As part of gearing up to respond to the Accounting Standards Board's (ASB) debate on the revision of the UK's pension accounting standard SSAP 24 to produce a new financial reporting standard (FRS) we held a series of consultation meetings with clients.
As a result of this exercise three points were consistently and unambiguously expressed:
p UK pensions are not like other company assets and liabilities. The principal mode of financial reporting on pensions is and should remain via the profit and loss account.
p The new FRS standard could encourage more investment in bonds and less in equities in future years - probably resulting in lower rates of investment return.
p The new FRS might lead to increasing numbers of defined benefit pension (DB) schemes being terminated, replaced by defined contribution schemes (DC), because of lower than expected investment returns or increased cost volatility.
We believe these concerns are well founded and more than a nostalgic wish to retain the flexible reporting format of SSAP 24.
On the issue of the use of market values, we recognise that it should be possible to attribute fair (market) values to the pension fund assets and liabilities and that these values, or the differences between them, could usefully be shown in a company's balance sheet.
But there are objections to this approach, including the intrinsic uncertainty in establishing a fair value for pensions liabilities, especially for final salary pensions, because of factors that cannot be priced by direct reference to a market.
We agree with the use of market values to measure pension scheme assets. Our clients generally were not happy with this proposal - but would accept a sensible approach that did not introduce unnecessary volatility. Because the key issue remains the notional asset model used in liability valuations, there need be little or no material difference between the traditional actuarial and the market based ap-proach, except form of presentation.
The ASB paper did not address the issue of adjusting normal pension costs for each future year of service to market conditions, but it appeared to lean that way. Although logical in terms of reconciling accrued pension liabilities from the start to the end of a year, this issue requires consideration because of the volatile normal pension cost which could ensue.
Choosing a discount rate: We support the approach of the Institute/ Faculty of Actuaries, which provides for an allowable range on the discount rate. In particular, there could be choice as between a bond rate based on gilts and one based on good quality corporate debt, as specified in IAS 19. This is because:
The future UK bond market might have a greater weighting of corporate bonds and less in gilts from which to choose.
It would allow consistency with IAS 19.
Flexibility in the discount rate even for current and deferred pensioners might remove the need for a gains/loss amortisation corridor.
There is some parallel between the financial nature of the pension liabilities of a company and that of its corporate debt.
We believe that the choice of the discount rate should be the subject actuarial professional guidance agreed with the ASB.
Turning to the recognition of gains and losses, two of the options presented in the ASB's paper were overwhelmingly rejected by our clients. One failed to pass gains/ losses information to the profit and loss account; another did not provide the relevant information concisely in the P&L and had to be read with the balance sheet for a proper understanding.
The two remaining options spread gains or losses through the P&L in the same way as SSAP 24. The choice between them relates to the proposed introduction of the Statement of Recognised Gains and Losses. There is a clear distinction between them, however, in that one involves full and immediate recognition of a gain/loss whilst the other does not.
The key point is that both retain the existing approach of SSAP 24 in the P&L.
Continued use of the SSAP 24 approach requires an improvement in mandatory disclosures - particularly a clear explanation of the reconciliation of the balance sheet position. The pensions note containing this reconciliation should also show the split of the pension cost for the year between the ongoing, normal cost and the variation for surplus/deficit. We think that, for simplicity, the straight-line amortisation method may be preferred.
Work remains to be done on the amortisation period. We believe that there is merit in adopting a uniform amortisation period for all companies.
We consulted with clients who help-ed shape our opinions and develop our thinking - from guiding principles to working rules on specific aspects of the accountancy treatment of pensions matters. It is clear that there is wider interest in revision of SSAP 24 than the cloistered walls of the actuarial and accountancy professions.
David Collinson is a principal at Watson Wyatt Worldwide in the UK