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Pension accounting – outlook for year-end 2021 and current topics

360°Benefits I News

By Adam Casey and Virginie Morand | September 2, 2021

Pension Accounting 2021 – outlook and updates

Discount rates remain close to zero or even negative at shorter durations

As a consequence of persistently low interest rates, accounting discount rates remain close to zero or even negative at shorter durations. The pandemic is still raging in many countries of the world and it is difficult to foresee any change in outlook to push discount rates up significantly before year-end 2021 - company pension liabilities are therefore expected to remain high. However, some relief comes from the asset side of the pension balance sheet position. sset returns have been very strong so far in 2021. This is expected to lower the pressure on companies’ pension balance sheet position, but with increasing risks on the global economy, it remains to be seen if asset gains can be maintained at this level until year-end and beyond. In addition, for Switzerland, the move to the new BVG 2020 tables (versus current BVG 2015 tables) will cause a decrease in pension liabilities and therefore help improve the balance sheet position. This will provide some further relief.

Market overview

It’s that time of year again, when many companies are preparing for their year-end accounting process. Under both US GAAP and IFRS accounting standards, companies must disclose various items related to the pension plans they sponsor, such as the difference between the current values of assets and benefit obligations. The value of these benefits affect both the company's balance sheet and profit and loss statement.

A key factor that affects the value of pension benefits is the discount rate, which is based on market-related corporate bond yields under US GAAP and IFRS. Discount rates have remained stable in 2021 (ca. 0.07% at 15-year duration in July, slightly up from 0.03% at year-end 2020) and remain close to zero. When the discount rate is low, the liabilities and pension costs are higher. The year-to-date asset returns for most pension fund portfolios have been strong. According to the Pictet LPP25 and LPP40 Indices, returns to 31 July 2021 have been 4.2% and 6.8%, respectively. If this level can be maintained until year-end, we expect that companies’ pension balance sheets will improve compared to last year-end (depending on the duration of the plans’ liabilities).

There are various moving parts impacting the year-end 2021 balance sheet position and ensuing following year budgets so companies should be mindful of recent market developments and coordinate with their relevant experts.

Opportunities: managing pension risk

Although the large drivers of volatility in pension accounting such as interest rates and asset returns are outside the sphere of influence of companies, there are opportunities to manage the pension risk and its footprint. We elaborate further on one option which has been a trend for a number of years in the market which aims to manage and reduce the future plan liabilities but other options also exist.

Managing liabilities: Swiss DC “1e” pension plans

A particularly attractive option is the introduction of a defined contribution Top-up “1e” pension plan. In Switzerland most pension plans are Cash Balance plans, which are typically treated as Defined Benefit for international accounting purposes. However, it is also possible in Switzerland to have a Defined Contribution (DC) style top-up plan for the portion of salary above 4.5 times the maximum AHV pension (i.e. CHF 129’060 in 2021) – so-called “1e” plans. If designed appropriately, these 1e plans can be eligible for DC accounting treatment.

Although Swiss DC 1e Pension Plans are not widespread yet there is a trend to continuous growth in the market.

The move to DC accounting treatment can have a significant impact on both the company balance sheet and pension expense, depending on the plan structure and membership profile. However, beneficial accounting treatment is not the only reason to implement a 1e plan; employees can also benefit from participation in these types of plans by gaining greater control over their investments and receiving transparent returns.

Demographic assumption changes

New BVG 2020 tables

At the end of 2020, the new BVG 2020 demographic tables were published and made available to actuaries, experts and pension funds. These tables are based on the observation of data from 15 large autonomous Swiss pension funds with a total of approximately 1.5 million active insured members and 0.9 million pensioners for the years 2015 to 2019 (so before the pandemic period). Used by the majority of private pension funds, these tables provide the majority of demographic assumptions necessary to evaluate pension fund liabilities. As these new tables were published very close to the fiscal year end of most companies in 2020, we expect them to take effect during the 2021 accounting year cycle. Companies switching from the BVG 2015 to the BVG 2020 tables will see positive impacts on their balance sheet position, as the tables imply lower long term pension costs.

Companies that switch to the BVG 2020 tables will see positive impacts on their balance sheet.

