance company fully or almost fully bear this risk. 210 In accordance with a DC plan the agreed contribution is usually determined such that an expected amount of benefit payments will be possible according to an assumed return on plan assets over the term of the employment. As stated, the employee 6 runs the risk of the ultimate benefit payments varying from the initial expectations. Accordingly, the legal entity has no obligation or cannot be obliged to fund the deficit of a plan.. Circumstances may, however, occur which indicate a DB plan. Indications are: a. the legal entity directly or indirectly guarantees a specified return on the contributions; or b. the policy that the legal entity has consistently applied gives rise to a constructive obligation that goes beyond the payment of contributions. 211 When classifying a post-employment benefit plan, the related communications to the participants concerning the post-employment benefit plan form another important factor. Usually, these communications will substantially agree to what has been stipulated in the pension agreement, the formal terms of the plan, and the administration agreement. If, however, the communications have created valid expectations with the participants that exceed what has been stipulated in the pension agreement, the formal terms of the plan, and the administration agreement, this may influence the classification of the post-employment benefit plan. It may, e.g., happen that based only on the contents of the pension agreement, the formal terms of the plan, and the administration agreement there is formal justification for a DC plan. Should the communications regarding the post-employment benefit plan create a valid expectation on the part of the participants that the legal entity will make additional contributions in the event of insufficient plan assets, it effectively results in a DB plan and classification as such. 212 Paragraphs 214 through 218 of this Guidance provide more detailed features regarding the classification of an industry-wide pension plan in the financial statements of an affiliated legal entity. Paragraphs 219 and 220 provide more detailed indications in that respect when a company pension plan implements a plan. Finally, paragraphs 221 through 224 discuss the further particulars in the event of implementation by a life insurance company. 213 If an industry-wide pension plan has one or more dominant participating employers, it may not be possible to classify a post-employment benefit plan transferred into that fund in accordance with the paragraphs 214 through 218. In such a case, the plan will to a greater or lesser extent have the characteristics of a company pension plan. The classification then takes place on the basis of the specific facts and circumstances, whilst considering paragraphs 219 and 220 (also see IAS 19R.BC39). Particular features involved with the classification of industry-wide pension plans 214 In general, the obligation to pay contributions to an industry-wide pension plan does not originate from the past, but from the employer s (mandatory) participation in the fund in the current year. Participation may be terminated in the Netherlands if the employer has been granted an exemption from the obligation to participate after a request to that end, or if the employer no 6 This would include former employees of the legal entity who participate or have participated in the defined benefit plan, i.e., the pensioners and the so-called sleepers. 9

10 longer has employees in the specific industry covered by the fund. In general, if the participation is terminated because the employer no longer has employees in the specific industry (e.g., due to termination of activities, due to transferring activities abroad, or in the event of a change of activities so the mandatory participation in the fund no longer applies), no settlement takes place. Paragraph 215 describes the situation where settlement does take place. A classification as a DC plan may technically apply if the employer solely has an obligation to pay contributions and not to pay additional contributions in the event of insufficient plan assets, even if the post-employment benefit plan is characterised as a defined benefit agreement under the Pension Act (see paragraph 206). If this situation occurs the benefit payments will effectively be based on the lower of the benefit formula and the plan assets available. (IAS 19R.BC30). 215 IAS 19R.45 stipulates that State plans commonly classify as DC plans. One of the situations where this occurs is if the legal entity s sole obligation is to pay the contributions over the year when they are due, while there is no obligation to pay the benefits earned by its own employees in prior years from the moment the legal entity ceases to employ members of the state plan. Also in Dutch industry-wide pension plans, the entity s sole obligation is to pay the contributions over the year. A settlement generally 7 only takes place if an actuarial-related loss for the industrywide pension plan arises in a situation where an employer voluntarily terminates its participation in an industry-wide pension plan, in order to obtain the required exemption to participate in the plan. However, if voluntary termination is expected, IAS 19R.39 stipulates that recognition and measurement of the obligation should not take place according to IAS 19R, but according to IAS 37 Provisions, Contingent Liabilities and Contingent Assets. 216 A legal entity that is a member of an industry-wide pension plan usually has no obligation to pay additional contributions, not being an increase of contributions related to future periods of service, if the fund has a deficit. Participating legal entities cannot assert their rights to any surpluses in a fund. Industry-wide pension plans will therefore usually be classified as a DC plan, except for extraordinary circumstances/agreements (related examples are outlined hereinafter). As detailed in previous paragraphs, the entity s only obligation concerns payment of contributions over the year when due and this obligation only originates from the participation in the fund in that specific year and not from participation during previous years. Furthermore if future contributions include limited variations in contribution levels, the plan may qualify as DC, provided the variability is merely expressed through average contributions related to future periods of service, that only need to be paid if and insofar as the legal entity continues to participate in the industry-wide pension plan through active employees. The classification process also considers whether the variation in contribution levels is expected to be limited to such an extent that, in substance, actuarial risks do not fall on the legal entity. 7 In practice there are industry-wide pension plans with which, in a situation other than voluntary termination, withdrawal amounts are paid based on an actuarial-related loss of the plan. If as a result thereof the actuarial risk falls in substance on the participating legal entity, then the industry-wide pension plan classifies as a DB plan. 10

