Pension liabilities of SLI companies in 2011

Transcription

1 companies in 2011 An analysis of coverage levels according to international accounting standards July 2012

2 Summary: funding of pension liabilities worsened in 2011 The funding situation for pension liabilities of SLI companies worsened considerably in This can be seen from the pension-related information provided in the companies annual reports. In contrast to 2010, when the funding ratio was just under 90 percent, and using very conservative balance-sheet accounting in accordance with IFRS or US GAAP, the funding ratio for 2011 fell back well below 90 percent. 1 This is primarily due to the current market environment: on the one hand, there was a marked fall in interest rates yearon-year which increased the value of the liabilities, and on the other, investment returns were lower than anticipated, meaning that total liabilities rose more sharply than plan assets. Nevertheless, in comparison with companies in the US and Germany, the funding ratio of SLI companies pension liabilities is higher than average. Fortune 1000 companies report a funding ratio of just under 80 percent for their pension liabilities, and DAX companies only around 65 percent. Further changes in the funding situation are to be expected in the future. According to the revised IAS 19 accounting guidelines, which must be used from 2013 onwards, the corridor method often used at present as a smoothing mechanism will no longer apply as well as the expected return on assets. Thus greater balance-sheet volatility and higher pension expenses are likely. 01 Summary: funding of pension liabilities worsened in 2011 The study methodology and underlying data As in previous years, Towers Watson has analysed the disclosed occupational pension liabilities of SMI and SLI companies under IFRS and US GAAP international accounting standards. The results therefore differ fundamentally from the data published by the Swiss pension funds according to local accounting guidelines. The pension liabilities and the amount and development of the pension expense are included in the analysis. For each company the study takes into account all schemes that are classified as defined benefit plans. Under IAS, Switzerland s defined contribution plans are considered to be defined benefit rather than defined contribution plans. The reason for this is the inherent risk of underfunding arising from the minimum benefits guaranteed by Swiss law and the resulting potential risk for the employer of having to meet any shortfalls in addition to paying contributions under the plan regulations. The term used to refer to this is constructive obligation. Essentially it obliges companies to establish reserves in their accounts in accordance with detailed rules and regulations and means that net pension costs recognised in the income statement do not correspond to the effective contributions of the employers. The study looks at the annual financial statements of companies in the Swiss Leader Index (SLI). This index comprises the 20 SMI quoted companies plus the ten biggest names of the 30 companies in the SMI Mid Cap Index. The SLI thus boasts the 30 most important companies on the Swiss stock exchange, and comprises Switzerland s leading listed companies. In comparison with 2010, the composition of both the SLI and the SMI has changed. Givaudan is now included in the SMI instead of Lonza; Schindler has replaced Petroplus in the SLI. At the time of data collection for this study, the annual reports of two companies, Synthes and Kühne & Nagel, were not yet available. In both cases the figures for the prior year have been used. The study analysed consolidated data for the pension plans of all the companies subsidiaries, including those abroad. For this reason, the Towers Watson study cannot be used to draw conclusions about the specific situation in Switzerland and the status of the respective Swiss pension plans. 02 The study methodology and underlying data 1 This funding ratio differs from the regulatory funding ratio reported by Swiss pension funds, which applies among other things to recapitalisation measures. 2

3 Accounting standards: IFRS dominates Almost three quarters of SLI companies prepare their accounts in accordance with IFRS. Despite the changes to the SLI itself, this situation remains the same as in The two sets of international accounting guidelines applied (US GAAP and IFRS) differ in their treatment of pension liabilities and pension expenses in company accounts. With accounting under US GAAP, surpluses or shortfalls in pension plans are presented in full on the balance sheet and unamortised actuarial gains / losses are reported under other comprehensive income (OCI), while under the currently applicable IFRS rules companies can still choose to present surpluses or shortfalls on their balance sheet either in accordance with the corridor method or as per US GAAP. Yet, unlike US GAAP, the recognition of an asset under IFRS requires evidence of underlying economic benefits from the perspective of the company. Accounting standards applied in SLI Around 60 percent of companies that use IFRS still apply the corridor method. In contrast to US GAAP, companies that use IFRS have the option of presenting net liabilities in their accounts by applying the corridor method or the OCI method. Under the corridor method, actuarial profit and loss are amortised only above a certain threshold (corridor). The net liabilities reported in the balance sheet do not correspond to the difference between pension liabilities and plan assets; rather, the amount takes into account unamortised actuarial profit and loss from previous years and is therefore smoothed out. Under the OCI method, actuarial profit and loss is shown under OCI. The net liabilities reported in the balance sheet correspond to the difference between pension liabilities and plan assets. This corridor method is still applied by just under 60 percent of companies who use IFRS for their accounting. The relatively high number of companies that apply the corridor method for the amortisation of actuarial profit and loss is surprising, particularly as this method will be eliminated when the revised IAS 19 is introduced (with effect from 1 January 2013) and application of the OCI method will become obligatory. 03 Accounting standards: IFRS dominates US GAAP IFRS Korridor OCI Significant rise in pension liabilities Pension liabilities reported by SMI companies rose by around 7.6 percent over the previous year to CHF billion. This trend is primarily driven by falling interest rates. As in 2010, the largest pension liabilities were reported by UBS, Nestlé, Novartis, Credit Suisse and Zurich Financial Services, totalling around CHF 104 billion. This corresponds to around 63.9 percent of the pension liabilities of all SMI companies. Pension liabilities rose at SLI companies for the same reason as at SMI companies, increasing by CHF 14.2 billion from around CHF billion to around CHF billion (+ 8.8 percent). SLI companies with the highest amounts of pension liabilities include Baloise, Swiss Life and Clariant, each with over CHF 2 billion. 04 Significant rise in pension liabilities 3

