Financial review
Post retirement benefits
The difference between the fair value of the plan assets (if any) of post retirement plans and the present value of the plan obligations is recognised as an asset or liability on the balance sheet. The Group has adopted the option under IAS 19 to record actuarial gains and losses directly in the Statement of Recognised Income and Expense.
The most significant assumptions used in accounting for post retirement plans are the long term rate of return on plan assets, the discount rate and the mortality assumptions.
The long term rate of return on plan assets is used to calculate interest income on pension assets, which is credited to the Group's income statement. The mortality assumption is used to project the length of time for which future pension payments will be made. The discount rate is used to determine the net present value of those future payments and each year the unwinding of the discount on those liabilities is charged to the Group's income statement.
Valuations are carried out using the projected unit method. The expected rate of return on pension plan assets is determined as management's best estimate of the long term return on the major asset classes, ie equity, debt, property and other, weighted by the actual allocation of assets among the categories at the measurement date. The expected rate of return is calculated using geometric averaging.
The sources used to determine management's best estimate of long term returns are numerous and include country specific bond yields, which may be derived from the market using local bond indices or by analysis of the local bond market, and country specific inflation and investment market expectations derived from market data and analysts' or governments' expectations as applicable.
In particular, the Group estimates long term expected returns on equity based on the economic outlook, analysts' views and those of other market commentators. This is the most subjective of the assumptions used and it is reviewed regularly to ensure that it remains consistent with best practice.
The discount rate used in determining the service cost and interest cost charged to income is the market yield at the start of the year on high quality corporate bonds. For countries where there is no deep market in such bonds the yield on government bonds is used. For determining the present value of obligations shown on the balance sheet, market yields at the balance sheet date are used.
Details of the key assumptions are set out in note 49 to the 2008 Full financial statements.
For 2008 the charge against income for post retirement benefits net of tax and minorities was US$367 million. This charge included both pension and post retirement healthcare benefits. The charge is net of the expected return on assets which was US$697 million after tax and minorities.
In calculating the 2008 expense the average future increase in compensation levels was assumed to be 3.7 per cent and this will decrease to three per cent for 2009 reflecting lower assumed inflation in most territories. The average discount rate used for the Group's plans in 2008 was 5.6 per cent and the average discount rate used in 2009 will be 6.2 per cent reflecting the net impact of changes in corporate bond yields in the regions where the Group has pension obligations.
The weighted average expected long term rate of return on assets used to determine 2008 pension cost was 6.4 per cent. This will decrease to 5.9 per cent for 2009. This reduction results mainly from lower government bond yields in most territories which drives assured return on other asset classes.
Based on the known changes in assumptions noted above and other expected circumstances, the impact of post retirement costs on the Group's EU IFRS net earnings in 2009 would be expected to increase by some US$72 million to US$439 million. This increase is mainly attributable to the lower expected return on assets. The actual charge may be impacted by other factors that cannot be predicted, such as the effect of changes in benefits and exchange rates.
The table below sets out the potential change in the Group's 2008 net earnings (after tax and outside interests) that would result from hypothetical changes to post retirement assumptions and estimates. The sensitivities are viewed for each assumption in isolation although a change in one assumption is likely to result in some offset elsewhere.
| EU IFRS US$m |
|
|---|---|
| Sensitivity of Group's 2008 net earnings to changes in: | |
| Expected return on assets | |
| - increase of 1 percentage point | 90 |
| - decrease of 1 percentage point | (90) |
| Discount rate | |
| - increase of 0.5 percentage points | - |
| - decrease of 0.5 percentage points | 2 |
| Salary increases | |
| - increase of 0.5 percentage points | (13) |
| - decrease of 0.5 percentage points | 12 |
| Demographic - allowance for additional future mortality improvements | |
| - participants assumed to be one year older | 15 |
| - participants assumed to be one year younger | (15) |
The figures in the above table only show the impact on underlying and net earnings. Changing the assumptions would also have an impact on the balance sheet. Further information on pensions and other post retirement benefits is given in note 49 to the 2008 Full financial statements.