11 Insofar as the variation in contribution levels is linked to future factors, such as the interest rate that affects the costs of future service benefits, this does not indicate an actuarial risk for the employer, because this variability does not relate to employee service in current and prior periods. 217 An industry-wide pension plan does classify as a DB plan if the terms of participation indicates that the participating legal entity has a legal or constructive obligation to fund the deficit of the plan. A situation where this may occur is if the legal entity has an obligation to make additional contributions to the industry-wide pension plan in the event of a deficit, other than by paying higher average contributions related to future periods of service (see paragraph 216 relating to limited contribution variability). If the future contributions may be increased by contract or due to valid expectations such that the deficits may be eliminated in the short-term either fully or almost fully, then there may be a legal or constructive obligation to make additional payments and a resulting classification as a DB plan. 218 IAS 19R.148 contains specific disclosure requirements for industry-wide pension plans that are classified as DB plans, but that are accounted for as if they were DC plans pursuant to IAS 19R.36. These requirements do not specifically apply if an industry-wide pension plan is classified as a DC plan. Considering the specific characteristics of industry-wide pension plans a number of the disclosure requirements may still be relevant to these plans. This may concern the disclosures, insofar relevant, referred to in IAS 19R.148 and/or DAS , e.g., a description of the main characteristics of the industry-wide pension plan, the administration agreement rules and any recovery plan of the industry-wide pension plan. Particular features concerning the classification of company pension plans 219 The pension agreement, the administration agreement, and the communications to the participants in the plan are important for the classification of a post-employment benefit plan. In practice, a legal entity may be obliged to pay additional contributions, pursuant to the pension and the administration agreement, or pursuant to a constructive obligation, if deficits arise in the company pension plan. If such an obligation to make additional payments exists, a company postemployment benefit plan is classified as a DB plan. A company post-employment benefit plan may only be classified as a DC plan if an employer runs no or hardly any actuarial risk. This can, e.g., be the case with CDC plans. Company pension plans can only be classified as a (C)DC plan if: 1 the administration agreement shows that the employer has no obligation to make additional payments if the plan has a deficit; 2 the agreed contribution setting mechanism 8 shows that the employer has no or hardly any actuarial risk; and 3 the (former) employees have been adequately informed about the conditional status of their benefits. 220 Examples of situations that do not meet the conditions referred to above and that, as a result lead to classification as a DB plan are: 8 A contribution setting mechanism is defined as a method by which the pension contribution is determined based on predetermined parameters, without taking into account a funding shortfall or surplus. 11