4 Steady increase of pension liabilities in absolute terms since 2008 Pension liabilities (in CHF Bill.) SLI SMI Relative to market capitalisation of the sponsoring employers, the share of pension liabilities increased significantly for both SMI and SLI companies (SMI: percentage points, SLI: percentage points). Thus in 2011 pension liabilities rose more strongly than market capitalisation. The share of pension liabilities also rose in relation to equity capital, compared to the previous year, and is now higher than its value at the end of 2009 (SMI: 41.7 percent, SLI: 41.4 percent). Steady increase in pension liabilities in relative terms since 2008 Pension liabilities Year SMI SLI relative to market capitalisation (%) % 21.9 % % 18.4 % % 18.2 % % 19.8 % relative to equity capital (%) % 41.4 % % 38.4 % % 40.6 % % 37.3 % A look at the underlying assumptions used shows that the average discount rate applied fell in comparison with 2010 (from 3.6 percent to 3.3 percent). The average assumption for salary increases also fell in the past year (from 2.9 percent to 2.6 percent), while the assumption for future indexing of pension benefits in payment rose slightly (from 0.6 percent to 0.7 percent). It was not possible to analyse changes in demographic assumptions (such as mortality) due to the fact that, in the majority of cases, the parameters used are not published. Assuming a duration of between 10 and 15 years for pension liabilities, the discount rate reduction of 0.3 percent leads to an increase in pension liabilities of around 3 to 4.5 percent or CHF billion for SMI companies (CHF billion for SLI companies). The lower assumption for future salary increases also reduces the level of pension liabilities. In contrast to the discount rate, however, only the pension liabilities of active insured members are affected by this. 4

5 Underlying actuarial assumptions of SLI companies 4.5 % 4.0 % 3.5 % 3.0 % 2.5 % 2.0 % 1.5 % 1.0 % 0.5 % 0.0 % 4.2 % 4.0 % 3.6 % 3.3 % 2.8 % 2.9 % 2.9 % 2.6 % 0.6 % 0.6 % 0.6 % 0.7 % Discount rate Salary increases Pension increases Falling discount rates in 2011 are a key reason for the actuarial losses reported by SLI companies, totaling around CHF 8.7 billion. Benefits paid out to insured members are of a similar magnitude (CHF 7.7 billion). The appreciation of the Swiss franc remained relatively moderate in 2011, and thus the effect of exchange rate development is limited (CHF 0.4 billion) in comparison to the previous year. In 2011 the Swiss franc appreciated by 2.8 percent against the euro, while it changed only slightly ( 0.4 percent) against the US dollar. Due to the inclusion of Schindler and the exclusion of Petroplus from the SLI, pension liabilities for SLI companies saw a net increase of approximately CHF 1.7 billion. Change in pension liabilities of SLI companies CHF Mio. 0 5'000 10'000 15'000 Service cost 3'966 Interest cost 6'099 Benefit payments 7'740 Actuarial (Losses) / Gains 8'693 Plan changes, acquisitions 373 Employee contributions 1'542 Currency exchange rate 449 Index 1'710 Change in liabilities 14'194 5

