Joint OECD/ABS Workshop on Pensions22-24 April 2013, Canberra

By Michèle Chavoix-Mannato & Isabelle Ynesta

OECD Statistics Directorate, National Accounts Division

To measure DB pension entitlements:

Three key assumptions Wage growth Discount rate Demographic data

Other assumptions Inflation (Un)employment rate Future prevalence of disability

Recording of under and overfunding in DB schemes.

DB schemes apply a formula to the member’s salary to determine the level of pension entitlements.

Future wage increases due to promotions/career progression modify the level of the pension.

Two approaches in the treatment of future wage growth: The Accrued Benefit Obligation (ABO) The Projected Benefit Obligation (PBO)

ABO does not consider any future wage growth while PBO takes account of expected promotions and other real or nominal wage growth factors.

ABO records only the benefits accrued to date.

PBO assumes wage increases and calculates pension entitlements according to:

The final salary of an employee; The number of years effectively worked by him.

PBO > ABO until the moment of retirement.

ABO increases in steps while PBO increases steadily over time.

Different impacts on pension entitlements occur according to the method used.

Clear guidelines are to be applied for comparability reasons.

How to choose between the two concepts?Criteria: The probability of a termination or a freezing of therespective pension scheme before the end of a worker’s career. If the probability is weak PBO method is to be selected. PBO better reflects certain pension reforms and indexation rules. PBO method is recommended for both government and non-

government pension entitlements by: IPSAS 25 IAS 19

PBO method is recommended by Eurostat/ECB Task Force for the estimations of pension obligations in DB schemes for government employees and social security pension schemes.

The IMF/BEA Task Force expressed a preference for ABO method. The SNA 2008 does not choose between the two.

What wage growth assumptions do you apply or are appliedby the relevant sources (ABO versus PBO)?

ABO approach: NLD, NOR, CHE, USA for all schemes; IRL for Social Security schemes (Pilot).

PBO approach: Most EU countries (Recommended by Eurostat); JAP for private DB schemes; USA for government DB schemes (Column E).

Both approaches: ESP for private DB schemes.

In National Accounts: Only pension entitlements due to actual and future pension benefits are

covered. Pension entitlements refer to a gross liability concept. Retained concept of pension entitlements: the accrued-to-date liabilities.

This concept includes the present value of liabilities arising from already accrued pension entitlements. It covers: Pension entitlements accrued by current workers and, Remaining pension entitlements of existing pensioners.

To calculate pension entitlements in present value terms, a suitable discount rate is necessary.

Three choices for a discount rate to be applied to government-managed pension schemes:

1. A discount rate based on the yield on (central) government bonds,

2. A discount rate based on the yield on high-quality corporate bonds, and

3. A risk-free rate reflecting the time value of money.

IAS 19 : choice number 2 – corporate bonds with an AA rating.

IPSAS Board: choices number 1, 2 & 3 or a discount rate based on a yield on another financial instrument (financial derivatives relating to bonds).

IPSAS Board considers that the same discount rate should be used for all levels of government.

The Eurostat/ECB Task Force recommends for all government-managed DB pension schemes:

1. One single rate set at 3% in real terms and 5% in nominal terms for all Euro Area countries;

2. A discount rate based on the yield on central government bonds;

3. Maturity of debt securities similar to that of pension entitlements;

4. Same discount rate for all government sponsored pension schemes;

5. Sensitivity analyses using different discount rates;

6. Projected real GDP growth rate used as discount rate – not envisaged.

What type of discount rate do you apply or is applied

by the relevant sources? Please specify the method used in practice in your country.

For private DC and DB schemes

In some countries: discount rate fixed by the company according to specific rules.

Often equivalent to long-term corporate bonds. DEU: high quality corporate bonds with a duration of 15 years; NLD: 10 years state bonds with AA rating; ESP: 100% of Spanish public debt average rate maximum; GBR: risk-free rate; USA: high quality corporate bonds with AAA rating.

What type of discount rate do you apply or is applied

by the relevant sources? Please specify the method used in practice in your country.

For government DB schemes

EU countries: Rate based on long-term government bonds (AUT, DEU, NLD, PRT, SVK); Rate used in the framework of EC AWG (ESP, HUN).

