Discount rate for IFRS/US-GAAP/UGB valuations

To determine the discount rate recommendation Mercer uses its own approach, the ‘Mercer Yield Curve Approach’ (MYC). The MYC is being used for setting discount rates for valuations made for USA, UK, Canada, Eurozone and some other countries. According to this approach, Mercer creates a ‘Spot Rate Yield Curve’ based on bonds from the Thomson Reuter’s Datastream indexes (until 31.5.2015 from Bloomberg indexes) in the Euro area. Since the discount rate in accordance with IAS 19.78 is defined by the ‘time value of money’, which by definition does not incorporate any greater risk of default, Mercer consequently uses only those bonds, which have no interest rate-distorting options, like e.g. it would be the case with call or put options. Furthermore, the bonds with much higher or lower interest rates compared to the other bonds (statistical outliers) are also not considered. A detailed explanation of the method described above can be found here. 

For the valuations according to international accounting standards (IFRS/US-GAAP/FRS), the discount rate should be determined according to the maturity of the liability based on "high quality corporate bonds". In the long-term average these rates were only around 0.5% points higher than the rates for (quasi safe) AAA rated government bonds. Therefore, the standard setters, auditors and actuaries typically use AA rated corporate bonds as ‘high quality corporate bonds’. E.g. the iBoxx corporate AA10+ is a commonly used benchmark index.

The  relevant method used to determine the discount rate has a very strong impact.

The companies therefore have a certain  latitude in the choice of the discount rate (although the principles of continuity and consistency still must be followed).

Our recommendation is based on durations of 10, 15 and 20 years. The discount rates for different durations can be determined by interpolating the values from the table below. It should also be noted that the current high level of discount rates may result in lower durations than those in the previous years.

Basis: Until 31.05.2015 Bloomberg indexes, since 30.06.2015 Thomson Reuters Datastream indexes. Discount rates Mercer Yield Curve 2006–2014 rounded to 10 basis points. Smaller adjustments in the calculation as of 30.06.2015, 30.11.2016, 31.08.2018 and 31.08.2021 (description here). The latest adjustment as of 31.08.2021 includes an improvement for less liquid bonds and for outliers. Without this refinement, the discount rate would have been a maximum of 0.01 percentage points lower.

The effects of changes in discount rates lead to so-called actuarial gains / losses. These must be taken into account in equity immediately according to the revised version of ASC 715 (US-GAAP) released in the end of September 2006 or according to the version of IAS 19 (revised 2011) released in June 2011 and applicable from 2013. In ASC 715, gains and losses may lead to increased (for losses) or reduced (for gains) expenses in the next year when the so-called corridor approach is used and the corridor is exceeded.

The statement of AFRAC (Austrian Financial Reporting and Auditing Committee) of "Provisions for pensions, severance payments, jubilee benefits and comparable long-term obligations according to the provisions of the Austrian Commercial Code (UGB)" is officially available since July 2015 and was revised in June 2016. This statement is mandatory for fiscal years beginning after December 31, 2015, early application is possible. The background to this is an approximation of the accounting for long-term personnel obligations under company law to that under IFRS (IAS19). 

Regarding the interest rate, one of the following two methods is to be applied according to the opinion:

• Current interest rate – this interest rate corresponds to the accounting interest rate for IFRS/US GAAP valuations – see paragraph 1).
• Average interest rate – this is the interest rate that is the average of the above-mentioned interest rate as of the reporting date and the interest rates determined in the same way for the previous reporting dates. In accordance with the German Regulation on the Discounting of Provisions (Rückstellungsabzinsungsverordnung), the average interest rate may also be calculated from the respective month-end rates in accordance with the German announcements of the legal regulations pursuant to Section 253 (2) fourth sentence dHGB.

The average interest rate shall selectively be determined on the basis of a period between 5 and 10 years. 

The selected average period shall be applied steadily. When determining the average interest rate, either the interest rate for a 15-year term can be applied on a flat-rate basis or the interest rate is selected in accordance with the actual remaining term of the obligations. 

The following table shows the interest rates for a 15-year term based on the 7-year average and the 10-year average (source: German Central Bank):