6 Slight increase in plan assets In comparison with the previous year, reported plan assets of SMI companies rose by CHF 1.7 billion to around CHF billion. This is primarily attributable to the slightly positive return on plan assets. As in 2010, the highest asset values were reported by UBS, Nestlé, Novartis, Credit Suisse and Zurich Financial Services, totalling around CHF 91.5 billion. This corresponds to around 65 percent of the plan assets of all SMI companies. Plan assets rose for SLI companies for the same reason: from CHF billion to CHF billion. For companies that are only present in the SLI, Baloise, Clariant, Swiss Life and Schindler reported the highest levels of plan assets at over CHF 1 billion each. In total, these four companies account for around 78 percent of the reported plan assets of companies that are only present in the SLI. 05 Slight increase in plan assets Steady increase in plan assets in absolute terms since 2008 Plan assets (in CHF Bill.) SLI SMI Relative to market capitalisation of the sponsoring employers, the share of plan assets increased for both SMI and SLI companies (+ 1.3 and percentage points respectively). Thus in 2011 plan assets rose more sharply than the market capitalisation of SLI companies. Relative to shareholders equity, in contrast, the share of plan assets fell from 36.1 percent to 35.8 percent (SMI) compared to the previous year or rose slightly by 0.7 percentage points (SLI). Increase in plan assets in relative terms since 2008 Plan assets Year SMI SLI relative to market capitalisation (%) % 18.5 % % 16.5 % % 16.1 % % 16.8 % relative to equity capital (%) % 35.0 % % 34.3 % % 36.0 % % 31.7 % 6

7 The return on assets achieved of around CHF 2.3 billion contributed to the increase in plan assets in However, returns on assets were significantly lower than expected, and therefore a total underlying loss of CHF 4.6 billion was recorded. Also, plan assets increased by a total of CHF 2.6 billion because of the new index composition and acquisitions. Employer s and employees contributions exceeded the plan benefits paid out by CHF 0.6 billion. Change in plan assets of SLI companies CHF Mio. 0 5'000 10'000 Expected return 6'990 Actuarial (Losses) / Gains 4'605 Employer contributions 5'339 Benefit payments 6'253 Employee contributions 1'542 Currency exchange rate 1'576 Acquisitions 1'001 Index 1'642 Change in plan assets 4'080 In 2011 the average return on investments (excluding exchange rate effects) amounted to about 1.6 percent for SLI companies and was thus lower than the expected return on investments of 4.5 percent based on assumptions. In comparison to previous years, the assumption of expected returns on investments was reduced. Expected Return on Assets assumptions of SLI companies 5.5 % 5.3 % 5.0 % 4.9 % 5.0 % 4.9 % 4.8 % 4.5 % 4.5 % 4.3 % 4.0 %

8 Funding ratio falls As pension liabilities increased much faster than plan assets in 2011, the deficit for SMI companies increased from approximately CHF 13 billion to approximately CHF 23 billion. The average funding ratio of all SMI deteriorated from 90 percent to 86 percent in Thus the average funding ratio is much lower than at the end of 2007 (94 percent) and the slight improvement in funding ratios observed over the last two years has reversed. The average funding ratio of all SMI companies also worsened in 2011, falling from 90 to 86 percent. Within the group of SMI companies, Syngenta (98 percent), Credit Suisse (97 percent) and Richemont (95 percent) reported the highest funding ratios for pension liabilities, while the lowest were reported by Transocean (66 percent), Roche (74 percent) and Holcim (76 percent). As in 2010, no company within the SMI reported full coverage of their pension liabilities. The average funding ratio of SLI companies fell from 83 to 79 percent. Among the companies listed in the SLI, Sonova reported the highest funding ratio at 97 percent, followed by Schindler (82 percent), while those with the lowest funding ratios were Swiss Life (40 percent) and Kühne + Nagel (28 percent). 06 Funding ratio falls Average funding ratio (SMI) 100 % 95 % 94.0 % 90 % 89.6 % 85 % 84.9 % 87.4 % 85.7 % 80 % 75 % Slight drop in pension expense Regular pension expense (excluding amortisation) for the SMI and SLI companies fell slightly in 2011 compared to last year: from CHF 2.8 billion to CHF 2.7 billion (SMI), and from CHF 3.3 billion to CHF 3.1 billion (SLI). This is primarily attributable to the reduced interest expense for pension liabilities due to lower market interest rates. Service costs in Swiss francs rose a little in comparison with the previous year. Interest expense was down slightly (SLI) or significantly (SMI) relative to the 2010 level. 07 Slight drop in pension expense Pension Expense SLI SMI CHF Bill Service cost (+) Interest cost (+) Expected return on assets ( ) Net expense for pension benefits* as % of revenue 0.7 % 1.0 % 0.8 % 0.9 % 0.7 % 0.7 % 1.1 % 0.8 % 0.8 % * Excluding amortisation of gains and losses / Plan changes 8

