Aon Hewitt has today announced that the Aon Hewitt 350 index showed an aggregate accounting deficit of the FTSE 350's final salary pensionschemes of £86bn on 28 August – the same as the previous month.
Simon Robinson, Principal at Aon Hewitt, said:
“While companies continue to be focused on working with trustees to tackle their pensionscheme funding deficits, we suspect the introduction of the revised IAS 19 in January 2013 is slipping under the radar of many financial directors.”
The changes to IAS 19 mean that companies will no longer be able to record a profit on the expected, return on their pensionscheme investments. With pensionschemes traditionally invested in riskier assets such as equities, this has often offset the corresponding interest cost on their liabilities. Although the changes are unlikely to have a major effect on the accounting deficit of UK defined benefit pension schemes, it is anticipated that they will have a significant impact on the profit and loss (P&L) charge of individual companies. Aon Hewitt has estimated that these changes will increase P&L charges annually for UK businesses by £10bn in total.
Aon Hewitt believes that in the short term financial directors should review their accounting assumptions, as this can help lower their P&L charge and balance sheet liability.
Simon Robinson, continued:
“Companies are required to make a number of assumptions to calculate their liabilities. While the majority of companies will make a reasonable best estimate for the key assumptions such as life expectancy, there are a number of ancillary assumptions such as retirement patterns, or the proportion of members with spouses, on which they may unintentionally be taking a 'prudent' view.
"We estimate that more accurate assumptions could reduce liabilities by as much as 5%. Therefore, as a priority, financial directors should review all their accounting assumptions, as this is an effective way for companies to offset the impact of these changes.”
To demonstrate the benefit; a pensionscheme with liabilities of £1m and assets of £975k which undertakes a review of its demographic assumptions, may find that a number of the assumptions are not best estimates but contain some prudence. Assuming those assumptions lead to a 5% overstatement of the liabilities, removing the 'prudence' could result in the liabilities reducing to £950k. So, the balance sheet item would change from a deficit of £25k, to a surplus of £25k. The net interest item in P&L would change from a charge to a source of profit.
Simon Robinson, concluded:
“While it would be unlikely in most cases to move pensionschemes from deficit to surplus, a review of all accounting assumptions should be an important exercise for ensuring that companies are not reporting larger deficits than is necessary. Over the long term, we believe that changes to IAS 19 will also impact discount rates. To date, the discount rate used might have had an effect on the balance sheet, but had a relatively small effect on the P&L.
"In the future the opposite will be true, with the discount rate having a much bigger effect on the P&L. Schemes will have to ensure that it is not lower than they can justify and financial directors will need to make certain that they keep this constantly under review.”
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