12 1 lack of a contribution setting mechanism agreed beforehand and the parameters to be applied; 2 surpluses in the plan available to the legal entity, directly as refund or as a reduction in future contributions, or indirectly by benefit improvements initiated by the legal entity; 3 the legal entity has the obligation to supplement any deficits in the plan; 4 the legal entity voluntarily supplements any deficits in the plan whereby there is a constructive obligation; 5 indexation 9 is unconditional; 6 a final pay plan is involved; or 7 communications to the employees about the conditional status of the benefits, i.e. the risk of lower or higher benefit levels for the employees, has been insufficient. Specific features involved with the classification of insured plans 221 The decisive factors for classifying a plan that has been transferred to a life insurance company are the contents of the post-employment benefit plan and the agreement between the legal entity and the life insurance company. 222 If a legal entity pays a life insurance company premiums to fund benefits, the plan may technically be recognised as a DC plan, unless the legal entity effectively still runs an actuarial risk relating to employee service in the current and prior periods. This may occur if based on the plan or a consistently applied policy the legal entity has an obligation to: pay the benefits as soon as they become payable; or pay additional amounts (e.g., as with a final pay plan). 223 If the legal entity continues to have such an obligation, the related plan is classified as a DB plan, unless the legal entity runs no or hardly any actuarial risk. Examples of actuarial risks that may be important to the related assessment and that will lead to classification as a DB plan, concern: 1 the pre-agreed contribution may be adjusted to occurred actuarial results; 2 indexation is unconditional and may lead to additional payments for the account of the employer; 3 in its communications vis-à-vis employees the legal entity states it will make additional contributions in certain expected and unexpected circumstances; 4 excess interest or profit-sharing pursuant to the insurance contract may become available to the legal entity, either directly as refund or as reduction in future contributions, or indirectly by the legal entity initiated benefit improvements, other than indexations agreed in the plan; 5 the legal entity pays surcharges for vested benefits relating past service years, such as for (interest) guarantee or solvency purposes; or 6 any losses or gains from individual value transfers (caused by the transfer of former employee s vested benefits to the plan administrator of the current employer of the former employee) which may be charged or credited to the legal entity. 224 Classification as a DC plan does allow a legal entity to run some actuarial risk. The following situations are examples where the conclusion may still be that the legal entity does not effectively 9 The Pension Act refers to supplement instead of indexation ; this Guidance consistently refers to indexation, partly because this aligns with DAS 271 Employee benefits. 12

13 run an actuarial risk: 1 one-off payments to the insurer that ensue from changes in legislation and regulations. This may include the situation where the risk of individual value transfer has been transferred to the insurer, but that the mortality tables prescribed by legislation and regulations change. This is conditional on all other risks immediately being transferred again after having made the one-off contribution to compensate for the adverse effect of the change prescribed by legislation and regulations; 2 a contribution that only increases due to prospective elements, such as an increase of the employees average age, or a falling interest rate, as a result of which the future cost of benefits increases. If the contribution only relates to the cost of the benefits earned in the current year, is set by a pre-agreed mechanism and does not relate to actuarial results in prior service periods, then the employer has no risk that can be linked to the past service. Measurement of DB plans: risk-sharing and shared-funding 301 This section of the Guidance discusses the IAS 19R provisions for taking into account risksharing and shared-funding when measuring defined benefit obligations. This section is solely relevant to plans that are classified as DB plans. Main IAS 19R provisions 302 The appendix includes the main changes to the IAS 19R provisions relating to measurement. Changes in the IAS 19R measurement provisions 303 The changes 10 in the IAS 19R measurement provisions relate to aspects of risk-sharing and shared-funding and contain three elements: 1. Consideration of the conditional status of indexation, and in certain situations also the benefits, when calculating the defined benefit obligation; 2. Consideration of a limit on contributions required by the employer when measuring the defined benefit obligation; 3. Consideration of employee contributions when measuring the defined benefit obligation and attributing the costs of the benefits to current and prior periods. This Guidance will now successively discuss these elements. Characteristics and risks of defined benefit plans that are relevant to measurement in the Dutch pension environment 304 A new element in IAS 19R is the explicit role of risk-sharing and shared-funding when measuring defined benefit obligations. Risk-sharing means the actuarial risk is spread over several 10 The changes sometimes concern further clarifications and the extent of change will depend on the extent in which to date, the legal entity already takes account of the related aspects. 13

