Pension Accounting explained
16 August 2002 - Reason for this document: In 2001 TPG has changed its accounting for pensions in line with FAS87. For those that are less familiar with the mechanism involved in FAS87 and to make sure that this change of accounting methodology is fully understood, this document outlines the effects on P&L, balance sheet and cash flow. Understanding the accounting for pensions should help you understand any potential value impact.
Disclosed information on pensions
TPG has disclosed all relevant information on pensions on pages 74 and 75 of its 2001 annual report. In summary, page 74 includes the information on the various pension schemes. It outlines that within TPG both Defined Benefit Plans and Defined Contribution Plans exist. A Defined Benefit Plan is characterised by the fact that the ultimate pension entitlement is linked with a qualifying salary that has been earned during the service life. Since the pension has been guaranteed by the employer, the ultimate risk remains with TPG.
A Defined Contribution Plan is characterised by the fact that the future pension is depending on the returns of such contribution. No additional liability arises for TPG.
As is described on page 74, TPG has three Defined Benefit Plans, including the early retirement plan, which in total cover its Dutch employees. In addition outside the Netherlands TPG participates in a number of Defined Benefit Plans, most notably in Australia.
With the exception of the early retirement plan that is managed by TPG, all Defined Benefit Plans are funded externally and managed independently by a Board.
Page 75 includes all information on the defined benefit plans in accordance with the disclosure requirements of FAS132.
Disclosed information on pensions re-arranged in the PricewaterhouseCoopers Valuation format The table below contains the disclosed information of page 75 in a re-arranged format that helps understanding the information on pensions.
| Actual | Movement: | Movement: | Estimated | Gains/ | Actual | |
| Position
at | Income | Cash | Position
at | (Losses) | Position | |
| 01/01/01 | 31/12/01 | 31/12/01 | ||||
| Benefit
Obligations | -3,271 | Service
cost -116 | Benefits
paid 88 | -3,510 | 212 | -3,298 |
| Interest
cost -209 | Participants
contribution -2 | |||||
| Plan
Assets | 3,283 | Expected
return 313 | Contributions
100 | 3,608 | -515 | 3,093 |
| Benefits
paid -88 | ||||||
| Funded
Status | 11 | -12 | Employer
contribution 98 | 97 | -303 | -206 |
| Unrecognized
Transition Cost | 116 | -45 | 71 | 71 | ||
| Unrecognized
Prior Service Cost | -433 | 40 | -393 | -393 | ||
| Unrecognized
(Gains)/ Losses | -670 | 26 | -644 | 303 | -341 | |
| (Accrued)/
Prepaid Pension Cost | -976 | NPPC
9 | 98 | -869 | -869 |
The weighted average assumptions as of 31 December 2000 that have been used to calculate the 2001 movements in the income statement include a discount rate of 6.3% and an expected return on plan assets of 9.5% (see page 75 annual report)
Benefit Obligations
Reading from left to right the table explains how benefit obligations in 2001 have moved from 3,271 million Euro at the beginning of 2001 to 3,298 million Euro at the end of 2001. The interest cost amounting to 209 million Euro have been calculated as 6.3% over the Benefit Obligations as per the 1st of January and including roughly half of the service cost applicable to the year.
The Benefit Obligations include the Obligations for early retirement managed by TPG that are part of the transition plan that includes any future entitlements for employees as from a certain age into the externally managed funds. The part of the early retirement plan managed by TPG has no separated Plan Assets. The accompanying Benefit Obligation for early retirement will gradually decrease as no new participants will be allowed under this scheme.
Plan Assets
Again reading from left to right the Plan Assets have moved from 3,283 million Euro at the beginning of 2001 to 3,093 million Euro at the end of 2001. The expected return calculated at 9,5% over the Plan Assets value as per the 1st of January 2001 amounted to 313 million Euro. As can be concluded from the movements by adding the expected return of 313 with the (515) from the Gains and (Losses) the actual return has been a loss of 202 million Euro (as was disclosed on page 75 of the annual report). The cash contributions made in 2001 are added to the plan assets and will add to the expected returns going forward at the expected return rate as assumed on 31st of December 2001.
Funded Status
The line that reads "Funded Status" is the difference between the Benefit Obligations and the Plan Assets.
A positive funded status means that the value of the Plan Assets more than covers the value of the Benefit Obligations. This could indicate a future reduction of contribution payments by the employer or a possible refund.
Similarly a negative Funded Status indicates a potential future cash outflow from the employer and/or the plan participants (if agreed by the unions).
As can be concluded from this line, the Funded Status during 2001 has been negatively impacted by the negative returns on the Plan Assets that in part were compensated by positive actuarial gains.
Both a possible refund of contributions or additional contribution requirements are governed by the various contractual arrangements that TPG has with the various schemes.
