Accounting standards applicable to employee future benefits: what Quebec-based companies listed on the S&P/TSX Index doLinkedIn
There, in black and white
NB Bulletin Vol. 12 N. 14, November 2009
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) plans and for group insurance plans offered to retirees (other post-retirement benefits).
|End of 2007|
(Sept. 30, 2007 to
March 31, 2008)
|End of 2008|
(Sept. 30, 2008 to
March 31, 2009)
|DB Pension Plans|
|Expected Long-Term Rate of Return on Assets|
|Compensation Growth Rate1|
|1Also applicable in some cases to other post-retirement benefits|
|Other Post-Retirement Benefits|
|Health Care Costs - Decreasing Rate Period|
|11.0 years||13.0 years|
|8.5 years||10.0 years|
|6.0 years||8.0 years|
|5.0 years||4.0 years|
|3.7 years||3.4 years|
|Trend Rate for Health Care Costs - Final Period|
|4.35 %||4.35 %|
- For DB pension plans, the median annual discount rate used at the end of 2008 was 1.83% higher than the rate used at the end of 2007 (7.33% versus 5.50%). This increase is the result of widening long-term rate spreads between federal bonds and corporate bonds. This substantial widening was prompted by the "flight to quality" that ensued from the credit crisis.
- The median annual expected long-term rate of return on DB pension plan assets was 7.01% for 2008, down 0.12% from 2007 and around 0.55% from 2004. Companies have thus gradually lowered their long-term returns expectations.
- 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 2008, the median annual compensation growth rate was 3.50%, a rate identical to the median rate used since 2004. Outlooks for the compensation growth rate have not changed in the last five years.
- 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 2008, more than half (60%) of the companies analyzed were using a discount rate for other post-retirement benefits identical to that used for DB pension plans.
- 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. The final median trend rate has been 5.00%, since 2004. However, in the last year, we observed a two-year increase in the median decreasing rate period (from6.0 years to 8.0 years).
- Discount rates for 2009
The discount rates used at the end of 2009 will likely be lower than those used at the end of 2008 owing to the significant decrease (close to 1.50%) in yield spreads between federal and corporate bonds in the last six months. This decrease is the boomerang effect from the "flight to quality" experienced at the end of 2008. Keep in mind that gains created at the end of 2008 through the increase in discount rates allowed DB pension plans to lessen the impact of losses resulting from disappointing returns for 2008. Despite potentially attractive returns for 2009, companies results' should be hit hard by the boomerang effect expected for the end of 2009. Some companies could, however, use only long-term rates for corporate bonds rated AA and higher to determine their discount rates at the end of 2009. Please note that there are very few issuances of these types of bonds (creating a lack of credibility for this source), and that they post maturity yields higher than those for A rated corporate bonds (constituting an aberration)
- Health care costs - decreasing rate period
Health care costs have increased faster than general inflation for several years. The choice of health care cost trend assumption takes into account the projection that the level of growth will return to a lower level for the long term. Consequently, a select period at decreasing rates was used. However, because trend rates for health care costs have continued to remain high at each actuarial valuation, this assumption was typically revised upward, thereby creating successive actuarial losses. In partnership with the Society of Actuaries, in December 2007, Professor Thomas E. Getzen developed and published a model allowing for a more accurate projection of health care costs. Many companies are expected to revise their health care cost trend assumption in the next few years based on this model. And, going forward, it will not be unusual to see a longer select period of 15 to 25 years used.
- Transition to international standards
For fiscal years starting on or after January 1, 2011, public companies will be required to adhere to international standards when preparing and presenting their financial statements. Because the presentation of financial results must include results for the previous year for comparison purposes, the actual transition will begin a year earlier on January 1, 2010. Therefore, companies must immediately begin the work required to manage this transition.
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