2 in 3 FTSE350 companies continue to use below market-implied inflation for pension accounting reducing reported deficits by £7bn
Wide variation in assumed CPI reflects uncertainty following indexation switch, highlighting need for CPI-linked bonds
Key findings of Hymans Robertson's 2011 "FTSE 350 Accounting Assumptions Survey":
RPI assumptions:
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65% of FTSE350 companies use below market implied inflation for pension accounting;
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Average assumed inflation adopted by FTSE350 companies is 0.1% below that implied by market yields reducing reported deficit by £7bn;
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Considerable improvement over 2009 where 82% of companies used below market implied inflation with an average assumed inflation rate of 0.2% below that implied by market yields.
CPI assumptions
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The Government's change in indexation from RPI to CPI introduces need for a CPI assumption.
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In the absence of any market in CPI bonds, there is a high degree of uncertainty over CPI inflation;
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Wide range of CPI assumptions adopted by FTSE350 companies of between 2.3% and 3.4%;
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Average CPI assumption is 2.8% - 0.7% lower than the average RPI assumption, consistent with historic differences;
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Uncertainty highlights need for CPI-linked bonds;
Longevity assumptions:
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There is a 7 year age difference in assumed life expectancy across the FTSE 350 for pensioners and 8 years for non-pensioners;
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FTSE350 companies allow for life expectancy improvements of one year per decade on average, less than half the rate of improvement indicated by current trends*
* Analysis produced by Club Vita indicates that life expectancy is increasing by at least 2 years per decade.
A report from Hymans Robertson has found considerable inconsistencies and variances particularly in the inflation and longevity assumptions used by companies to report their pension liabilities under IAS19. The number of FTSE 350 companies using an RPI inflation assumption below the market implied rate for their pension scheme has fallen from last year, but still represents two thirds of the total. At the same time, CPI assumptions vary greatly as schemes struggle to place an accurate benchmark on this in the absence of CPI-linked bonds. Furthermore longevity assumptions vary greatly across the FTSE350.
The impact of these variations on pension liabilities can be considerable, meaning investors need to carefully scrutinise the pension risks inherent in company accounts. The findings are part of the annual FTSE 350 Accounting Assumptions Survey from Hymans Robertson, the independent pensions & benefits consultancy.
Clive Fortes, Head of Corporate Consulting at Hymans Robertson, comments:
"While two-thirds of FTSE350 companies adopt inflation assumptions below that implied by market yields, this is down from 82% last year. The average difference between assumed inflation and market implied inflation has fallen from 0.2% in 2009 to 0.1% in 2010.
"Our report also found a high degree of variation in CPI assumptions. The switch to CPI indexation has clearly saved companies considerable amounts of money - as much as £25bn across the FTSE350. There is, however, considerable uncertainty about the level of CPI inflation given the lack of appropriate CPI-linked bonds against which to benchmark CPI inflation making this estimate unreliable.
"Notwithstanding the uncertainty over future CPI inflation, based on the extent of the impact of the change to CPI, we estimate that the market demand for CPI linked bonds by FTSE350 sponsored pension schemes could be approximately half of that for RPI linked bonds. Although some investment banks are prepared to quote a price for CPI hedging, the market capacity is extremely thin. There is therefore likely to be a strong demand for Government issued CPI bonds.
Clive Fortes, commenting further on life expectancy assumptions, added:
"Perhaps not surprisingly, there is a range of assumed life expectancy adopted by FTSE350 companies. What is, however, surprising is the extent of the difference (7 to 8 years) and the apparent underestimate in the rate of future improvement in life expectancy. Current studies suggest increases of two years per decade, yet companies are assuming on average only a one year per decade improvement."
"Given the differences in assumptions adopted by FTSE350 companies, investors cannot simply take at face value reported IAS19 figures but need to analyse them and understand the risks inherent in pension schemes in a more comprehensive way."
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