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UK scheme surplus rules causing concern for sponsors: KPMG

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An influential survey of UK defined benefit (DB) pension accounting has revealed uncertainties regarding rules governing the reporting of scheme surpluses.

KPMG’s Pensions Accounting Survey 2017 reported the concerns following the decision of the International Financial Reporting Standards’ (IFRS) Interpretation Committee to amend its asset-ceiling guidance, IFRIC 14. This helps companies determine when they can recognise an DB surplus as a balance sheet asset.

The KPMG survey looked at trends in best-estimate assumptions among 247 of its clients with UK DB schemes, and covered accounting under IFRS standards and UK and US generally accepted accounting principles, as at 31 December 2016.

The report’s author, Narayan Peralta, told IPE: “There is a risk that the revised IFRIC 14 is even less clear than the 2008 original. It is an updated interpretation and although it should add clarity, it might not.

“In my view, the original exposure draft was fairly clear. However, the discussions in the last quarter of 2016 have added considerable uncertainty on the question of how the final version will impact clients.”

He continued: “Potentially, IFRIC 14 could treat a power to insure individual benefits in the same way as a power to wind up a scheme, which in a UK context are very different. We will have to wait and see what the final wording says later in 2017.”

Consultants have also warned scheme sponsors that the IFRIC 14 project could turn into a major headache for UK schemes.

The IFRS published its IFRIC 14 project in 2014. IFRIC 14 interprets the requirements of the pensions accounting standard IAS 19.

Discount rates

Among its other findings, the KPMG report also found that median net discount rates – the difference between the discount rate and retail price index (RPI) inflation assumptions – were negative for the first time since 2004.

Among the companies sampled, the median discount rate was 2.7% – a fall of 1.1 percentage points on last year.

At the same time, median RPI inflation hit 3.3% at the end of December.

The survey also found that the range of assumptions used by companies had narrowed. Overall, the market was more tightly packed around the median than a year earlier.

Although the median discount rate fell from 3.8% to 2.7% at 31 December 2016, around 85% of sponsors responding to KPMG’s survey used a discount rate within 10 basis points of the median. This compares with 75% of sponsors last year.

Politics also impacted pensions accounting over the past 12 months – most notably with the dive in bond yields after the UK’s June 2016 vote to quit the EU.

The Bank of England’s decision to cut interest rates to 0.25% from 0.5% also weighed heavily on discount rates, as did the decision by the Bank to embark on a £10bn (€11.8bn) corporate bond buying spree.

Life expectancy

Away from financial assumptions, KPMG found that life expectancy assumptions for current and future pensioners have fallen by 0.1 years, from 22.3 and 24.1 years respectively. These latest assumptions compare with 18.4 and 19.4 years back in 2004.

KPMG reported that companies are making growing use of scheme-specific mortality studies, meaning that companies can quantify their longevity risk more accurately.

Mr Peralta told IPE: “Where yields are negative, the average term or duration of a liability is longer than it would be in a higher-yield environment. This makes the longevity assumption more crucial because a higher value is being placed on payments further out.”

He also noted that emerging trends from the Continuous Mortality Investigation models, which are typically used for IAS 19 purposes, had also flattered results.

The KPMG analysis chimes with recent findings from consultants Mercer and accountancy giant PwC. According to the Mercer data, a slowdown in life expectancy improvements had shaved £2.5bn off FTSE 350 pension scheme liabilities.

Mercer’s analysis shows that employers typically assume a 65-year-old woman will live to 89.5 years and a 65-year-old man to 87.5.

PwC estimated that schemes could reduce future liabilities by up to £310bn in the long term if the CMI’s recent data continues on its current trajectory.

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