14 parties. Employers, employees 11, and other third parties, e.g., insurers 12 mostly share the actuarial risks in the Dutch pension environment. Shared-funding means several parties provide funding for the obligation to pay benefits: in the Dutch pension environment these parties are employers and employees. The following characteristics of many Dutch defined benefit plans are examples of risk-sharing and shared-funding that may influence the measurement of defined benefit obligations under IAS 19R: Conditionality of indexation and benefits: - indexations takes place from excess returns on investment; - indexations are reduced or forfeited in deficit situations; - vested benefits are reduced (written down) in deficit situations. Limitation on employer contributions (liability ceiling): - restriction of employer s obligation to pay additional contributions in the event of a plan deficit; - limited contribution increase in the event of a plan deficit; Employee contributions: - employees pay a fixed percentage of their pensionable basis (e.g., salary); - employees pay a fixed part of the total pension contribution. The financial or solvency status of the defined benefit plan is one of the basic assumptions for measuring the defined benefit obligation under IAS 19R. The plan s financial status is relevant to, e.g., setting the level of contribution, granting indexation (whether partially or not) and to any measures in the event of a plan deficit. The plan s financial status is determined on the basis of the Financial Assessment Framework (FAF), which applies to defined benefit plans in the Netherlands. It is therefore essential to take account of the FAF s effect on the measurement under IAS 19R in the Dutch pension environment (see paragraph 307). The remaining part of this Guidance will address the particular features of the characteristics referred to above. The interactions between the various aspects will have to be examined if the best possible measurement of the legal entity s defined benefit obligation is to be achieved. Estimating future indexations is influenced by, e.g., the agreements on future employee and employer contributions, which are provided in the indexation matrix as laid down in the Pension Act. Distinctive elements include the funding source (excess return, contribution, or a combination of surplus return and contribution) and the ambition level (such as no policy, fixed percentage, salaryindex/price index-compensation) of future indexations. 11 This includes former employees of the legal entity who participate or have participated in the defined benefit plan, i.e., the pensioners and the so-called sleepers. 12 The defined benefit plan itself generally bears no risk, because it merely implements the pension agreement. However, the assets within the plan may serve as a buffer, temporarily or otherwise. Ultimately, the effects of these risks will, however, be for the account of the employer, employee, or a third party. 14

15 Specific measurement features relating to conditional status of indexations and benefits 305 The IASB clarifies in IAS 19R.BC147 and BC149 that when calculating the defined benefit obligation the best estimate of the expected conditional indexations based on the current funding status of the plan must be taken into account. In this respect the financial assumptions to be applied must be based on the market expectations applicable at balance sheet date for the period in which the obligations will be settled. Therefore, the measurement must include the best estimate of the expected indexations based on market expectations, even though the expected indexations are conditional. 306 Conditionality of future indexations is a regularly occurring instrument to share actuarial results with the employees. The best estimate of the future indexation should be taken into account as basic assumption. This need not correspond with the indexation ambition. Estimating future indexation partly depends on the related agreements made, e.g., the pension agreement and administration agreement, including agreements on any catch-up indexation (i.e., the possibility to compensate for any forfeited indexation in later years, just as soon as the funding status permits this). 307 The indexations to be effectively granted and the (other) increases or reductions of benefits, depend on the defined benefit plan s current and future funding status and the related Financial Assessment Framework (FAF). Estimating the plan s future funding status is based on assumptions of the legal entity based on current market expectations, e.g., relating to the expected return on plan assets. Those assumptions may deviate from the assumptions applied in the FAF principles. 308 IAS 19R.88 (c) stipulates that a best estimate must be made regarding the expected increases or reductions of the benefits (also see IAS 19R.BC150(c)). This is how the best estimate of the benefit levels as required by IAS 19R.76 (b) (ii) is made. Specific measurement features in the event of a restriction of employer contributions (liability ceiling) 309 Dutch defined benefit plans may include a ceiling on employer contributions. IAS 19R.91 stipulates that such limitations (liability ceiling) are taken into account if this results in a reduction of the costs of the benefits to the employer. It may be deduced from this provision and the related note in IAS 19R.BC150 (d) that future service costs exceeding the limit on the employer s (future) contributions, will affect the amount of the defined benefit obligation and the service costs. 310 Consideration of the liability ceiling shows similarities with the so-called asset ceiling requirements of IFRIC 14. This is particularly true for the period over which its effects are determined. Both IAS 19R.91 and IFRIC determine this period to be the shortest of the estimated life of the entity and the estimated life of the plan. IAS 19R includes no other guidance or examples as to how the effect of the liability ceiling must or can be determined. 311 The maximum contributions payable by the employer can be lower than the future service cost. This is, for instance, the case if: 1. indexation is not funded by the employer, as a result of which the employer s obligation is limited, e.g., if a current salary plan with conditional indexation financed from excess returns on plan 15

