In a Flap Over Pension Regulations
The recent introduction of accounting standard FRS17. While FRS17 has been much criticised, the fact is that it is succeeding in forcing companies to confront the true value of their pension scheme liabilities – and many companies can’t handle the truth.
(PRWEB) July 12, 2006
As you might expect, detection of that potentially deadly form of bird flu, H5N1, sends waves of panic surging through the country – especially poultry farmers.
What you may not realise is that another number - FRS17 – is just as likely to get companies, trade unions and pension advisers in a real flap.
Many of them have voiced their disgruntlement over the recent introduction of accounting standard FRS17. And the reason - they can’t handle the truth.
FRS17 was introduced to address the discounting of pension scheme liabilities, based on the erroneous assumption that equities would continue to deliver a healthy level of return for years ahead. Of course, as we now know, the equity market suffered a marked slump.
As a result, there has been a definite shift towards valuing liabilities in a more transparent manner by relating them directly to yields on secure assets, such as government bonds.
But as bond rates have also fallen, the value placed on liabilities has increased substantially, with the result that we have seen the value of assets fall at the same time as the liability. And for the first time, courtesy of FRS17, funds are being valued correctly.
So while FRS17 has been much criticised, the fact is that it is succeeding in forcing companies to confront the true value of their pension scheme liabilities – and many companies can’t handle the truth.
Likewise, many trade unions dislike FRS17 because when companies do face up to the value of their liabilities, they’re then forced to do something about it - more often than not cutting back on future pension provision. Pension advisers dislike it because clients are switching to lower cost, lower risk pension arrangements.
Whilst by no means perfect, from the perspective of shareholders, analysts and financiers, FRS17 is valuable because by placing a realistic value on pension liabilities, it provides a benchmark against which one company can be consistently compared against another. Its use could be further enhanced by the requirement to disclose all assumptions.
It seems quite ludicrous to even attempt to defend the alternative approach whereby a pension cost would be valued according to the preferred assumptions of the actuary concerned. This could mean that company A and company B might have identical pensions arrangements but with entirely different pension scheme costs.
Many responsible pension schemes sponsors are now hoping that a recovery in the equity markets will pull them out of the mess within which they have become mired. However as such a recovery is by no means certain, organisations would be well advised to contact their financial advisors to get pension schemes health checked to make sure they are not teetering on the brink of financial meltdown.
Worryingly for scheme sponsors, there is also a great deal of uncertainty in relation to future life expectancy, with all the evidence appearing to suggest that, until now, likely future improvements in life expectancy have not been fully incorporated.
Over the next few years, new mortality tables will be introduced, factoring in improved life expectancy which will push up company pension liabilities. Whilst the downside of uncertainties in equity markets can be reduced or removed by investing in bonds, companies are completely exposed to the risk of current employees enjoying a much longer retirement than had previously been assumed.
The suspicion lingers that some companies are simply hoping that further gains in equity markets are inevitable rather than there being any convincing reason to believe this should be so. Meanwhile, many companies that have learned, from bitter experience, the risks associated with equity investments, have subsequently sought a degree of protection by investing in bonds, which clearly reduces the potential for upside gain.
Ultimately, though, FRS17 is a good thing for the simple reason that it forces companies, trade unions and some pension advisers to confront the truth about the extent of pension scheme liabilities. The truth may hurt at times, but surely it’s preferable to self-deception?
Kevin Walker and his team at RMT FM can be contacted on 0191 256 9600 and the company’s website is at www. rmtfm. co. uk
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