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Discount range leaves firms with accounting choice

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  • Discount range leaves firms with accounting choice

EUROPE - Recent distortions to corporate bond yields, particularly among bonds in the financial sector, mean the range of discount rates available to value pension liabilities could alter results by as much as €2.5bn, Lane Clark & Peacock (LCP) has revealed.

Findings from the firm's European Pensions Briefing suggested the International Accounting Standard 19 (IAS19) used in pension accounting is "cracking under the extreme market conditions recently witnessed, with many arguing it is no longer fit for purpose".

LCP has found the range of discount rates - under IAS19 this based on 'high quality corporate bonds' - has moved from a narrow range of possible outcomes available before the credit crunch to a period where it is "hard to even tell if the yield curve slopes up or down over time" - a problem which the firm claims is apparent in the UK, Eurozone and the US.

As a result, actuaries from two firms could plot a yield curve with "completely different results", warned LCP, meaning companies are able to choose to "disclose anywhere between a 20% deficit and a 10% surplus for its pension plan", which for a typical FTSE Global 100 company, such as Sony and BP, could equate to a balance sheet differential of €2.5bn.

LCP suggested one of the main drivers of the wide dispersion in discount rates and bond yields results from bonds in the financial sector.

That said, although the extra yield, or credit spread, on AA-rated bonds compared to gilts is still growing - and reducing the value of liabilities - the firm warned companies need to decide whether to fully report the 'good news'.

The actuarial consultancy said although reporting an improved deficit or surplus in the scheme could be beneficial, there may be a downside at a later date if, or when, credit spreads return to more long-term levels.

For example, LCP noted were UK credit spreads to revert to the pre-credit crunch levels, pension liabilities would increase by around 40%, and a similar situation would occur in other European countries such as the Netherlands, Belgium, Ireland and Germany.

In addition, the report highlighted a potential issue for multi-national companies as there is a "wide range of discount rates possible in almost every country in the world".

 

LCP has recommended employers set a central approach on key issues and then communicate this to each country in an effort to ensure consistency. 

The LCP report, which highlights key pension issues facing finance directors and other senior management of firms with European operations, meanwhile claimed true pan-European pension plans (PEPs) "remain a distant vision".

The research argued despite some progress, "there is a significant lack of clarity in the EU Directive, inconsistent implementation among member states, social and labour laws remain fundamentally different and last but not least the tax situation remains a daunting challenge".

LCP said it is "no surprise" there are no true PEPs involving a "significant' number of the 27 EU states, and admitted "in fact such plans may never exist".

Despite this, the report acknowledged some European convergence in pensions and the development of other solutions such as cross-border asset pooling, offshore plans, multi-national pooling of insured risks.

In addition, LCP said there "have been considerable developments in cross border plans, which are less ambitious versions of PEPs" - as they include fewer countries and are either geographically close together or have similar social and labour laws - the report also notes that these are "not necessarily restricted to EU locations.

Martin Haugh, partner at LCP Ireland, said: "Despite the continuing challenges to the emergence of truly Pan-European plans, we are seeing continued growth in cross border plans, including those with home-host combinations in Ireland, the UK and certain other countries. We are also seeing increased investment in international pension plans based in Ireland."

And PEPs have not been abandoned completely, according to Peter Bastiaens, partner at LCP Belgium, said: "Our clients are increasingly interested in PEPs, and with Belgium at the forefront of 'PEP-friendly' regulation we anticipate further piecemeal developments over the next few years."

Other key findings from the report showed a "sharp convergence" of investment strategies, with equity allocations in Europe starting to converge to the global average, while the analysis indicated some global companies might be underestimating the longevity of employees in certain countries, such as Germany and the Netherlands.

The report noted although it is "impossible" to tell which countries are under or over estimating longevity, if all the FTSE Global 100 companies adopted the typical UK longevity assumptions - which are more prudent - this could add €25bn to the reported pension liabilities, more than double the €24bn reported at the end of 2007.

If you have any comments you would like to add to this or any other story, contact Nyree Stewart on + 44 (0)20 7261 4618 or email nyree.stewart@ipe.com

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