16 assets is in place; or 2. a plan deficit will not or not exclusively be funded by employer contributions, e.g., if benefits are reduced (see also paragraphs 305 through 308). IAS 19R does not unequivocally prescribe a method for determining the effect of the liability ceiling that can be applied in all cases. The legal entity must apply a calculation method tailored to the specific situation based on the facts and circumstances. Considering the position of IAS 19R.91 within IAS 19R, i.e., as part of the actuarial assumptions for measuring the defined benefit obligation, as yet the following approaches have been identified: 1. Based on the current workforce; and 2. Based on a stable workforce (see also IFRIC 14.17). An approach based on the current workforce (i.e., without influx of new employees) seems to represent a calculation method applicable in situations such as in example 1, whilst an approach based on a stable workforce seems to represent a calculation method applicable in situations such as in example 2. Application of those approaches and the ensuing discussion in practice will have to indicate whether and in what situation which of these approaches, or perhaps other variants, are acceptable. 312 In the approach based on the current workforce, the maximum employer contributions are compared against the future service costs of the current employees (net of the related employee contributions). In this approach the defined benefit obligation is limited by the liability ceiling and the effect of the liability ceiling will, therefore, usually impact the service cost attributable to a service period. Under the approach based on a stable workforce (mirror image of the asset ceiling under IFRIC 14), the net defined benefit obligation (defined benefit obligation minus plan assets) will be reduced to the present value of the maximum future employer contributions less the future service cost (net of the related employee contributions). Under this approach a calculation is, therefore, only made if a net defined benefit obligation exists at the end of the period. The effect of the liability ceiling will usually be part of the actuarial results. The approach based on a stable workforce specifically takes account of the situation whereby the contributions for future (usually younger) employees are also used to fund part of the benefits earned by current employees, due to the fact that in the Netherlands average contributions are calculated instead of individual contributions. The average contributions for younger employees usually exceed the contributions individually determined for those individuals. Conversely, the average contributions for older employees tend to be lower than the contributions individually determined for them. 313 Any reduction due to the liability ceiling may not create a net defined benefit asset. Specific features of measurement relating to employee contributions 314 In the Netherlands, the manner in which employees contribute to the costs of the plan is usually agreed contractually (pension agreement, employment contract, formal terms of the plan). 16

17 This implies that employee contributions are usually part of the formal terms of the plan and are not discretionary by nature (IAS 19R.92). 315 Employee contributions are a form of shared-funding and may, in addition, lead to risk sharing. This is the case if the employee contribution varies according to the funding status of the defined benefit plan. If the employee contribution consists of a fixed percentage of the salary or the pensionable basis, there is joint funding but only a limited extent of risk-sharing (effectively solely relating to future salary increases). Such employee contributions are also included in the measurement as described in the following paragraphs. 316 If the employer and the employee share the pension costs and risks fully on a pro-rata basis, it would be justified to reduce the net defined benefit obligation (asset) calculated without taking into account the employee contributions, by the part that will be borne by the employees. In the Dutch environment, risk-sharing with the employee is generally not so comprehensive and it will have to be assessed whether and to what extent the net defined benefit obligation is borne by the employee. 317 IAS 19R.93 stipulates that a distinction should be made between employee contributions that are linked to service and contributions that cover an existing deficit or existing losses. The latter effectively implies a claim on the employee that will remain valid on or after his resignation. The latter situation is exceptional in the Netherlands, where employee contributions are generally collected on continuation of employment through withholdings from the salary. Therefore, they are generally linked to the periods of service. The risk exists that employee contributions will not be received if the employee leaves service, since the employee will no longer pay any contributions in that situation. These employee contributions are, however, still taken into account given that IAS 19R is based on the principle of an entity s best estimate of the ultimate cost of providing post-employment benefits, and their attribution to the related service periods. 318 Under IAS 19R.93, contributions from employees in respect of service are deducted from the service cost and are attributed to periods as negative benefits in accordance with the benefit attribution method required by IAS This means, as IAS stipulates, that on balance the net benefit should be attributed to periods of service. IAS 19R.BC150 (a) explains this. 319 It would be outside the scope of this Guidance to elaborate the above principles into concrete actuarial measurement models. Nevertheless the following approaches have been identified as yet, based on the text of IAS 19R.93 and IAS 19R.BC150 (a): 1. the negative benefit can be expressed by attributing the present value of the aggregate employee contributions to periods of service based on the projected unit credit method, this requires the availability of (or an estimate of) the history of paid contributions of the employees; or 2. the increase in the future contributions payable by the employee due to future salary increases is attributed to periods of service based on the projected unit credit method. Application of these approaches and the ensuing discussion in practice will have to indicate whether and in what situation which of these approaches, or perhaps other variants, are acceptable. In a 17

