Which discount rate?

Published on 10 January 2014 0 comments

By John Hitchins

As another reporting season approaches, discount rates inevitably will be a subject for discussion. It continues to be a hot topic with the standard setter. The IFRS Interpretation Committee ("IC") has discussed the IAS 19 discount rate at six out of their last seven meetings, publishing an agenda rejection in November 2013 and including some changes in the December Annual Improvements Project ED. 

It seems that with the continuing low level of bond yields, efforts are on-going to justify increased discount rates or reduced pension expenses. Here are a few justifications that I have heard; "there are no longer enough AA rated bonds so high quality should include A", "I want to include more bonds to come up with my rate so I will include anything over €50m, rather than €200m", "I used to look at yields between the 10th and 90th percentiles, now I am going to look at the 40th to 90th percentiles", "Euro rates are being driven by Germany and France and we don't have any AA rated bonds in our country, so we should use Government bond rates". I am sure there will be more in the coming weeks, but it is worth looking at the latest IASB and IC discussions before you make your argument.

The proposed improvement confirms that it is the currency, not the country, which is important. So for entities paying their employees in Euros, the assessment of whether or not there is a deep market in high quality corporate bonds will have to be made for the Eurozone as a whole, not each individual country. That means that pension plans with similar durations should be using the same discount rate from Finland in the North to Italy in the South, Ireland in the West to Cyprus in the East.

You might argue that is inconsistent with the assertion in IAS 19 that assumptions that depend on the level of inflation, such as interest rates and salary or benefit increases, should assume the same inflation level; inflation is not the same in all the Eurozone countries, so should the discount rates be the same? The proposed improvement says no, but what do you think? Is consistency within a country or across borders more important?

The latest rejection from the IC also promotes cross border consistency. It highlights that high quality is an absolute measure, not a relative one, and should not change over time. Equally, the IC emphasised that the methods and techniques used to determine the discount rate, including for example how the population of high quality corporate bonds is determined, might be a significant judgement that requires disclosure.

So what does this all mean? Well the guidance has not changed but several justifications for changing the discount rate have been more clearly ruled out. There may be some good reasons to change, but "we need to reduce the pension liability" is not one of them! 

Whatever else the New Year may hold I am sure that there will be some interesting discussions between accountants and actuaries.

John Hitchins:
Read profile | Contact by email | Tel: 020 7804 2497


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