Update on using multiple discount including bond matching models

Insights
from People and Organization
Update on using multiple discount
rates to develop benefit plan costs –
including bond matching models
December 11, 2015
In brief
Our original HRS Insight relative to the use of multiple discount rates, dated September 9, 2015,
discussed using multiple discount rates to develop benefit plan costs under US GAAP (ASC 715). Its main
focus was on a change in estimation technique to a new approach (referred to subsequently as the ‘spot
rate approach’, but also called the ‘full yield curve approach’ by some in practice) to measure Interest
Cost and Service Cost. This new approach uses the individual spot rates from a high quality corporate
bond yield curve to separately and directly determine Interest Cost and Service Cost based on projected
benefit plan cash flows in each future period, rather than the historical approach of deriving a single
weighted-average discount rate from the calculation of the projected benefit obligation and utilizing that
average rate to calculate the components of net benefit cost.
This Insight provides an update relative to certain issues and considerations regarding the multiple
discount rate approach, which reflects continuing discussions between the accounting firms and the
FASB and SEC staffs and comments in a speech at the annual SEC conference this week, including the
significant challenges to using the spot rate approach if a company uses techniques other than a full yield
curve to measure its projected benefit obligation, such as ‘bond matching’ models.
In detail
UPDATE - December 11, 2015
Bond Matching Approach
At the time of publication of our
initial HRS Insight on this topic
on September 9, 2015, the SEC
staff had only addressed the use
of the spot rate approach for
developing Interest Cost and
Service Cost for an employer
that uses a full yield curve to
measure its projected benefit
obligation. The SEC staff had
not addressed whether it would
be acceptable to adopt the spot
rate approach if an employer
was not previously developing
its discount rate using a yield
curve.
Some employers use a ‘bond
matching approach’ to measure
their projected benefit
obligation and develop their
discount rate. Under that
approach, the projected benefit
obligation and single weightedaverage discount rate is
determined based on the
internal rate of return expected
on a hypothetical bond
portfolio, that is constructed
using a small set of individual
high quality (but typically
higher yielding) bond issues
whose future coupon and
principal repayment cash flows
match the expected future plan
benefit payment cash flows.
As spot rates across the time
spectrum are not the primary
focus of the bond matching
approach, there is no set of full
yield curve spot rates that ties
directly to the measurement of
the projected benefit obligation
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and development of the single
weighted-average discount rate to
directly apply to disaggregated benefit
cash flows. Therefore, in order for a
company that utilizes a bond
matching approach to apply the spot
rate approach, it would need to
develop a comparable set of spot
discount rates across the time
spectrum, or to adopt a yield curve
approach to measuring the projected
benefit obligation.
The accounting guidance indicates
that a company may change its
approach for determining discount
rates, but (a) only if there is a change
in facts and circumstances from the
prior period, and (b) only if it results
in a better estimate of the rates at
which the obligation could be
effectively settled.
A spot rate yield curve is typically
developed from many more bonds
than exist in a bond matching bond
portfolio. So it could be challenging to
conclude that changing from a bond
matching approach to a yield curve
approach would result in a better and
more refined estimate of the
settlement rate. Furthermore, many
companies that utilize the bond
matching approach changed to that
approach from a yield curve (or other)
technique in the recent past, often on
the basis that the bond matching
approach resulted in a better estimate
of settlement rates.
Additionally, the determination of
Interest and Service cost should
incorporate the same information and
discount rates that were used to
determine the projected benefit
obligation. This could make it
challenging to derive or develop a full
set of spot discount rates, if those
rates were not used in the calculation
of the overall discount rate and
projected benefit obligation under the
bond matching approach.
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There have been ongoing discussions
with the FASB and SEC staff on this
issue. At the National AICPA
Conference on Current SEC and
PCAOB Developments in Washington,
D.C. on December 9, an SEC staff
member commented in a speech that,
while the staff would be willing to
discuss an individual registrant’s facts
and circumstances and its rationale
for changing to an alternative discount
rate development approach, the staff
believes the focus of the assessment
should be on the measurement of the
benefit obligation and determination
of the best rate for settling the
obligation, rather than on the
calculation of components of net
benefit costs. So a company must also
consider their prior basis and reasons
for selecting the bond matching
approach and whether those are still
relevant, and what economic facts and
circumstances have changed to
warrant a change in approach, beyond
accounting perspectives on the
calculation of net benefit cost. The
staff also noted that the materiality of
a change from a bond matching model
approach to a spot rate yield curve
approach should not be used as a
basis for selecting a model. That
would be the case even if the change
would result in little or no difference
in the plan’s benefit obligation at the
current time. In discussions with the
accounting firms, the SEC staff
encouraged registrants to consider
pre-clearing if they believed that their
facts and circumstances supported
such a change.