18 number of cases, however, the outcome of both approaches will not differ materially. This will particularly depend on the age structure of the employee population and on the actuarial financial assumptions applied. Moreover, in certain cases the effect of the employee contributions will be less relevant if the effect of a liability ceiling as described in paragraphs 309 through 313 has already been taken into account. 320 Since at the end of an employee s period of service no more contributions will be collected that might reduce the employer s benefit obligation, the defined benefit obligation for this employee will equal the defined benefit obligation of an identical plan without employee contributions. 321 IAS 19R.94 states how the effect of changes in employee contributions must be presented. As in the Netherlands this effect usually concerns changes in contributions that are part of the formal terms of the plan, this effect will usually be part of the actuarial gains and losses. This means that if the employee contribution is increased in case of a low solvency ratio of plan, for instance due to investment losses, the corresponding effect is recognised as an actuarial result in the same way as the recognition of investment losses. Disclosure on aspects of measurement 322 The choices and estimates a legal entity makes to take account of risk-sharing and shared funding in the application of IAS 19R, can have a major impact on the net defined benefit liability or asset. Therefore and in accordance with IAS 19R.135, it is relevant to disclose information that explains the nature and characteristics of these specific features, the manner in which these have been taken into account and the impact thereof. IAS 19R.136 stipulates that the legal entity considers the level of detail necessary to satisfy the disclosure requirement of IAS 19R

19 Appendix: main relevant provisions in IAS 19R Main provisions relating to classification (the changes compared with IAS 19 have been marked) Definitions relating to classification of plans IAS 19.8 Defined contribution plans ( DC plans in the Guidance) are post-employment benefit plans under which an entity pays fixed contributions into a separate entity (a fund) and will have no legal or constructive obligation to pay further contributions if the fund does not hold sufficient assets to pay all employee benefits relating to employee service in the current and prior periods. IAS 19.8 Defined benefit plans ( DB plans in the Guidance) are post-employment benefit plans other than defined contribution plans. 19

20 Distinction between defined contribution plans and defined benefit plans IAS Post-employment benefit plans are classified as either defined contribution plans or defined benefit plans, depending on the economic substance of the plan as derived from its principal terms and conditions. IAS Under defined contribution plans the entity s legal or constructive obligation is limited to the amount that it agrees to contribute to the fund. Thus, the amount of the postemployment benefits received by the employee is determined by the amount of contributions paid by an entity (and perhaps also the employee) to a post-employment benefit plan or to an insurance company, together with investment returns arising from the contributions. In consequence, actuarial risk (that benefits will be less than expected) and investment risk (that assets invested will be insufficient to meet expected benefits) fall, in substance, on the employee. IAS Examples of cases where an entity s obligation is not limited to the amount that it agrees to contribute to the fund are when the entity has a legal or constructive obligation through: (a) a plan benefit formula that is not linked solely to the amount of contributions and requires the entity to provide further contributions if assets are insufficient to meet the benefits in the plan benefit formula; (b) a guarantee, either indirectly through a plan or directly, of a specified return on contributions; or. (c) those informal practices that give rise to a constructive obligation. For example, a. constructive obligation may arise where an entity has a history of increasing benefits for former employees to keep pace with inflation even where there is no legal obligation to do so. IAS Under defined benefit plans: (a) the entity s obligation is to provide the agreed benefits to current and former employees; and (b) actuarial risk (that benefits will cost more than expected) and investment risk fall, in substance, on the entity. If actuarial or investment experience are worse than expected, the entity s obligation may be increased. Main measurement provisions (the changes compared with IAS 19 have been marked) Actuarial assumptions: salaries, benefits and medical costs IAS Financial assumptions shall be based on market expectations, at the end of the reporting period, for the period over which the obligations are to be settled. 20

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