Indeed, life expectancy at age 65 has decreased for both men (from 22.83 to 22.57 years) and women (from 24.86 to 24.37 years) using consistent generational tables published with the 2015 and 2020 BVG tables (Menthonnex model), with further convergence in life expectancy between men and women (the gap between life expectancies is narrowing). At the same time, the life expectancy of widows and widowers has also decreased with the transition to the new BVG 2020 tables.

In addition, the experience of disability cases shows a significant decrease of about 20% in the number of disability cases compared to the BVG 2015 tables (mainly due to the conditions for eligibility by the Swiss 1st pillar insurance for disability). Further, there is a continuing trend in the market to adjust the disability incidence rates from the standard BVG rates. The BVG 2020 disability incidence rates do not reflect partial disablement and therefore somewhat overstate the best estimate cost. The actual average disablement rate based on the Swiss 1st pillar insurance for disability over the past ten years was 80% so an 80% adjustment has been commonly applied in recent years to reflect a more realistic best estimate of actual cost. Overall, updating the assumptions from 80% of BVG 2015 to 80% of BVG 2020 disability incident rates will alone lead to a reduction in active member liabilities and ongoing company service cost by around 1% to 3%.

Taking into account all BVG 2020 tables, a typical range of expected demographic assumption impacts will be a decrease of 3% to 6% of the liabilities and a decrease of 4% to 7% of Company Service Cost.

Since 2018 an alternative model (the so called “CMI” model) to determine mortality improvements is available in Switzerland and has been considered a valid alternative model to the improvement rates published with the BVG 2015 tables and adopted by many companies. Consistent with the use of the CMI model in recent years, the BVG 2020 tables release now includes the CMI model as an alternative published Swiss improvement model. For those companies that have not yet adopted the CMI model, changing from the BVG 2020 Menthonnex model improvement rates to the CMI improvement rates would lead for most plans to an additional decrease of 3% to 5% of the liabilities.

Additionally, conducting an experience study to look at valuation assumptions can help ensure that the accounting assumptions used are appropriate and provide a best possible estimate of future experience. Key assumptions to review may include withdrawal rates, retirement rates, salary increases, disability rates, lump sum election rates, and the proportion of members with a spouse or partner eligible to receive benefits. The results of an experience study can have a significant impact on the accounting figures. In any case, such exercises help provide a more realistic assessment of the company’s benefit obligations and costs, which is the goal of the accounting disclosures.

Latest pandemic – impact on mortality rates

The COVID-19 pandemic has had a major impact on society and the economy. What about the impact on overall pension fund mortality? The chart below shows the average Swiss mortality over the last 5 years for 2 groups (those 65 and older and those below age 65). It is clear from the top line that the 1st and 2nd pandemic waves in 2020 have had a significant short term impact on Swiss mortality. For example, the 1st wave produced mortality 50% higher than normal for a month or so and the 2nd wave produced mortality close to double the normal rates for around 2 months. While these were significant increases they were for relatively short periods and there have been similar jumps (albeit not quite as extreme) in mortality for this age group in the last 5 years (e.g. strong flu waves). We would expect the next set of tables (BVG 2025) to have some impact from the latest pandemic but it may not be particularly significant. In addition, it is debateable whether the experienced mortality for the 2020 to 2024 years in the BVG 2025 tables should be used as a future assumption given the extraordinary (and possibly once-off) nature of the pandemic and progress already made in the fight against it (through various techniques and sanitary measures). Afterall, accounting assumptions should be best estimate for the future. In general, the development of mortality is a key factor for swiss pension funds and will continue to get much attention.

The latest pandemic might not have any impact on mortality rates in the future.

The chart shows Swiss actual mortality over the past 7 years compared to a statistically expected range - Description Below
of mortality for 2 groups, namely those over age 65 and those under age 55. For the 5 or so years prior to the pandemic the actual mortality for over 65 year olds spikes above the normal mortality on 3 occasions up to around 50% higher than normal (strong flu waves and heat wave). Since the pandemic begun the actual mortality spikes above normal by up to 100% for the 1st and 2nd Swiss Covid-19 waves (around April 2020 and January/February 2021). The mortality for the under age 65 group broadly remains in normal statistical range for the whole 7 year period.
Source: Bundesamt für Statistik

Head of Corporate Retirement Consulting

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