Corporate Israel Faces Huge Losses on Actuarial Liabilities

The rewriting of capital market changes in accounting rules could dearly cost Israel's employers.

The rewriting of capital market changes in accounting rules could dearly cost Israel's employers. Accountants and experts from the pensions sector estimate that large employers could be facing combined losses as high as NIS 2.5 billion to NIS 3.5 billion after losing between NIS 7 billion to NIS 10 billion in severance compensation funds.

Severance compensation funds are where employers deposit money on a monthly basis to assure payment of compensation if workers are dismissed. Typically, severance compensation is based upon the employee's last paycheck multiplied by the number of years the employee worked. Alternatively, some employers deposit the monthly provisions into insurance plans or pension funds. In any case, the fund invests this money in the capital market, as it does the worker's own provisions for his retirement.

An enormous problem occurred at the end of October 2008 when the public lost between 15% to 20% of the value of these various pension vehicles because of plunging asset prices in the market. Israel's companies have been required to adopt IFRS - international financial reporting standards - instead of the old Israeli standards, and under the new rules they have to make up the difference, even if they are not dismissing workers or currently paying them compensation.

The new rules do allow companies to ignore a loss of up to 10% in the funds (on a yearly basis) by classifying the loss as temporary. That rule was instituted in order not to pester the companies' accountants with the effects of transient volatility - rising and falling asset prices.

But as fate would have it, it appears that the losses the pension vehicles suffer this year will be greater than 10%. Therefore, the companies will have to factor the losses by the funds (losses beyond 10%) into their annual financial statements for 2008.

As of the end of October, as said, the losses are believed to have reached between 15% to 20%. Employers will therefore have to recognize losses of 5% to 10% in their books. That translates into about NIS 3.5 billion to NIS 5 billion, industry sources estimate.

IFRS gives companies three options to record these losses in pension liabilities. One is to spread losses out over years - throughout the "employment lifetime" of workers. Or companies may deduct losses from shareholder equity. Lastly, companies are permitted to post losses in their profit and loss statements.

Under these rules, Israeli companies would decide which option they prefer.

A survey by Price-Waterhouse (Kesselman & Kesselman) conducted among Israel's 100 largest companies (not including banks and companies listed only overseas) during the last few months found that 68% elect to record losses straight into their profit and loss statements, while 24% prefer to write down their shareholders' equity. Another 8% have opted to spread out the loss.

Kesselman & Kesselman surmised at the time, when releasing the report two months ago, that most companies do not believe actuarial losses would be that great and would not seriously harm their bottom lines. In retrospect, that means that almost 70% of these large companies will be reporting heavy actuarial losses amounting to between NIS 2.5 billion to NIS 3.5 billion.

The accounting firm noted that most companies, preferring to quickly recognize losses on their balance sheets, are engaged in real estate and insurance (80% of companies chose this option), or in trade and services (70% of companies choose to book actuarial losses in their P&L statements).

Barring a momentous upswing in the market, the bottom line is that Israel's companies face a major loss on actuarial liabilities this year.

Also, spreading the loss over years does have a downside in its creating complicated calculations when applied over many years.

The actual figures remain to be seen. Different provident funds lost different amounts of money and proper pension funds lost less money than provident funds and insurance policies. Also, some companies entered new arrangements under which they pay the pension provisions directly to the workers and are no longer liable to make up the sum when the market slumps.