Accounting for UK Pensions – A Change Is Gonna Come

August 28, 2013 Categories: Investment Strategy

Russell Investments Wire - Pension accounting

One of my favourite songs, “A Change Is Gonna Come”, is a 1964 single by R&B singer-songwriter Sam Cooke.

The song gained popularity and critical acclaim in the decades since its release, and was voted #12 on Rolling Stone’s 500 Greatest Songs of All Time. Listening to that song always takes me back to my childhood days where music played a big part of bringing political and social change or echoed the true feelings of a society.

Talking about change, there is a big one coming for finance directors (FDs) involved with UK corporate defined benefit (DB) pension funds. A bombshell is hidden away in the 335 pages of the recent publication of Financial Reporting Standard (FRS) 102. From 1 January 2015 (earlier adoption is allowed) most companies with significant equity investments in their UK DB pension funds will see a reduction in their reported profits!

So, FDs really need to pay very close attention to the investment strategy of their UK DB pension funds. For example, reported profits could fall by at least £25m a year for a pension fund with around £1bn invested in return-seeking assets. The challenges are greater if pension fund deficits dwarf the size of the sponsor’s balance sheet. Importantly, the international accounting standard for pension and employee benefits (IAS 19) brought similar changes that came into effect from 1 January 2013. So, it is urgent now to consider the recommended actions below.

The important changes

In summary, the main differences between the current financial reporting standard (FRS 17) and FRS 102 are:

  • The removal of the expected return on assets assumption – this will affect profits.
  • Interest, at a high quality corporate bond yield, will be charged on the difference between the value of the pension fund’s assets and liabilities, rather than the value of the fund’s liabilities.
  • For the first time, many multi-employer pension funds will need to disclose a liability on their balance sheet which reflects their share of any pension deficit.

For comparison, prior year figures will also need to be restated under the new FRS 102 in the year of adoption.
So, in practical terms, sponsors of UK DB pension plans that invest a significant portion in return-seeking assets will likely see their P&L pension costs rise, while those invested more in bonds / liability hedging assets will likely see the opposite effect.

Across corporate UK, the above changes could hit reported profits really hard – estimated to be a rise of £8bn to £12bn. Some companies will also see increased volatility in their balance sheets, making it hard to plan for future needed corporate activity. To make matters worse, implementing the extra disclosures will be onerous.

So what should FDs do now?

  • Estimate the impact of the above changes on the pension costs in the P&L;
  • Estimate any potential changes to your balance sheet;
  • Proactively engage with their pension fund trustees from now regarding changes to the investment strategy to reduce any potential negative effects on the business;
  • Communicate to your Board regarding the risks posed by the pension fund to your business;
  • Decide what changes to the pension fund investment strategy you will take to reduce balance sheet risks.

It’s been a long, a long time coming, but a change is gonna come. Oh yes it will.

Norbert Fullerton, Director, Pension Solutions Group

Russell Investments Wire - Norbert Fullerton


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