Employer retirement pension schemes UN STATISTICS DIVISION Economic Statistics Branch National Accounts Section UNSD/ECA National accounts workshop November 2005

Background Current SNA Evaluation of the problem Recommendations of the EDG Implications Examples General Government Unfunded Employee Scheme: SNA recording - Proposed recording Defined benefit autonomous scheme: proposed recording Issues raised by Eurostat Recommendations of the AEG

Background In 2001 the Intersecretariat Working Group on National Accounts (ISWGNA) requested the Statistics Department of the IMF to establish an Electronic Discussion Group (EDG) on pensions. Initially, the task of this EDG was to make proposals to account for employers’ pension schemes. Later the EDG was asked to broaden its review all pension arrangements. The extension of the EDG’s mandate was related to ongoing policy debates on the fiscal sustainability of the government social security schemes in times of demographic change.

Current SNA Promises to pay future pensions are recognized as assets/liabilities for funded employers’ pension schemes, not for unfunded. The values that the 1993 SNA records as “employers’ actual social contributions” to defined benefit pension funds reflect amounts paid rather than the true cost to the employer of the pension entitlements that staff accrue. Underfunding or overfunding of defined benefit employers’ pension schemes is not shown as an obligation or a claim of the employers.

Evaluation of the problem The “core question”: Are the promises from unfunded employer pension schemes definite enough to be recorded as assets and liabilities in statistics ? The EDG considered that a promise to pay future pensions answers the definition of a financial asset if (i) honoring such promise is legally enforceable, or (ii) the promise has the character of a “constructive obligation” The EDG agreed that all such assets should be recognized irrespective the institutional form the pension plan may take. The case of employers’ pension funds would pose no problems in this respect as the pension obligations directly arise from their deferred compensation nature and therefore should be either legally enforceable or constitute constructive obligations.

Evaluation of the problem EDG: For other types of scheme the situation may be less clear. Social security + Household behavior influenced by expectations on benefits + Political pressure not to reduce the rights + Need of knowledge about future obligations + Innovation has blurred distinction between social security and other social insurance (warrant equal treatment) - Government can change conditions Future benefits not economic assets (cannot enforce ownership rights) Variable systems

The EDG considered that the cost of employment would be better measured if employers’ social contributions to defined benefit schemes would be recorded according to actuarial standards. Furthermore, the EDG found it also appropriate to measure property income attributed to insurance policy holders according to actuarial norms. The EDG recommended that the employers’ final responsibility should be disclosed by recording a liability/claim of the employer in case of underfunding/overfunding. GFSM 2001 recognizes unfunded obligations as liabilities (NZ, Australia, Canada).

Recommendations by the EDG The EDG recommends the following: Treat unfunded employers’ pension schemes identically to funded employers’ pension schemes; For all defined benefit employers’ pension schemes, use actuarial valuations to measure (i) employers’ social contributions and (ii) property income attributed to insurance policy holders; Allocate the net assets of defined benefit employers’ pension schemes to the sponsoring employers. “In view of the wide range of conditions under which social security schemes operate, the EDG considered it was too early to make concrete proposals regarding such schemes for the present SNA update.” No changes for defined contribution schemes

Implications The first recommendation implies a significant change to the 1993 SNA. In practice, the effects will be particularly important for the government. Increased deficit and increased GDP. The second recommendation changes the accrual of employers’ social contributions and property income attributed to insurance policy holders; actual payments that employers make to defined benefit pension schemes would be treated as pure financial transactions.

Implications The third recommendation changes the 1993 SNA by setting the net worth of all employers’ pension schemes at zero by definition. No change for the treatment of defined contribution pension schemes because by definition these schemes cannot be under- or overfunded. No changes in social securities. The recommendations are consistent with the market value principle and the accrued principle – and GFSM2001.

