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Normandin Beaudry

Accounting standards applicable to employee future benefits: what Quebec-based compagnies listed on the S&P/TSX index do

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There, in black and white

Bulletin NB Vol. 11 N. 14, December 2008

Please note that, in spite of simplification efforts, given the subject matter and use of terms defined in Section 3461 of the Canadian Institute of Chartered Accountant's (CICA) Handbook, this document contains technical content.

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-retirement 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 21 Quebec-based companies listed on the S&P/TSX Index whose fiscal year ended between September 30, 2007 and March 31, 2008. All of these companies sponsored at least one DB pension plan and 14 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 2007 (between September 30, 2007 and March 31, 2008) and in 2006 (between September 30, 2006 and March 31, 2007). 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 fourth year that we have conducted this analysis. We therefore invite you to consult the "Publications" section of our website to review the results, findings and comments for previous years. 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 in prior years. The results presented on a comparable basis for 2006 may also differ from those presented in previous years.

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-retirement benefits. 


 End of 2007
(Sept. 30, 2007 to
March 31, 2008)
End of 2006
(Sept 30. 2006 to
March 31, 2007)

DB Pension Plans

Discount Rate
  • 5th percentile
5.90%5.40%
  • 25th percentile
5.75%5.25%
  • 50th percentile
5.60%5.25%
  • 75th percentile
5.25%5.10%
  • 95th percentile
5.15%4.95%
Expexted Long-Term Rate of Retourn on Assets
  • 5th percentile
7.80%7.95%
  • 25th percentile
7.50%7.50%
  • 50th percentile
7.15%7.15%
  • 75th percentile
7.00%7.00%
  • 95th percentile
6.65%6.20%
Compensation Growth Rate1
  • 5th percentile
5.00%5.00%
  • 25th percentile
4.00%3.95%
  • 50th percentile
3.50%3.50%
  • 75th percentile
3.25%3.25%
  • 95th percentile
2.50%2.50%
    1Also applicable in some cases to other post-retirement benefits

Other Post-Retirement Benefits

Discount Rate
  • 5th percentile
6.00%5.59%
  • 25th percentile
5.80%5.42%
  • 50th percentile
5.65%5.28%
  • 75th percentile
5.50%5.14%
  • 95th percentile
5.36%4.91%
Trend Rate for Health Care Costs - Initial Period
  • 5th percentile
11.22%11.57%
  • 25th percentile
9.88%10.00%
  • 50th percentile
9.45%9.68%
  • 75th percentile
8.63%8.25%
  • 95th percentile
6.80%7.07%
Trend Rate for Health Care Costs - Final Period
  • 5th percentile
6.00%5.68%
  • 25th percentile
5.21%5.19%
  • 50th percentile
5.00%5.00%
  • 75th percentile
4.83%4.83%
  • 95th percentile
4.33%4.33%

2. Findings

  • For DB pension plans, the median annual discount rate used at the end of 2007 was 0.35% higher than the rate used at the end of 2006 (5.60% versus 5.25%). However, the annual discount rate increased by 0.50% or more in one third of the companies analyzed. Moreover, 60% of the companies analyzed used an annual discount rate between 5.50% and 5.75% at the end of 2007. This increase in discount rates can be explained in part by higher yield spreads between federal bonds and corporate bonds caused by asset-backed commercial papers (ABCPs). 
  • The median annual expected long-term rate of return on DB pension plan assets was the same for 2007 as it was for 2006 at 7.15%. This stability follows declines of 0.25% and 0.15% in previous years. 
  • Several of the companies analyzed sponsor DB pension plans and other post-retirement benefits that offer benefits based on salary at retirement. These companies must therefore establish an assumption related to the compensation growth rate. At the end of 2007, the median annual compensation growth rate was 3.50%, a rate identical to the median rate used since 2004
  • For companies sponsoring both DB pension plans and other post-retirement benefits, the median discount rates used for all of the plans were similar. At the end of 2007, one third of the companies analyzed were using a discount rate for other post-retirement benefits identical to that used for DB pension plans. The proportion was twice as high at the end of 2006.
  • The trend rate for health care costs is the most important assumption for other post-retirement benefits. The initial rate, which is higher than the final rate, can vary significantly from company to company. However, the final rate at the end of 2007 was identical to the 2006 rate in 90% of the companies analyzed. The final median trend rate at the end of 2007 was 5.00%, the same rate observed since 2004.

3. Comments 

Discount rates for 2008

The discount rates used at the end of 2008 will likely be higher than those used at the end of 2007 owing to the significant increase (close to 1.50%) in yield spreads between federal bonds and corporate bonds during the months of September and October 2008, which is caused by the credit crisis. Given the volatility recently observed on bonds yields, it is difficult to predict the level of discount rates that will be used at the end of 2008. We suggest to companies that normally set their discount rate before the end of their fiscal year to modify their process and wait until the end of the fiscal year to set the discount rate. Moreover, when selecting the discount rate, companies should take into account the fact that the credit rating for certain issuers deemed "superior quality" could be lowered by the end of the year. 

Losses from poor return on assets for 2008

The discount rates that will be used at the end of 2008 will likely create sizeable actuarial gains. However, for DB pension plans, they will partially offset expected actuarial losses on assets. For some companies, this could result in a less significant change than expected in the financial position of plans on an accounting basis but could create an improper impression as regards the financial health of these plans. In fact, several of these companies will eventually experience significant increases in amortization payments for solvency and funding deficits created by losses from poor return on assets in 2008. 

For other post-retirement benefits, if actuarial gains generated by discount rates are not offset by actuarial losses linked to other assumptions (following a modification or the experience), they could reduce the cost to be recognized in 2009 for companies that amortize losses in excess of the 10% corridor. 

 

Please feel free to contact us for additional information.

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