Don't be fooled by the emergence of pension accounting surpluses

16 July 2018

Actuaries are using more sophisticated approaches to setting the discount rate for IAS 19 financial reporting purposes.  These approaches might involve the removal of certain bonds from the index that are arguably not corporates such as university bonds.  In addition, actuaries may include corporate bonds which are rated AA by only one of the main credit rating agencies and redrawing the yield curve for AA corporate bonds at longer durations where there are no bonds in the index.

In almost all cases, the impact of changing approach is to increase the discount rate and, as a result, the measured accounting liabilities can be materially lower.  This in turn leads to larger accounting surpluses (or smaller accounting deficits).  Of course, the accounting position is a measurement based on current market conditions.  It could all change if the bond market moves, which it inevitably will over time through economic cycles.

Whilst accounting surpluses may be higher as a result of methodology changes, that does not mean the underlying economics of the pension scheme have changed.  Pension schemes still need to pay benefits out of assets, returns on those assets and future contributions.  None of these components have changed under the new discount rate methodologies and so the expected cash outflow is the same.  The cost of taking pensions completely off balance sheet also has not changed as this is driven by insurance pricing not pension accounting.  And, according to PwC research, investors are more concerned about the relative size of the pension obligations and risk compared to the scale of the business rather than the size of the accounting surplus or deficit.  Indeed, the most sophisticated investors primarily look at the emergence and risk of pension scheme trustees’ cash demands over time.

The overall message for readers of financial statements is beware of higher accounting surpluses or reduced deficits, particularly where the primary cause of the movement is a change in discount rate methodology.  It doesn’t necessarily mean the pensions problem is closer to resolution or that the underlying risks are different than before.

Brian Peters | Partner
Profile | Email | +44 (0)20 7212 3353

Twitter
LinkedIn
Facebook
Google+

Comments

Verify your Comment

Previewing your Comment

This is only a preview. Your comment has not yet been posted.

Working...
Your comment could not be posted. Error type:
Your comment has been saved. Comments are moderated and will not appear until approved by the author. Post another comment

The letters and numbers you entered did not match the image. Please try again.

As a final step before posting your comment, enter the letters and numbers you see in the image below. This prevents automated programs from posting comments.

Having trouble reading this image? View an alternate.

Working...

Post a comment

Comments are moderated and will not appear until the author has approved them.