Unrecognised positions
FAS87 is known for its smoothing mechanisms that, in short, results in any gains and/or losses being amortised over the remaining service lives of the employees in order to ultimately match the total pension cost over the entire service lives of the employees.
The table includes three types of unrecognised items.
The first is called the "Unrecognised Transition Cost". This was the shortfall in the funded position that was calculated in the past when TPG for the first time applied the FAS87 calculation. The amortisation period was set at that time and the total amount is amortised on a straight line basis adding 45 million Euro to the cost in the P&L untill the total position has gone.
The second is deferred income called "Unrecognised Prior Service Cost" and reflects any amendments of the pension schemes in the past. The major amendment of TPG’s main Defined Benefit Plan was decided upon in 2000 and resulted in a change from a scheme based on final pay to average pay. The future savings of this new plan amendment have been added into the "Unrecognised Prior Service Cost" and are amortised into the P&L as a benefit over the remaining service lives of the employees which at that time was some 11 years.
The third type is deferred income called "Unrecognised Gains/Losses". These include any actuarial gains or losses as well as the gains or losses on Plan Assets. As is clearly demonstrated in the table in the column that is headed "Gain/(Losses)" in 2001 in total 303 million Euro of losses was added to this position. If these deferred gains or losses exceed 10% of the highest of either Plan Assets or Benefit Obligations, this difference is again amortised into the P&L over the remaining service lives of the employees (so called "Corridor approach").
All FAS87 calculations, including arriving at the effects of amortisation, are performed on a per scheme basis and subsequently these effects are consolidated.
Accrued Pension Cost
Adding the line "Funded Status" with the "Unrecognised" positions totals to the pension liability that is included in TPG’s balance sheet. This last line clearly shows how the total liability has moved from 976 million Euro as per the 1st of January into 869 million Euro as per the end of the year by adding the P&L pension cost expense (which was a benefit in 2001) and subtracting the cash payments made by TPG. The net cash movement impacts the balance sheet in the year the contributions are made but not the P&L
Cash flow and P&L are two separate things
The column that heads "Movement: Income Statement" includes all separate cost items that in total make up the Net Periodic Pension Cost (NPPC) for the Defined Benefit schemes. Any cash movement from TPG into the Plan Assets of the schemes has no immediate effect on the P&L and vice versa the P&L effect is a non-cash movement. The P&L impact is based on an actuarial calculation (service cost, interest cost, expected return on assets) less the effect of the gains and losses being amortised over the remaining service lives of the employees.
Characteristics of accrued liability should be understood
The table clearly shows that although in 2001 the total liability has decreased, within this total liability the funded status has turned into a shortfall whilst the unrecognised gains have diminished. The funded status is a indicator for a potential cash inflow/outflow. The unrecognised positions are indicators for deferred income/losses.
Funded status directly linked with cash contributions by TPG
The logic of the table also indicates that the Funded Status moves (amongst others) with the cash payments made by TPG. In the particular case a higher cash contribution from TPG in 2001 would have reduced the shortfall of the Funded Status (and consequently would have resulted in a lower liability in its balance sheet).
How does this information link with note 9 on provisions and note 18 on cost?
Note 9 on page 49 of our annual report include the movement table of the "Provision for pensions and retirement schemes". The column that heads "Pensions" indicates that the start position of 976 million moved into a position at balance sheet date of 869 million by way of a "withdrawal" of 107 million Euro. This 107 million Euro consists of the 9 million Euro P&L benefit for the Defined Benefit plans plus the 98 million of cash contributions from TPG.
Note 18 on page 54 of our annual report gives a break down of the "Salaries and Social Security Contribution Cost" of our P&L. It reads total Pension Contributions of 37 million Euro. This is the summation of the 9 million Euro benefit for the Defined Benefit Plans plus a total of 45 million Euro (negative) for all Defined Contribution Plans.
What is the main difference between the FAS87 accounting method and the method TPG used prior to 2001? P&L
Prior to 2001 the pension cost in the P&L for the Defined Benefit plans consisted of the cash contributions under the contractual arrangements with the externally managed funds as well as a addition to the early retirement provision based on certain actuarial assumptions.
Today under FAS87 the pension expense/credit for the Defined Benefit plans is an amalgam of different components that aim to match the total pension cost of employees over the entire service lives. None of these components reflect an actual cash movement in the particular period.
Balance sheet
Prior to 2001 the pension liability for the Defined Benefit plans in the balance sheet only included the liability for the early retirement plan based on certain actuarial assumptions.
Today under FAS87 the total liability for the Defined Benefit plans still include the liability for the early retirement plan as managed by TPG, but on the basis of different more prescribed actuarial assumptions. On top of that the liability includes the funded position of all externally managed funds and the deferred income/losses that stem from the smoothing approach as prescribed by the FAS87 method.