Rate cuts Impact pension provisions reported on financial statements
The long-awaited regulatory intervention will presumably be passed into law in late February. The erosion of rates has caused pension provisions to skyrocket since 2014, which places an enormous burden on company balance sheets, as they cause reported earnings to shrink. The steep rise in pension provisions is mainly a result of the regulation in force which requires rates to be calculated on a 7-year average.
Legislators have long been discussing a change to averaging rates over 15 years. The current bill only extends the period to a 10-year average. In general, the new regulation should be mandatory to all financial years ending after 31/12/2015. However, companies have the option of applying it earlier. The bill prohibits companies from paying out the difference between the 7-year-average and 10-year-average valuations.
On the basis of this change in rate calculation, pension provisions can be assumed to perform as shown below (cumulative 3-year view from 2014 to 2017):
| 2015 | 2016 | 2017 | |
| Old regulation (7-year average) | 15% | 25% | 35% |
| New regulation (10-year average, starting in 2016) | 15% | 10% | 15% |
| New regulation (10-year average, starting in 2015) | 5% | 10% | 15% |
When first applied in 2016, in addition to normal allocation, the new regulation will trigger a release equal to 5 per cent. Applying it to the unclosed 2015 financial statements yields a harmonious increase with significant easing for 2015 and smooth additional increases thereafter.
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Regardless of the alleviation caused by stretching the provision increase based on the planned law, there is no mistaking the fact that the values of the two methods will be adjusted again. Without changing the average, the cumulative increase through to the year 2022 comes to approx. 60 per cent. Changing the averaging period from 7 to 10 years postpones this peak until 2024.
In spite of the alleviation in the short term, this means that there is room to manoeuvre to avoid this impact on the balance sheet if companies wish to do so. Doing so would require outsourcing the pension commitments or a combination of funding them in a manner which moves them off the balance sheet and reorganising the commitment type.