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Normandin Beaudry

ACCOUNTING STANDARDS APPLICABLE TO EMPLOYEE FUTURE BENEFITS: WHAT QUEBEC-BASED COMPANIES LISTED ON THE S&P/TSX INDEX DO?

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There, in black and white

NB Bulletin Vol. 10 N. 14, November 2007

Several private sector companies will soon be finalizing their budgets for the upcoming fiscal year and preparing their financial statements for the current fiscal year. Included among the accompanying notes that should be prepared for these financial statements are those pertaining to costs for defined benefit (DB) pension plans and group insurance plans offered to retirees (other post-employment benefits).

The assumptions required to determine the accrued benefit obligation and the cost must be established by the company's management. To help companies select these assumptions, we have analyzed the annual reports of 25 Quebec-based companies listed on the S&P/TSX Index whose fiscal year ended between September 30, 2006 and March 31, 2007. All of these companies sponsored at least one DB pension plan and 19 of them offered at least one group insurance plan to their retired employees.

Our analysis is divided into three sections. The first section presents the assumptions used by the companies included in our analysis in percentile format. The charts present a comparison of the assumptions used for fiscal years ending in 2006 (between September 30, 2006 and March 31, 2007) and in 2005 (between September 30, 2005 and March 31, 2006). The second section summarizes the findings from these charts and additional results that could be obtained only through data analysis. The third and final section presents our comments with respect to some measures that could potentially impact future results.

Please note that this is the third year that we have conducted this analysis. We therefore invite you to consult Bulletin No. 14, Vol. 9, to review last year's results, findings and comments. However, given that the composition of the S&P/TSX Index varies regularly based on predefined criteria, the group of companies analyzed this year differs from that analyzed last year. The results presented on a comparable basis for 2005 may also differ from those presented last year.

1. Selection of assumptions

The following charts present the analysis results, in percentile format, for the key economic assumptions used for DB pension plans and other post-employment benefits
 

2.Findings

  • For DB pension plans, the median annual discount rate used at the end of 2006 was 5.25%, the same rate used at the end of 2005. As was the case at the end of 2005, close to 90% of the companies analyzed used an annual discount rate between 5.00% and 5.50% at the end of 2006. Thus there is little variance in this choice of assumption. The variance observed in this assumption may be explained in part by the demographic profile of the members of the analyzed companies and the relative weight of DB pension plans outside Canada (a different discount rate may be used for DB pension plans outside Canada).
  • The median annual expected long-term rate of return on DB pension plan assets was 7.15% for 2006, as compared to 7.25% for 2005. Close to one third of the companies analyzed reduced this assumption over the two observation years. This reduction followed the decline in the median rate by around 0.25% from 2004 to 2005. The companies gradually recognized that long-term rates of return should not be as high as those observed in the past few decades. It is also important to note that all of the companies that use an expected long-term rate of return higher than 7.50% have sizeable operations in the United States, where the rates used are typically higher.
  • 60% or more of DB pension plan assets was invested in equities at the end of 2006 for 40% of the companies analyzed. This proportion compares to 35% of companies at the end of 2005 and 15% at the end of 2004. This increase is due in part to the good returns on Canadian equities between 2004 and 2006.
  • Several companies sponsor DB pension plans and group insurance plans that offer salary-based benefits. These companies must establish an assumption related to the compensation growth rate. At the end of 2006, the median annual compensation growth rate was 3.50%, a rate identical to the median rates used at the end of 2005 and 2004.
  • For companies offering a group insurance plan to retired employees, the median discount rate was slightly higher than the rate used for DB pension plans. At the end of 2006, around 35% of the companies analyzed were using a discount rate that was higher than the rate disclosed for DB pension plans, which may be explained by the demographic profile of the members (they may not be the same) and the timing of benefits (incidence, inflation and use levels may differ). The discount rate for the remaining 65% of companies was the same as the rate for DB pension plans.
  • The trend rate for health care costs is the most important assumption for group insurance plans offered to retirees. Given the significant increases witnessed over the last few years, health costs are generally expected to rise at a higher level in the short term (initial period) and gradually fall to a lower level during the final period. At the end of 2006, around 65% of the companies analyzed had used an initial rate equal to or higher than 9.00%, a percentage similar to the one observed at the end of 2005 and 2004. The variability of the trend rate may be explained in part by the nature of the benefits (prescription drugs, hospitalization, dental care, etc.) and the experience of the plans.
  • The final median trend rate for health care costs was 5.00%, the same rate observed at the end of 2005 and 2004.

3.Comments  

Exposure draft withdrawn

At the end of 2006, around one third of the companies analyzed were using a measurement date different than the fiscal year end date. As permitted under Section 3461 of the CICA Handbook, they were using a measurement date within three months preceding the fiscal year end. Among other things, this provision is used by companies wishing to allocate more time to the preparation of notes to financial statements.

The same provisions exist in the United States under FAS standards. However, the adoption of FAS 158 in September 2006 abolished this provision for fiscal years ending after December 15, 2008. As a result of this initiative, at the end of March 2007, the CICA issued an exposure draft modeled after FAS 158 and prescribing the application of provisions for all fiscal years ending on or after December 31, 2008.

The exposure draft was, however, withdrawn in August 2007. As a result, Canadian companies are not forced to disclose their financial statements on a measurement date corresponding to their fiscal year end date.

Funded status vs. accrued benefit liability

Pension plans for around 90% of the companies analyzed were in a deficit position at the end of 2006. However, an accrued benefit asset as opposed to an accrued benefit liability was reported on the balance sheet for about 70% of these companies. For the remaining companies, the accrued benefit liability was lower than the deficit at the end of 2006. The difference is due in large part to the substantial actuarial losses accumulated (representing around 15% of the accrued benefit obligations at the end of 2006) that will be recognized in part (only the portion exceeding the 10% corridor) over the next 15 years or so.

In the United States, the adoption of FAS 158 requires companies to recognize, for fiscal years ending after December 15, 2006, the funded status of pension plans and other retirement benefits in their balance sheet. The exposure draft issued by the CICA in late March 2007 and withdrawn in August 2007, provided for an application similar to FAS 158 for fiscal years ending on or after December 31, 2007.

One of the reasons behind the withdrawal of the exposure draft is the project targeting the convergence of Canadian standards toward international standards (IAS 19), effective on or after January 1, 2011. The introduction of the FAS standard would have created two sets of modifications over a short period of time.

With the exposure draft withdrawn in August 2007, for the time being, Canadian companies are not forced to present the funded status of their pension plans and other retirement benefits in their respective balance sheets. However, depending on the approach adopted to harmonize Canadian standards with international standards, some companies may be obligated to recognize a larger portion of actuarial losses accumulated and past service costs in their balance sheet. This could have a negative impact on the balance sheets of Canadian companies in the coming years.

 

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