Note 19: Post-retirement benefit provisions

Post-retirement benefit provisions relate to defined benefit pension and other post-retirement benefit plans, including healthcare or welfare plans. The largest defined benefit pension plans are the ICI Pension Fund (ICIPF) and the Akzo Nobel (CPS) Pension Scheme in the UK which together account for 86% of defined benefit obligations (DBO) and 91% of plan assets. Other pension plans include among others the largely unfunded plans in Germany, the plans in the US and certain other smaller plans in the UK. The benefits of these pension plans are based primarily on years of service and employees’ compensation. The funding policy for the plans is consistent with local requirements in the countries of establishment. We also provide certain healthcare and life insurance benefits to retired employees, mainly in the US and the Netherlands.

Valuations of the obligations under the plans are carried out regularly by independent qualified actuaries. We accrue for the expected costs of providing such post-retirement benefits during the service years of the employees. Governance of the benefit plans is the responsibility of the Executive Committee Pensions. This committee provides oversight of the costs and risks of the plans including oversight of the impact of the plans on the company in terms of cash flow, pension expenses and the balance sheet. The committee develops and maintains policies on benefit design, funding, asset allocation and assumption setting.

Pension plans

Almost all of the defined benefit plans have been closed to new members since the early to mid-2000s, although in many plans long-serving employees continue to accrue benefits. For plans in the US, benefit accrual is frozen and employees participate in defined contribution plans for future service. In countries where plans are closed, new employees are eligible to join a defined contribution arrangement. In countries in high growth markets, pension schemes currently are not material. Unless mandated by law, it is our policy that any new plans are established as defined contribution plans.

The most significant risks that we run in relation to defined benefit plans are investment returns falling short of expectations, low discount rates, inflation exceeding expectations, retirees living longer than expected and legislation changes. The assets and liabilities of each of the funded plans are held outside of the company in a trust or a foundation, which is governed by a board of fiduciaries or trustees, depending on the legal arrangements in the country concerned. The primary objective with regards to the investment of pension plan assets is to ensure that each individual plan has sufficient funds available to satisfy future benefit obligations in accordance with local legal and legislative requirements. For this purpose, we work closely with plan trustees or fiduciaries to develop investment strategies. Studies are carried out periodically to analyze and understand the trade-off between expected investment returns, volatility of outcomes and the impact on cash contributions. We aim to strike a cautious balance between these factors in order to agree affordable contribution schedules with plan fiduciaries.

Plan assets principally consist of insurance (annuity) policies, long-term interest-earning investments and (investment funds with holdings primarily in) quoted equity securities. Our largest plans use derivatives (such as index futures, currency forward contracts and swaps) to reduce volatility of underlying variables, for efficient portfolio management and to improve the liability matching characteristics of the assets. Limits have been set on the use of derivatives which are periodically subject to review for compliance with the pension fund’s investment strategy.

In line with our proactive pension risk management strategy, we seek to reduce risk in our pension plans over time. We continue to evaluate different potential de-risking strategies and opportunities on an ongoing basis. Some future de-risking transactions may have both cash flow and balance sheet impacts which may be substantial, as have some of the de-risking actions already taken. The cost of fully removing risk would exceed estimated funding deficits.

Between 2014 and 2020, ICIPF and a smaller UK plan, the ICI Specialty Chemicals Pension Fund (ISCPF), have invested in annuity buy-in contracts that aim to hedge all key risks related to their pensioner populations. CPS has an insurance contract to hedge longevity risk in respect of a portion of its pensioners. In 2020, the Trustee of the ICIPF entered into a further annuity buy-in agreement with Legal and General Assurance Society Limited and the Trustee of the ISCPF entered into a further annuity buy-in agreement with Pension Insurance Corporation plc. Together they cover, in aggregate, £84 million (€94 million) of pensioner liabilities (insurer valuation). The buy-in involved the purchase of a bulk annuity policy under which the insurer will pay to ICIPF and ISCPF amounts equivalent to the benefits payable to members who have recently become pensioners. The pension liabilities remain with, and the matching annuity policies are held within, ICIPF and ISCPF. The accounting impact of the transaction is a lower valuation of the plan assets giving a reduction in Other comprehensive income of £21 million (€23 million) of which £18 million (€20 million) relates to ICIPF and £3 million (€3 million) relates to ISCPF.

