In its 2008 discussion paper, the IASB proposed a change in the classification of pension liabilities. Since then, the IASB has made clear that this proposal will be dropped. Our opinion of this initial proposal is that clearer classification is indeed necessary, but that the proposed changes to the classification and measurement of post-retirement benefits do not allow clear classification of plans by type of sponsor commitment. A clearer classification needs to determine whether the sponsor guarantees financial risk alone or in combination with longevity risk and whether risk is shared by participants (employees) and sponsors (employers).

The IASB is also proposing to change the presentation of the balance sheet, comprehensive income, and the profit and loss account. In 2009, the IASB made clear that it would reiterate its proposal to abolish the corridor approach in a draft to be published in the fourth quarter of 2009. If adopted, this proposal would lead to immediate and full recognition of the volatility of the surplus or deficit in the profit and loss account of the sponsor. By no means would mandatory immediate recognition of the volatility of the surplus in the P&L of the sponsor be appropriate. We show in our new position paper, "IAS 19 – Penalising changes ahead," drawn up as part of the AXA Investment Managers research chair on Regulation and Institutional Investment, that this proposal would lead pension funds to shed risky assets—possibly all of them—when sponsors seek to minimise P&L volatility from pension funds, and in any case to reduce holdings of risky assets as a result of the sponsor’s aversion to reporting P&L volatility. We thus firmly warn the IASB against the temptation to do away the corridor approach.

In addition to defending the minimum 90% threshold of the current IAS 19 corridor, an incentive to maintain adequate funding ratios, we defend the amortisation feature of the current IAS 19 approach: amortisation reflects the underlying economic rationale of pension fund management and the general treatment of debt (which is amortised in the accounts of the sponsor). The balance sheet should be made transparent by presenting the net pension obligation at fair value, i.e., with immediate recognition in the balance sheet but delayed recognition in the P&L––this recognition implies a recycling approach similar to that taken in the American FAS 87.

The discount rate has been overlooked in IASB recommendations. We recommend that IAS 19 authorise smoothing market yields on a quarterly basis. The recent volatility of long-term interest rates, which serve as a reference to discount liabilities, has called into question this particular use of these rates. Because pension liabilities are neither traded nor fully replicable, they need not fully reflect the market noise of long-term zero and forward rates derived from traded bonds. After all, defined-benefit pension liabilities will always be different from traded instruments. Because the market for long-term bond yields is relatively thin, long-term yields are noisy, and the noise in long-term yields is highlighted in the long-term zero-bond yields and even more in the long-term forward yields, both of which affect the valuation of pension liabilities. Because there are more data for government bonds, we use them to illustrate our point in the position paper; however, the market for corporate bond yields is much thinner than that for government bonds, so filtering techniques are more necessary. In general, we recommend that the volatility of the long-term market bond yields be filtered out; however, to prevent the creation of any perverse incentives, any smoothing or filtering should be done on an infra-annual basis––on a quarterly basis when accounts are published at this frequency.

In addition, we stress the importance of managing the real risk for plan members: the combined risk of underfunding and default of the sponsor. Managing this combined risk, which the pension fund should disclose to its members and the regulators, calls for a measurement of the value of the guarantee of the sponsor; however, pension liabilities should not be discounted at the sponsor’s own credit risk in the sponsor’s accounts, as doing so would lead to accounts that very strongly overstate the strength of the sponsor when its financial health worsens, as may have happened to the banks that stuck with full fair value during the ongoing financial crisis. The 2008 IASB proposal to discount pension liabilities at own credit risk has been severely criticised and may be permanently shelved.

In short, whereas the current method is appropriate for measuring the cost of providing pensions as they are reported in the profit and loss account of the sponsor, the IAS 19 liability measure is inconsistent with the prudential measure of pension liabilities; it is also inconsistent with the run-off approach generally taken in other accounting standards. Overall, we recommend that IAS 19 require that the accrued benefit be reported in the balance sheet, an option that would pave the way for a measurement of the liability consistent with that of other reporting standards; the transparency and legibility of the accounts would thus be enhanced.

This research was carried out by EDHEC-Risk as part of the AXA Investment Managers research chair on Regulation and Institutional Investment.