Non-EU countries: AUS: long-term bond rate or expected average earnings on fund assets; CHE: rate of return on cumulated contributions of previous years; USA: rate based on AAA corporate bond yield or on government bonds

held by the trust fund, depending on the types of general government employee DB schemes.

Pension entitlements are also dependent of future: Life expectancies Fertility rates Migrations

Life expectancy determines the expected number of years for which the pension annuity has to be paid.

Since mortality rates differ between women and men, a gender-specific differentiation of mortality data is necessary.

Demographic tables are well established for the modelling pension schemes.

Future fertility rates play a role in the estimation of an orphan’s pension.

A higher fertility rate a higher number of children receiving an orphan’s pension.

Migrations may influence the estimations of pension entitlements.

In some countries, if contributors migrate, individual pension levels may vary.

Demographic assumptions to be used in pension schemesmodels should be harmonised to ensure comparable dataacross countries.

What type of demographic assumptions is applied in your country?

Among demographic assumptions, are specifically mentioned in replies: Life expectancy: AUT, DEU, ESP; Population: HUN, NLD, GBR; Mortality: DEU, PRT, ESP, GBR; Disability: LUX, ESP; Fertility: PRT, GBR; Wedding: DEU, ESP.

EUROPOP database, used by a number of EU countries: CZE HUN IRL PRT SVK

Inflation influences the level of pension entitlements if future flows are to be projected in nominal terms.

Both discount rate and wage growth rate should include future inflation expectations.

If the level of pension entitlements is linked to (un)employment rates in the economy, assumptions on this rate should be made.

The probability of becoming disabled in the future has also an impact on the calculation of future pension entitlements.

The prevalence rate reflects this probability.

It represents the total number of disabled persons divided by the total population.

Are there other indexation assumptions for pensioners made in your country? If yes, please specify and explain.

For General Government DB and Social Security schemes

Main indexation assumption refers to the inflation rate:

AUT, CZE, HUN, SVK, ESP, USA.

For non-government DB schemes

Often, there is no legal obligation to adjust the level of pension:

DEU, ESP. CHE.

The financial account records the changes in pension entitlements of the various sectors.

Employers undertake to be responsible for under or over-funding.

The financial account records the amount of: Underfunding as a claim of the pension fund against the employer; Overfunding as a payment due by the pension fund to the employer.

Net lending/net borrowing of both capital and financial accounts are identical since entries in the financial accounts: Are the counterparts to entries in the other accounts or; Reflect the exchange of financial assets and liabilities only.

Generally, a pension plan is rather underfunded as investment shortfalls tend to be more common.

Underfunding Characteristics of an underfunded pension plan:

More liabilities than assets Negative surplus.

Assets do not cover both current and future retirements.

Consequences for future and current retirees: no assurance To receive the pensions they were promised;

To continue to get their previously established distribution amount.

Reasons for a pension plan to become underfunded: Pension’s investment are not going as expected due to a weak stock

market or interest rate changes.

Retirees are living longer than expected.

Underfunding (cont.)

The pension fund records a claim on the employer.

The employer retains the liability for this under-funding.

This claim is equal to the difference between: The increase in pension entitlements and,

The sum of the contributions and contribution supplements during the period.

Plus investment income earned on the entitlements and holding gains.

Less pension payable and fee charged by the pension administrator.

Overfunding

Characteristics of an overfunded pension plan: More assets than liabilities Positive surplus.

Assets cover both current and future retirements.

Reasons for a pension plan to become overfunded: When there is a stock market boom or

When a DB plan is converted to a cash balance plan.

The pension fund records a liability towards the employer.

The employer retains the benefit for this over-funding.

In the case of (autonomous) funded pension schemes, how do you record possible under or overfunding?

For most countries, either no recording or partial recording:

CHE: recorded as negative/positive net worth of pension fund.

NLD: currently added to actuarial technical reserves.

PRT: recorded as liabilities in the supplementary table for DB schemes managed by financial corporations (Col. B & E).

ESP: for private DB schemes, calculated in models. Deficits must be covered within 5-10 years.

GBR: recorded as employers’ imputed contributions for col. B & E.

USA: overfunding is recorded as a negative claim of the pension plan on the employer.

Thank you very much for your contributions to the OECD survey on

pension liabilities.