Issues raised by Eurostat It can be questioned whether unfunded or pay-as-you-go schemes are economically the same as funded schemes. One consideration is whether the capacity of the debtor to unilaterally alter the value of the pension promises should be a main criterion for asset recognition. Will the use of this concept of constructive obligations be extended to other areas of SNA, and what would be the criteria against such extensions? Can accumulated rights be converted into cash or transferred between schemes? In some schemes, pension rights cannot be transferred and can even be lost upon change in employment.

Issues raised by Eurostat There is also a concern that the inclusion of data on pensions may put at risk the overall quality of statistics produced. It is argued that the use of models and the number of imputations should be limited to the extent possible, to avoid volatility in data and reduce scope for manipulations.

Issues raised by Eurostat European government finance statistics … ESA 1995… Excessive Deficit Procedure (EDP)………… fiscal surveillance in European Union….. “Stability and Growth Pact” The current proposals would impact government accounts, as civil servants schemes are often unfunded. [European] Government deficits and net worth would deteriorate, up to 1 to 2% of GDP.

Recommendations of the AEG The group agreed that governments have an liability for pensions of their employees, regardless of whether the scheme is funded or unfunded. Governments should also have a corresponding “liability” under social security, but this might be of a different nature and more difficult to quantify. The problem in some countries is to disentangle unfunded employers’ pension schemes from social security.

Recommendations of the AEG Practical guidelines are needed to show national accountants how to estimate employee pension liabilities when public account estimates are not available. The SNA definition of the output of pension funds needs to be reviewed. This topic is one of the most important in the SNA review, thus there needs to be a speedy and clear resolution of these issues to meet the deadlines. One possibility was to create a task force would coordinate with the TFHPSA.

Report on the Meeting of the Task Force on Employers’ Retirement Schemes Washington, DC September 21-23, 2005

Origin of Task Force At December 2004 meeting, the Advisory Expert Group on National Accounts (AEG) asked for a task force (TF) to prepare AEG’s further discussion on recording pension funds in the national accounts That TF would prepare a discussion paper for the AEG’s meeting in January 2006

Task Force planning IMF and BEA put together the TF Drafted a Terms of Reference (TOR) Circulated TOR for comments among the Inter- secretariat Working Group on National Accounts (ISWGNA) After some discussion the ISWGNA agreed Focused TF on defined benefit pension schemes Some discussion of defined contribution schemes and the borderline with social security Invited participants for the TF, asking them to draft discussion papers on the topics identified in the TOR Task Force meeting held in Washington, DC from September 21 to 23, 2005

Task Force participants IMF and BEA co-chairs Representatives of international organizations ECB, Eurostat, IMF, OECD, UN, World Bank Country representatives Australia, Canada, Denmark, India, Netherlands, Sweden, USA US pension actuaries

What are employers’ pension schemes? TF Conclusions Schemes set up to provide retirement benefits to participants, based on employer-employee relationship Funded, unfunded, or over- or under-funded May or may not be mandated by government Autonomous or non-autonomous Autonomous schemes involve institutional units separate from employers Non-autonomous schemes are managed by employers, with or without segregated reserves

1993 SNA treatment of pensions Output Autonomous pension schemes: measured separately Non-autonomous schemes : not recorded separately Ancillary to employer’s main output Employers contributions (part of compensation): Funded schemes: actual contributions Unfunded schemes: imputed In principle, SNA recognizes imputation should be based on actuarial considerations In practice, SNA suggests using benefits paid in current period

1993 SNA treatment of pensions Employee contributions Recognized for all pension schemes Property income Attributed to beneficiaries Only recorded for funded pension schemes As investment return on fund assets (insurance technical reserves) Investment return includes only property income, not holding gains Anomalous treatment of interest-bearing versus non-interest bearing securities

Shortcomings of 1993 SNA Output from non-autonomous funds ancillary to main employer activity Fails to recognize that pension schemes provide services to beneficiaries, not employers Estimating employer contributions based on amounts paid SNA does not do this for any other liability Employers’ contributions should reflect liabilities to employees, regardless of funding PV of future pension benefits from service in current period

