Accounting standards applicable to employee future benefits: What assumptions do Canadian companies use?
Several private sector companies must include the recognition of their obligations towards defined benefit pension plans (DB plans) and group insurance plans offered to retirees (other post-retirement benefits) in their financial statements.
The assumptions required to determine the defined benefit obligation and the defined benefit cost (the expense) must be established by the company’s management. Again this year, we have analyzed the assumptions that were used, but have revised our methodology in order to include in our analysis more companies listed on the S&P/TSX Index. We have analyzed the annual reports of Canadian companies listed on the S&P 60 Index (60 largest companies) and on the S&P MidCap Index (mid-cap companies) whose fiscal year ended between September 30 of the previous year and February 28 of the current year. Close to 80 companies are sponsoring at least one DB plan and 75% of them are offering other post-retirement benefits. Finally, 85% of the companies disclose their results in accordance with International Accounting Standard (IAS) 19, and the remaining 15% percent disclose them in accordance with U.S. accounting standards.
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 tables present a comparison of the assumptions used for fiscal years ending in 2014 (between September 30, 2014 and February 28, 2015) and in 2013 (between September 30, 2013 and February 28, 2014). The second section summarizes the findings from these tables and from our data analysis. The third and final section presents additional information with respect to measures that could potentially impact future accounting results for some companies.
- For DB plans, the discount rate assumption is the most important assumption. Because it is based on market rates, it can vary from month to month. According to our analysis, the median annual discount rate used at the end of 2014 was 0.73% lower than the rate used at the end of 2013 (4.00% versus 4.73%). At the end of 2013, we observed an upward trend in interest rates based on Canadian bond market data. Since this temporary increase, the rates began to decrease in November 2014 and this decrease continued through the beginning of 2015.
- Several of the companies analyzed sponsor DB 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. A downward trend in the median annual growth rate began in 2012. The median annual growth rate was 3.25% at the end of 2013 and this rate fell to 3.01% at the end of 2014. Outlooks for the compensation growth rate for accounting recognition purposes have therefore decreased over the past few years.
- For companies sponsoring both DB plans and other post-retirement benefits, the median discount rates used for all plans were similar. Hence, 50% of the companies analyzed were using a discount rate for other post-retirement benefits identical to that used for DB plans at the end of 2014.
- The trend rate for health care costs is an 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 rate varies less from company to company and the median final trend rate has been relatively stable at 4.50% for the past several years.
- It should be noted that a decrease in the discount rate results in an increase in the obligation recognized in the financial statements. For an average DB plan, we can assume that the 0.73% decrease in the median discount rate resulted in an increase of approximately 10% in the obligation. The increase would have been similar for other post-retirement benefits unless they were not lifetime benefits (in which case the increase would have been more limited). Finally, for DB plans, the increase in the obligation may have been offset by a better than expected return on assets or other changes in assumptions.
The IASB will soon be publishing an exposure draft aimed at clarifying that, in cases where the defined benefit obligation is remeasured during the year (amendment, curtailment or settlement), the current service cost and net interest for the remaining period should be calculated using the same assumptions as those used for the remeasurement.
A new approach concerning the discount rate assumption is currently being discussed on the market. This approach involves the use of several discount rates to reflect the different benefits payment schedules for active employees and retirees participating in the same plan. Several issues have been raised in relation to this approach. Market stakeholders (companies, auditors, actuaries) will need to agree on their level of comfort with the approach in accordance with various standards (IFRS, ASPE and U.S. standards). We will keep you informed of further developments regarding this approach.
Please feel free to contact us for additional information.