II - Provisions: Specific points and Examples

2. Employee Benefits

Funding versus Accounting

Funding
- Determines employer cash contribution to plan (contribution to plan assets for funded plans and direct benefit payments for unfunded plans)
- Often governed by tax and employment legislation
- Cash contribution recognized in cash flow statement
Accounting
- Charge (Income) recorded as expense in P&L:
  - benefit expense recognized as service accrued
  - not recognized when paid
- and Net liability recognized in the balance sheet, which reflects cumulative difference between expense and cash contribution.

Actuarial Valuation: Types and Purposes

Why do companies spend a lot of time on assumption setting?

Small changes in some assumptions have a big impact on the P&L, funded status and/or balance sheet
To ensure consistency across plans/countries
To ensure compliance with IAS 19 requirements
Increasing scrutiny by auditors and regulators
Increasing disclosure requirements --> need to be able to justify assumptions to analysts/investors

Actuarial assumptions

IAS 19 requires financial and other assumptions to be determined at each year-end, by reference to market conditions and company expectations on that date
Actuarial assumptions should be unbiased and mutually compatible
They are the company’s best estimates of the variables that will determine the ultimate cost of providing employee benefits
Under IAS 19, actuarial assumption setting is ultimately the responsibility of the company
The main actuarial assumptions are:
- Financial assumptions:
  - Inflation
  - Social security ceiling increases, or legal pension increases
  - Salary increases
    - Expected long-term average annual rate of pay increase
    - Inflation + Productivity + Merit & Promotion
    - Increase (decrease) in salary increase = Higher (lower) DBO
    - Increase of pensions in payment (if applicable)
    - Discount rate (selected depending on the type/purpose of the actuarial valuation)
      - Time value of money
      - Must reflect current rates of return on high quality fixed on income investments
        Bonds with AA or higher rating
        Duration matching timing of benefit payments
        Increase (decrease) in discount rate = Lower (higher) DBO
- Demographic assumptions:
  - Mortality
  - Turnover
  - Disability
  - Retirement age