By purchasing bulk annuities, the ICIPF and ISCPF Trustees have both taken significant steps in actively de-risking liabilities and reducing the risk that AkzoNobel will be required to contribute additional cash in the future.

In October 2018, the UK High Court provided clarity for trustees and employers on providing equal pension benefits for men and women where they are in receipt of Guaranteed Minimum Pensions (GMPs) as a result of the Lloyds Banking Group judgment. According to this judgment, pension schemes were required to retrospectively equalize GMPs by uplifting pensions to the same level, as far as needed, for men and women. On November 20, 2020, the High Court ruled that pension schemes will need to revisit individual transfer payments made since May 17, 1990, to check if any additional value is due as a result of GMP equalization. As a result, a past service cost of £5 million (€6 million) has been charged across the AkzoNobel pension schemes in the UK in 2020.

In setting the discount rate assumption for calculating the DBO of each plan, the so called Willis Towers Watson (WTW) RATE:Link model is used for the majority of the plans in the group. RATE:Link had previously been using a Bloomberg fixed income securities Bloomberg Industry Classification Standard (BICS) framework to provide the relevant inputs. However, due to a change in the Bloomberg BICS framework in 2020, this framework is no longer deemed suitable and RATE:Link now uses the Bloomberg BCLASS framework. Although the curve-fitting methodology has not changed in 2020, the change in Bloomberg framework used by RATE:Link has resulted in an estimated net €170 million remeasurement gain included in Other comprehensive income. The impact of this change in accounting estimate in relation to bond inclusion is included in the reconciliation table as a €270 million gain within the overall actuarial loss due to liability financial assumption changes in the DBO, partially offset by a €100 million reduction in the experience gain in plan assets in respect of the UK buy-in annuity policies.

On November 25, 2020, correspondence between the Chancellor of the Exchequer and the UK Statistics Authority (UKSA) was published regarding the future of the Retail Price Index (RPI) measurement of inflation. With effect from February 2030 onwards, increases in the RPI will be aligned with those under the Consumer Prices Index (CPI) with owner occupiers’ housing costs (CPIH). Broadly this is expected to result in RPI inflation being 1% lower in the longer term than under the existing methodology. The inflation assumption continues to be calculated using a market breakeven inflation rate. However, the CPI inflation assumption, on which the benefits of some plans are based, is set with reference to RPI. Until 2030, the CPI inflation assumption is calculated as 1% below RPI and from 2030 onwards as 0.1% below RPI. The impact has been recognized within remeasurements in Other comprehensive income. The impact on the actuarial loss due to liability financial assumption changes in the DBO is partially offset by an impact on the experience gain in plan assets in respect of the UK buy-in annuity policies and is not material.

The remaining pension plans primarily represent plans accounted for as defined contribution plans. This includes, among others, the Pension Fund APF in the Netherlands and the 401k Plan in the US. The ITP2 plan in Sweden is financed through insurance with the Alecta insurance company and is classified as a multi-employer defined benefit plan. As AkzoNobel does not have access to sufficient information from Alecta to enable a defined benefit accounting treatment, it is accounted for as a defined contribution plan.

Contributions in 2020 were €1 million (2019: €1 million). Alecta’s funding ratio in 2020 is normally allowed to vary between 125% and 175%. The most recently quoted ratio at December 2020 stood at 148%. The expenses of all plans accounted for as defined contribution plans in AkzoNobel totaled €82 million in 2020 (2019: €86 million).

Other post-retirement benefit plans

AkzoNobel provides certain healthcare and life insurance benefits to retired employees, mainly in the US and the Netherlands. The risks to which the US healthcare plans expose AkzoNobel include the risk of future increases in the cost of healthcare which would increase the cost of maintaining the plans. The benefit payments to retirees under the Dutch plan are frozen. Both plans expose AkzoNobel to the risk of a further decline in discount rates, which increases the plan obligations, and longevity risk as the plans generally pay lifetime benefits.