9 Employer s contributions fell in a year-on-year comparison, to around CHF 4.3 billion (SMI) or CHF 5.3 billion (SLI). Relative to operating Cash Flow, contributions to pension funds by the employer rose considerably, amounting to 10.7 percent (SMI) or 12.5 percent (SLI) for Cash Flows SLI SMI CHF Bill Benefit payments from plan assets from Cash Flow Employer contributions Decrease of liquidity as % of operating Cash Flow 3.8 % 4.8 % 7.7 % 12.5 % 8.9 % 9.8 % 8.2 % 9.0 % 10.7 % Funding situation above average in an international comparison Similarly to the SMI / SLI companies, the funding situation of the 422 defined benefit pension plans of companies in the Fortune 1000 index also deteriorated somewhat in The aggregate funding ratio fell from 84 to 78 percent, while the average funding ratio dropped from 80 to 76 percent. Overall, the funding situation of US companies is still lower than that of SLI / SMI companies, however, with a shortfall of around USD 343 billion. The companies in the leading German DAX index reported an even lower funding ratio than their counterparts in the Fortune 1000 and SLI of 65 percent at the end of However, compared to 2010, this is only a negligible decline versus those posted by the SLI and Fortune 1000 companies. The increase in pension liabilities due to lower discount rates counteracted the respectable return on investments of around 3 percent and the allocation of around EUR 9.4 billion in employer contributions to plan assets. 08 Funding situation above average in an international comparison Funding ratio Fortune 1000 and DAX 140 % 120 % 100 % 80 % 115 % 95 % 76 % 81 % 83 % 83 % 89 % 96 % 70 % 77 % 80 % 76 % 60 % 40 % 20 % 52 % 47 % 45 % 49 % 50 % 56 % 65 % 71 % 65 % 65 % 66 % 65 % 0 % Fortune 1000 DAX 9

10 New IAS 19: greater balance sheet volatility, higher pension expenses With effect from 1 January 2013, the revised version of accounting standard IAS 19 will come into force for pension plans. The most important reforms relate to the elimination of the corridor method. Without this smoothing mechanism, any funding shortfalls or surpluses will have to be recognised in full in company accounts. As a consequence, companies will witness a considerable increase in balance sheet volatility. As mentioned above, at the end of 2011 the corridor method was still being used by just under 60 percent of SLI firms that prepare their accounts in accordance with IFRS. Based on the figures of SLI companies as at the end of the 2011 financial year, the changeover will lead to an increase in reported net liabilities of an estimated CHF 7.9 billion. This increase will be at the expense of shareholders equity. At the individual company level, the net liabilities to be reported in the balance sheet will rise the most at UBS (+ CHF 6.4 billion) and Swisscom (+ CHF 2.0 billion). In addition to the elimination of the corridor method, with its consequences on corporate balance sheets, the replacement of interest cost and expected return on plan assets by net interest expense or income will lead to an increase in regular pension expense (excluding amortisations). This is because the expected asset returns assumed are generally higher than the new discount rate to be used to determine net interest expense. A rough estimate based on the conditions at the end of 2011 (assumptions and financial situation) gives us reason to expect interest income (expected return on assets less interest expense) of approximately CHF 1.5 billion for all SLI companies in 2012, according to current IFRS methodology. In contrast, when applying the new IAS 19 rules, we would expect a net interest expense of approximately CHF 0.8 billion instead of interest income. This means an encumbrance on results of about CHF 2.3 billion. Thus regular pension expense will increase substantially for companies reporting under IFRS. Worst affected will be those companies with riskier investment strategies or more aggressive assumptions for expected returns on assets. Net liabilities will also be affected by risk-sharing, which is a new factor to be taken into account. Risk-sharing will particularly affect the Swiss pension plans of SLI companies. However, the implications are difficult to assess overall. That said, it is possible to assume in general terms that pension liabilities will fall and annual service costs will tend to rise. 09 New IAS 19: greater balance sheet volatility, higher pension expenses 10

11 Lausanne Towers Watson Avenue Gratta-Paille Lausanne Phone: Fax: infoch@towerswatson.com Zurich Towers Watson Talstrasse Zurich Phone: Fax: infoch@towerswatson.com The information in this publication is of general interest and guidance. Action should not be taken on the basis of any article without seeking specific advice. Copyright 2012 Towers Watson. All rights reserved. TW-EU-CH-0016 Juli 2012