Pensions accounting deficits - no longer a shoulder shrug
July 27, 2016
Pensions accounting has suddenly become very interesting. For many years, pensions numbers reported in financial statements were largely ignored. From conversations with analysts, evidence suggests investors focused their attention on forward looking cash requirements when pensions were material and paid little attention to pensions when they were not.
The investment markets have been volatile since 23 June 2016. In particular, whilst some equity markets have risen, yields on UK government and high quality debt have fallen to their lowest ever levels, this volatility is likely to continue.
This has meant that, unless investment risks have been fully hedged, pension deficits for IFRS accounting purposes have been rising, as liabilities are determined by discounting future cash flows at yields on high quality debt. In fact, the Skyval Index shows that the aggregate accounting liabilities across all UK pension schemes increased by around £90bn between the date of the EU referendum vote (23 June 2016) and 30 June 2016.
While business tries to figure out the consequences and opportunities of the referendum results, those with a quarterly, half yearly or full year reporting date of 30 June 2016 are likely to need to report an updated number for the IFRS pension deficit that takes account of these unprecedented reductions in yields on debt. At the same time, expectation of longer term inflation has reduced the need to mitigate the rises in pension deficits.
In other times, the response to reports of large pension deficits would have been a shoulder shrug. After all, quarter on quarter pension deficits go up and down with market movements and companies often do not need to take into account the new shortfall even if they are in the middle of a negotiation with the pension trustees on cash funding.
This time feels different. We may not know what the UK leaving the European Union means for years to come so increased pension deficit reports may be.
As a consequence, management need to be ready to explain to investors how they will respond to this new environment of lower returns on investments and if cash contributions to the pension scheme will have to increase to make up the shortfall.
Management will need to explain to investors their strategy for dealing with the ongoing pension risk. The use of technology to give management an accurate idea of the current state of play and the impact of alternative options could be invaluable. Technology enables sponsors and trustees to better manage pension scheme's risk at a time of such global volatility by monitoring, and reacting to, the latest impact of market movements.
Brian Peters is a partner in PwC’s pensions team.