Reconciliation balance sheet

The closing net balance sheet position of €827 million (2019: €668 million) includes the pension plans (€963 million net asset; 2019: €826 million net asset) and other post-retirement plans (€136 million liability; 2019: €158 million liability).

Administrative expenses

In addition to the expenses borne by the funds themselves, some expenses are borne directly by AkzoNobel. Administrative expenses are incurred, especially for the UK pension funds, of €18 million (2019: €19 million), which are included in operating income. In addition, we directly incurred asset management expenses of €2 million (2019: €4 million), which have been included in other comprehensive income.

Interest costs

Interest costs on DBO for both pensions and other post-retirement benefits, together with the interest income on plan assets, comprise the net financing income related to post-retirement benefits of €14 million (2019: €21 million), refer to Note 8.

Pension plans in asset position

Pension balances recorded under Financial non-current assets totaled €1,543 million (2019: €1,418 million). The increase in 2020 was due to €145 million of net actuarial gains, €45 million of employer contributions and net income of €7 million, partially offset by €72 million of exchange rate translation losses in the relevant plans. These assets could be recognized under IFRIC 14 because economic benefits are available in the form of future refunds from the plan or reductions in future contributions to the plan, either during the life of the plan or on the (final) settlement of the plan liabilities.

Plan assets

The equities and government bond debt assets have quoted prices in active markets, although most are held through funds comprised of such instruments which are not actively traded themselves. The total value of plan assets not quoted in active markets is €8,354 million (2019: €8,812 million, including the UK buy-in annuity policies totaling €7,595 million (2019: €8,018 million), investments in real estate, totaling €381 million (2019: €405 million) and other investments in infrastructure, catastrophe bonds, insurance policies and high-yield credit strategies. The UK buy-in annuity policies have a value that is equal to the DBO of the pensioners covered by the policies. Plan assets did not directly include any of AkzoNobel’s own transferable financial instruments, nor any property occupied by or assets used by the company.

Cash flows

In 2021, we expect to contribute €88 million (2020: €101 million) to our defined benefit pension plans, including £26 million (€29 million) of top-up contributions to the CPS plan, paid from an escrow account, in line with the agreed recovery plan following the March 31, 2017 triennial valuation. We expect to pay a further €11 million (2020: €13 million) to our other post-retirement benefit plans. No allowance is made for any special one-off contributions that may arise in relation to new de-risking opportunities.

The sensitivity effect on DBO shown allows for an alternative value for each assumption while the other actuarial assumptions remain unchanged. While this table illustrates the overall impact on DBO of the changes shown, the significance of the impact and the range of reasonably possible alternative assumptions may differ between the different plans that comprise the total DBO. In particular, the plans differ in benefit design, currency and average term, meaning that different assumptions have different levels of significance for each plan.

The sensitivity analysis is intended to illustrate the inherent uncertainty in the valuation of the DBO under market conditions at the measurement date. Its results cannot be extrapolated due to non-linear effects that changes in the key actuarial assumptions may have on the total DBO. Furthermore, the analysis does not indicate a probability of such changes occurring and it does not necessarily represent our view of expected future changes in DBO. Any management actions that may be taken to mitigate the inherent risks in the post-retirement defined benefit plans are not reflected in this analysis, as they would normally be reflected in plan asset changes rather than DBO changes.

The sensitivities in the table only apply to the DBO and not to the net amounts recognized in the balance sheet. Movements in the fair value of plan assets (which include the de-risking instruments) would, to a significant extent, be expected to offset movements in the DBO resulting from changes in the given assumptions. At ICIPF, the annuity buy-in contracts cover 99% of pensioner liabilities (2019: 99%) and 83% of total liabilities (2019: 84%).

At CPS, the longevity hedge contract covers 49% of pensioner liabilities (2019: 58%) and 30% of total liabilities (2019: 35%).

Future benefit payments

The figures in the table below are the estimated future benefit payments to be paid from the plans to beneficiaries over the next ten years.