Observation
Based on the SEC staff’s views, we
believe that using the spot rate
approach for developing Interest Cost
and Service Cost by a company that
presently utilizes the bond matching
approach to calculate discount rates
and the projected benefit obligation
would be very difficult to justify with
either of the following changes:
(i) switching from the bond
matching approach to the yield
curve approach to develop the
benefit obligation, Interest Cost
and Service Cost using an
existing yield curve’s spot rates,
or
(ii) continuing to use the bond
matching approach to develop
the benefit obligation, but
developing a yield curve with
spot rates that under the yield
curve approach would
mathematically produce a
comparable benefit obligation,
and using that yield curve’s spot
rates to develop the Interest Cost
and Service Cost.
Consistency of Approach
For companies that do utilize yield
curves and are considering a change
to the spot rate approach, we believe a
consistent estimation approach
should generally be used for all of an
entity’s retirement benefit plans
(pension and OPEB), unless relevant
facts and circumstances provide
adequate rationale for a difference in
approach for a particular plan or a
plan in a particular jurisdiction, and
subject to materiality considerations.
Observation
In some countries, credible high
quality bond yield curves may not be
available and so other approaches
are used by employers in developing
the discount rate in those countries.
This is an example of a situation
where it may be appropriate for a
company to change to the use of the
spot rate approach for certain plans,
but not for others (i.e., plans in
countries where there are no viable
yield curves).
Rounding Conventions
If a company historically has used a
rounding convention (e.g., nearest 10
basis points) in developing a plan’s
single weighted-average discount rate
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Insights
used to value plan obligations, we
believe that rounding convention
should be discontinued if a change to
the spot rate yield curve approach is
made.
Observation
Under the spot rate yield curve
approach, spot rates from the full
yield curve are used directly in the
calculations, rather than using a
calculated single weighted-average
rate. As the obligation, Interest Cost
and Service Cost should be calculated
based on the same actual spot rates in
the yield curve under the spot rate
approach; the use of rounding would
not be consistent.
Disclosures
The SEC staff has indicated robust
disclosures would be expected if a
change in estimate to an alternative
approach (such as the spot rate
approach) is made. If adopting an
alternative approach at the year-end
2015 measurement date, we generally
believe footnote disclosures for 2015
should include:
If an alternative approach is adopted
at the year-end 2015 measurement
date, financial statement disclosures
for 2016 should include:
 the difference in expense under the
new approach compared with the
previous approach, in any interim
financial statements (i.e. 10-Qs)
and in the 2016 year-end financial
statements, and
 in addition to the traditional
disclosure of the weighted-average
discount rate relative to
measurement of the benefit
obligation, new weighted-average
discount rates (or effective rates)
relative to benefit cost
development for Interest Cost and
Service Cost (and possibly interest
on Service Cost, but that may not
be significant enough to mandate
separate disclosure).
 A statement that a change in
estimate is being made at year-end,
which will have a prospective
impact on expense,
 A brief description of the new
approach and how it will be
applied vs. the old approach, and
 The impact on the current year
financial statements, if any.
[NOTE - There may not be any
impact on the 2015 reported
amounts or the consistency in their
calculation from prior periods.]
Additionally, for SEC registrants,
Management’s Discussion and
Analysis (‘MD&A’) in 2015 should
discuss (subject to materiality) the
expected future impact of the change
in estimate on income from
continuing operations.
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Let’s talk
For more information, please contact our authors:
Ken Stoler, Los Angeles
(213) 270-8933
[email protected]
Jay Seliber, Florham Park
(973) 236-7277
[email protected]
Nicole Berman, Florham Park
(973) 236-4202
[email protected]
Grant Peterson, Los Angeles
(213) 356-6804
[email protected]
Al Johnson, Boston
(617) 530-4114
[email protected]
or your regional People and Organization professional:
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(646) 471-0651
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(312) 298-2164
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