Supplementary evidence from Tim Bush LDI0069

I’ve set out below an extract of IAS 19 (Employee Benefits [pension accounting]) which refers to high quality corporate bonds and where applicable government bonds.

I’ve also set out below an extract of IFRS 17 (Insurance) which does not refer to corporate bonds or government bonds, but the  term “financial instruments”.

EXTRACTS

IAS 19 (“Employee benefits” [pension accounting])[1]

Para 52 -When contributions to a defined contribution plan are not expected to be settled wholly before twelve months after the end of the annual reporting period in which the employees render the related service, they shall be discounted using the discount rate specified in paragraph 83.

Para 83 The rate used to discount post‑employment benefit obligations (both funded and unfunded) shall be determined by reference to market yields at the end of the reporting period on high quality corporate bonds. For currencies for which there is no deep market in such high quality corporate bonds, the market yields (at the end of the reporting period) on government bonds denominated in that currency shall be used. The currency and term of the corporate bonds or government bonds shall be consistent with the currency and estimated term of the post‑employment benefit obligations.

IFRS 17[2] 

Discount rates (paragraphs B72–B85) 

Para 36 An entity shall adjust the estimates of future cash flows to reflect the time value of money and the financial risks related to those cash flows, to the extent that the financial risks are not included in the estimates of cash flows. The discount rates applied to the estimates of the future cash flows described in paragraph 33 shall: (a) reflect the time value of money, the characteristics of the cash flows and the liquidity characteristics of the insurance contracts; (b) be consistent with observable current market prices (if any) for financial instruments with cash flows whose characteristics are consistent with those of the insurance contracts, in terms of, for example, timing, currency and liquidity; and (c) exclude the effect of factors that influence such observable market prices but do not affect the future cash flows of the insurance contracts. Risk adjustment for non-financial risk (paragraphs B86–B92).

END OF QUOTED EXTRACTS.

As the extracts show, IFRS 17 (Insurance) is considerably more flexible than IAS 19 (“Pensions”) in determining what instruments are used as reference points for the discount rate and, for example, IFRS 17 (Insurance) has a mark to market “waiver” “exclude[s] the effect of factors that influence such observable market prices but do not affect the future cash flows of the insurance contracts”.

Further, the OECD estimated[3] that the average length of a corporate bond is less than 13 years, so that apparent option in IAS 19 (“Pensions”) to take corporate bond yields - rather than government bonds - is somewhat constrained where the term of pension liabilities is greater than that. 

The class of assets to draw the discount rate from is broader than the gilts or corporate bonds as specified in IAS 19 [Pensions] and also the approach to discounting in IFRS 17 (Insurance)  is broader in scope than a market bond rate.

Thus I described the IFRS 17 position  as “a non-bond rate” in my written evidence and “the assets they chose to hold” as that is the effect of IFRS 17, it has been drafted to accommodate the classes of assets insurance companies hold. 

If John Ralfe is saying that pension obligations expressed as discounted liabilities in the hands of insurers don’t go down, then that doesn’t explain the incentive for an insurer to buyout a scheme, not least as an insurer will wish to take a profit margin from a buyout.

A buyout will usually involve the sponsoring company paying a lump sum (call it a “dowry”) to the insurer. Were the dowry the sole source of the profit to the insurer, then that would beg the question why the company didn’t top up the scheme by an equivalent amount, cut out the insurer, and have a scheme that would be in surplus due to the saving of profit margin extracted by the insurer.

As an aside. It would seem that buyouts also create a timing loss to HMRC where the buyout lump sum gets tax relief sooner than would have occurred from an employer’s normal annual contributions.

I believe it may also be relevant to enquire whether John Ralfe advises on scheme buyouts. If so that would suggest that he must know that the switch of pension assets in an open scheme from equities to gilts – as in the case of the Boots scheme - cannot produce returns sufficient to maintain a pension fund open to accrual (future years defined benefits) for existing members or new members: unless the contribution rate increases substantially above the traditional 15% employer/employee rate. The Bank of England rate of circa 50% is a very rare example of the latter outcome in action given that scheme hasn’t closed.

Therefore the switch from equities to bonds sets a trajectory for scheme failure. By that I mean closure, then followed by buyout: or extremely high contribution rates.

I would regard advising on buyouts, having previously advised on switching from equities to bonds as a conflict of interest. Essentially, the doctor having finished off the patient, then becomes the undertaker. That is analogous to an audit firm acting as an insolvency practitioner on the same company. But the sector is not regulated, as the Lords Industry and Regulators Committee has recognised.

Neither myself or my firm advise on pension fund asset allocation, structures, or buyouts etc.

Note UK-FRS17 (Retirement Benefits [pension accounting).

It is somewhat confusing that:-

                  The UK According Standards Board adopted the International Standard IAS19 (Employee Benefits) as UK-FRS17

                  The International standard setter then changed the name of new standards it issued from IAS to IFRS.

Thus the International standard for insurance IFRS17 (Insurance) has a similar name to UK-FRS17 (“Pensions”). Though UK is also a misnomer as the UK Accounting Standards Board standards covered the whole of the island of Ireland.

February 2023