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Accounting Matters: Full agenda for 2019

• GMP equalisation is a new funding headache for UK pension scheme sponsors
• Changes in mortality assumptions are affecting benefit obligations
• IFRIC 14 amendment could force additional liabilities on UK sponsors

German defined-benefit (DB) plan sponsors might be busily acquainting themselves with new longevity tables, while in the US the focus might well be on the impact of President Donald Trump’s next tweet, but in the UK, there is really only one question on some accountants’ minds as this financial year ends – GMP (guaranteed minimum pension) equalisation.

There is no simple way to explain GMP equalisation – mainly because of its convoluted history stretching back some four decades. So, in essence, it is a legacy question that affects a cohort of pension scheme members – predominantly male – who between 1990 and 1997 were treated less favourably than their female counterparts because women could retire earlier.

And although a recent UK High Court case involving Lloyds Bank might have forced pension schemes to compensate scheme members who lost out on pension benefits, less certain is how it should happen in practice. All of which has left accountants and actuaries to tot up the cost of the compensation bill.

“Although we don’t know if the Lloyds judgment will or will not be appealed,” says Willis Towers Watson consultant actuary Andrew Mandley, “there is a view from the major audit firms that sponsors need to account for that in this year’s accounts.”

He puts the impact of the issue in the range of an additional liability of zero to three per cent of a sponsor’s defined-benefit obligation (DBO) – yes, a small percentage, but of a big number. For their part, auditors are of the view that most companies must treat this new liability as past service cost under both US Generally Accepted Accounting Principles (GAAP) and International Financial Reporting Standards (IFRS), This means it goes through profit or loss. The good news is that under US GAAP there is at least scope to amortise the cost. 

But away from the furore over GMP equalisation, discounting, it turns out, is much less of a drama this year than in past years. That is despite potential disruption in global credit markets from the Italian sovereign debt crisis, Brexit, Trump’s trade policies and the imminent dial-down of the European Central Bank’s bond-buying programme.

Mercer’s chief actuary in Germany, Thomas Hagemann, reports that euro-zone discount rates are coming in at about 15-20bps higher than at the end of 2017 on the Mercer yield curve. This, he explains, is in line with the marketplace. In hard numbers, it was 2.05% at 15 years’ duration and 2.26% at 20 years out as at 31 October. 

Over in the UK, says Mandley, Willis Towers Watson clients at the end of October were discounting at between 2.6% and 3.0% – a rise of 30 to 40bps over the year. These figures are broadly in line with the numbers Aon Hewitt consultant actuary Simon Robinson is seeing among his clients. Overall, Robinson says, a typical UK FTSE 100 sponsor discount rate is about 2.9%, which is a shade up on 2017. 

He explains: “Although discount rates have increased somewhat, a lot of UK schemes are well hedged and so they are relatively immune to changes in market conditions. Even those that aren’t with a large equity exposure might not show the improvement that you would otherwise think. Overall, I think it has been pretty neutral for schemes.”

andrew mandley

Meanwhile, says Beth Ashmore, a senior director at Willis Towers Watson, US pension discount rates over the past few years have gone down at the same time as equity markets have gone up. This means that a lot of sponsors have not seen improvements in their funding status over the past several years. “However,” she adds, “we saw funded status begin to improve in 2017 and it has continued thus far in 2018.

“In fact, this year has been very good for sponsors in the form of interest rates and we expect discount rates to probably be around 85-90bps up between year-end 2017 and year-end 2018. That is helpful for funding position.” And despite equity market volatility definitely causing what she sums up as “some angst”, her assessment of the funding landscape is that “their funding status to be up as we sit here at the end of November”.

However, as in the UK, local factors have also had an impact – potentially boosting the accounting number under US GAAP. “We had a major change in US tax law,” explains Ashmore, “and that spurred a lot of employers to think about making contributions to their pension plans. This was because they got a tax deduction at the previous higher rate, knowing that future deductions would be at a lower rate. The change in law drove a fair amount of contribution activity in 2017 and through the third quarter of 2018.” 

Another factor that will affect the size of scheme deficits this year are changes in mortality assumptions. “At Aon,” says Robinson, “we are saying this is a real trend and have to make an allowance for it. So you will see this development reducing benefit obligations. A few years ago life expectancy was growing by one year annually, but now it is almost reversing.” Essentially, he says, people are not living as long as expected.

A similar pattern is evident in the US where, says Ashmore, where the pace of mortality improvement has slowed. “In some cases,” she says, “we’ve had a couple of years where even mortality rates have increased slightly relative to the past. So most sponsors have probably seen a slight pull back in their longevity assumptions for 2018.

In Germany, however, the picture is more complex. The Heubeck longevity tables were recently updated, with the revisions expected to be endorsed by the end of the year and most German pension sponsors are expected to apply them.

“Present values of the obligation will rise about one to two per cent,” says Hagemann. But he cautions that the outcome will vary with each sponsor’s specific circumstances and, he adds, effects either side of that range are in evidence. Moreover, one curiosity of the new tables is that they include an acknowledgement that workers with a higher income tend to have a longer life expectancy which, explains Hagemann, could feed through into an increase in total liabilities of between 1% and 2%.

One issue that is lurking on the horizon is IFRIC 14. For those with long memories, this project started life in 2014 and blossomed into an exposure draft during the course of 2015. Since then, however, the International Accounting Standards Board (IASB) has struggled to finalise the amendment. Broadly speaking, it could affect plans in the UK by forcing them to recognise a large addition liability, if it emerges that the sponsor does not have an unconditional right to a plan surplus.

According to well-placed sources, that amendment is tipped to resurface at the board during the first quarter of next year. On top of that, the IASB research work on asset-linked pension promises fires into life, meaning 2019 promises to be anything but dull. At least by the standards by which actuaries calculate dullness.

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