Shortcomings of 1993 SNA SNA internally inconsistent Compensation of employees in income account includes imputed employer contributions for unfunded schemes But, the concomitant assets/liabilities related to future benefits are not recognized in the financial accounts or balance sheets In contrast, such assets and liabilities are recognized for funded schemes Under- and over-funding is not recognized as an employer obligation or claim

Output – TF conclusions There is output for both autonomous and non- autonomous funds Output of pension funds should be measured at cost Including the full management cost of any insurance company managing a fund Output is consumed by the beneficiaries (i.e. households) More work required to determine if the output of autonomous pension funds should be based on actual or expected transactions and holding gains/losses

Property income – TF conclusions The value of property income should be The expected property income on the accumulated value of benefits (due to the unwinding of the discount of these benefits) Plus the service charge for funds management For autonomous funds: The fact that some property income may be funded from holding gains is not a reason to exclude this amount

Developing actuarial estimates Actuaries develop estimates from Information on individual workers and pension plans External information (e.g. discount rate) Actuarial standards require that the discount rate be based on high quality bond rates relevant to employer and with relevant time to maturity Present value of pension liabilities is sensitive to discount rate

Developing actuarial estimates There are a number of different valuation approaches Projected benefit obligation (PBO) Part of total pension benefits employee will earn during entire career, due to years of service to date Accrued benefit obligation (ABO) Calculated for years of service to date based on current wage and salary rates PBO > ABO, with large difference in early years decreasing towards retirement date

Developing actuarial estimates TF conclusions The accumulated value of benefits should only be calculated based on service to date (ABO) Should not take projected future wages and salaries into account (PBO) PBO estimates could be provided in memoranda The value of household pension assets is consistent with the actuarial value of the employer’s liability to provide future retirement benefits Due to service provided to current date

Actuarial and accounting standards TF conclusions Professional practice confirms the consistency of actuarial estimates and accounting conventions Accounting conventions are likely to move from including PBO to ABO based estimates in the balance sheet PBO based estimates are expected to continue to be available

Discount rate - TF conclusion An acceptable discount rate would be the interest rate on high quality securities relevant to the sponsor of the pension scheme

Multi-employer schemes TF conclusions A multi-employer defined benefit pension scheme typically assumes the liabilities of all employers within the scope of the scheme In that case, an employer does not incur any further liabilities once it has joined the scheme, apart from regular contributions to the scheme, until he withdraws from the scheme

Pension scheme sectoring TF conclusions Autonomous schemes Include in the pension subsector of the financial corporations sector Non-autonomous schemes Include in the sector of the sponsor Unless, quasi-corporations can be established for funds In which case they are sectored the same as autonomous funds

Recording issues - papers Four papers were presented, with different proposals for the recording of pensions Brian Donaghue (consultant, IMF) Record both funded and unfunded pension schemes in the core accounts Record based on actuarially-determined accrued liabilities Reimund Mink (ECB), Dieter Glatzel (Eurostat) Leave core accounts unchanged Record unfunded pension schemes and social security identically in supplementary accounts

Recording issues - papers François Lequiller (OECD) A compromise between the two previous positions Incorporate unfunded pension schemes in the core accounts Treat stocks and flows of unfunded schemes separately from funded schemes leading to alternative balancing items Keep stocks and flows of social security outside core accounts Include an estimate of contributory social security liabilities in supplementary accounts Record pension liabilities associated with government employees in the core accounts regardless of label

Recording issues – TF conclusions A clear majority of the task force recommended the following: All pension liabilities of employers should be recognized, irrespective of the degree to which the schemes are funded Stocks and flows of all pension schemes should be recorded in the core accounts Specific guidance needs to be given to so-called “notional defined contribution” schemes Recognizing practical problems and user needs, stocks and flows of funded and unfunded schemes should be separately identified

Social security borderline TF conclusions Social security is essentially a redistributive process imposed and controlled by government benefits provided are not directly linked to the size of contributions Some governments operate schemes which combine this basic social security function with what is effectively a multi-employer pension scheme The criteria for distinguishing basic social security from employer-related pension schemes need to be reviewed as a matter of urgency

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