Disclosing pension accounting liabilities - three top tips to consider
September 19, 2017
By Brian Peters
The Financial Reporting Council has announced a thematic review of companies’ disclosures about pension costs to encourage more transparent reporting of pension accounting liabilities and risks. This is partly because pension liabilities have grown substantially in recent years.
According to PwC’s Skyval Index covering 5,900 UK defined benefit pension schemes, liabilities have risen 30% over the last three years to about £2 trillion. This rise in liabilities is a direct consequence of falling interest rates and rising rates of inflation.
Our analysis of one industry sector shows share prices of companies over the past 3 years with large pension schemes have performed much worse than others reflecting general concerns about risk irrespective of how the assets are performing. It can be deduced from this that companies with material defined benefit pension schemes are becoming less attractive to investors.
There are steps companies can take to build trust that they are managing pension risk. In particular, our research from discussions with the investor community suggests there are a number of additional disclosures companies can make, going beyond the requirements of the accounting standards, to better inform the readers of the accounts about pension risk.
- Update scheme funding deficits more regularly
The standard disclosures about expected cash requirements may not fully reflect the results of the most recent estimate of the scheme funding deficit. This is because IAS 19 requires disclosures about current cash demands and these may have been set in a negotiation with the pension trustees up to three years in the past. In addition, the expected levels of future cash requirements are impacted by the trustees’ latest assessment of the employer covenant. Any changes in this assessment since the last actuarial valuation would be beneficial to investors’ analyses.
- Explain pension accounting changes
There are possible changes that might further restrict recognition of surpluses on balance sheets and might cause greater liabilities to be recognised too (known as IFRIC 14). Information on how companies could be impacted by the forthcoming IFRIC 14 changes could be useful to investors, albeit there remains uncertainty over exactly how companies will be affected by these changes.
- Disclose risk management actions
Investors would value disclosures on the sensitivity of changes to key assumptions such as the discount rate, mortality and inflation that take into account sophisticated approaches that are now commonplace in pension scheme investment strategies.
For example, where pension schemes have adopted hedging strategies such as liability driven investment (LDI) or longevity swaps it could help investors if they knew what impact these had on cash requirements, the income statement and the balance sheet in changing market conditions, rather than just the impact on the liabilities.
There will undoubtedly be further iterations of the debate on what is helpful to investors. It is clear though that the old adage that investors are primarily concerned about cash rather than pension risk is no longer valid.
For more information on pensions accounting please click here.