Posts Tagged ‘Financial Reporting Standards 17’

David Davison

Finance Directors of charities not disclosing their multi-employer pension liabilities on their balance sheet may be sleeping just a little uncomfortably at the moment following a consultation document issued by the Financial Reporting Council.

If the proposals are accepted charities will need to recognise any agreement to fund a deficit in a multi-employer scheme on their balance sheet. Read more »

David Davison

Organisations participating in the Social Housing Pension Scheme (“SHPS”) will no doubt be experiencing that sinking feeling, perhaps mixed in with a little déjà vu, as the results of the 2011 scheme valuation hit their desks this month.

The communication will have brought the unwelcome news that the ‘on-going’ funding deficit has increased from £663m to £1,035m as at 30 September 2011 (having increased from £283m in 2005). Read more »

Alan Collins

With recent market turmoil sending scheme funding levels tumbling, pensions present a potential Pandora’s Box for even the most enlightened Finance Director.

In this month’s issue of CA Magazine (pg. 56) Alan Collins, head of employer advisory services at pension actuaries Spence & Partners suggests 10 key questions that Finance Directors should be asking themselves about their defined benefit schemes and some guidance on each of these key issues.
Read more »

David Davison

Nearly 30 pension funds have filed claims at the High Court seeking damages from Henderson Global Investors over claims it took too much risk with one of its funds, the Henderson PFI Secondary Fund II, when it used the majority of the fund’s assets to buy John Laing, a firm with a large pension deficit.

The fund subsequently lost 2/3rds of its value, not least because of the pension scheme deficit. Now I’m not seeking to comment on this case specifically and indeed Henderson’s have signalled they “will vigorously defend these proceedings” but more on some wider pension related implications.

I would have expected that at least when conducting due diligence on the investment Henderson would at least have been aware of the existence of a defined benefit pension liability Read more »

Alan Collins

Yesterday, the International Accounting Standards Board (IASB) confirmed the much-trailed changes to accounting for pension benefits in accordance with IAS 19. The changes will be effective for accounting years commencing 1 January 2013, though earlier adoption is encouraged.

IAS 19 applies to all UK (and EU) listed Companies, though can be adopted by non-listed companies. The main UK pension accounting standards, FRS 17, is effectively being replaced from 2012, so these changes will generally also affect non-listed companies.

The main changes are as follows:

  • The replacement of the expected return on assets element of the profit and loss charge by a credit linked to the discount rate used to measure the liabilities. Therefore given that an interest charge already applies to the liabilities, the final result on the P&L account will effectively be an interest charge (credit) on the plan deficit (surplus); and
  • Companies which partially recognise actuarial “experience” in the profit and loss account will either need to fully recognise year on year experience or alter the accounting method to recognise experience gains and losses via the Statement of Recognised Gains and Losses (STRGL).

Further disclosures will also be required in relation to the characteristics of defined benefit plans and the risks which plan sponsors are exposed to by operating these plans.

So, what does this mean?

The main conclusion is that, all else being equal, Company profits will be reduced. It has recently been estimated that the replacement of the expected return credit could reduce UK Company profits by £10 billion per annum.

Where full recognition of actuarial experience is adopted, the profits or losses arising from defined benefit pension schemes will be significantly more volatile.

It has also been argued that the changes will lead to a move away from equity investments by defined benefit pension schemes as holding equities is no longer “rewarded” on the P&L.

However, many within the pensions industry often over-dramatise the attention paid to disclosed pension accounting figures in the profit and loss account. I agree with the views that most analysts already set-aside any windfalls on the P&L associated with the pension scheme, particularly when brought about by the current expected return on assets credit.

It will interesting to see if the changes do hasten a move away from equity investment by schemes. There is already a trend to de-risk and I see this continuing, but doubt whether the major driver will be these accounting changes. More likely, it will driven by trustees and employers who are less willing to be exposed to the risk of volatile funding levels and greater uncertainty in future funding costs.

Alan Collins

UPDATE : FRS17 has been updated to FRS102 follow the link to find out how this affects you


As the year-end approaches, I thought it was worth taking a back-to-basics look at the underlying actuarial assumptions used in FRS 17 calculations and what flexibility exists to change the results depending on the specific circumstances of each organisation.

So what is FRS17?

FRS17 is an accounting standard used to assess the balance sheet impact and pension costs associated with the operation of occupational pension schemes. For defined benefit arrangements (e.g. final salary pension schemes), the balance sheet asset or liability for the organisation is calculated as the surplus or deficit of the scheme assessed in accordance with assumptions appropriate for FRS 17.  The pension cost is a combination of the cost to the organisation of providing benefits built up over the past year and an interest charge applied to the liabilities built up in the past, offset by a credit in respect of the expected return on the scheme’s assets.  The elements of the pension cost are again calculated in accordance with assumptions appropriate for FRS 17.  Some organisations who participate in multi-employer schemes retain an opt-out, whereby the pension cost is set equal to the amount of employer contributions and there is no balance sheet impact.  This opt-out continues to be placed under serious scrutiny by company auditors and is looking increasing untenable.

FRS17 Assumptions

The responsibility for the FRS17 assumptions adopted lies with the directors/trustees of each organisation.  The agreement of the auditor is required, and the organisation should seek the advice of an actuary on the assumptions.  There is a considerable degree of flexibility in setting these assumptions and the impact of small changes to the assumptions can be quite substantial (some examples are provided in the table below).

In many cases, the assumptions proposed by the actuary will be based on the “average” index values and mirror those assumptions used for the Trustees funding valuation and therefore may not be appropriate for the individual circumstances of each organisation.  As the assumptions are the responsibility of the directors/trustees, they are entitled to request that the actuary carries out their calculations on alternative assumptions which they feel might be more appropriate.

It is important as early as possible in the process for each organisation to consider whether the assumptions proposed are appropriate and take suitable action if not.  However, it is not appropriate to “cherry pick” assumptions on a year by year basis as directors/trustees need to ensure a consistent approach is used.

FRS17 requires a market-related approach, with assets being taken at their market value.  Liabilities are valued using the ‘discount’ rate equivalent to that available on AA corporate bonds.  The rate should be adjusted to make it appropriate for the maturity of the scheme’s liabilities (this will depend on the proportion of pensioner and active members in the scheme).   Other assumptions (e.g. pension increases, mortality) are on a best estimate basis.  The expected return on asset assumption is set independently of the liability discount rate.  The assumptions should be mutually compatible and lead to best estimates of the future cash flows arising from the Scheme’s liabilities.  The assumptions should also reflect market conditions at the reporting date.

How assumptions can change from organisation to organisation

As noted above, the impact of small changes to FRS 17 assumptions can have a significant impact on the organisation’s balance sheet asset/liability and pension costs.  The main assumptions driving FRS 17 disclosures are the rate at which future values are discounted to “present day” terms (the discount rate), the expected rate of future price and salary inflation and the life expectancy of members.  Taking a scheme with a total liability of £30 million, an indication of the impact of assumption changes on the balance sheet would be as follows:-

Change Reduction in liability
Discount rate increased 0.25% per annum* £1.8 million
Salary inflation less 0.25% per annum (assuming 50% of members are active) £0.5 million
Price inflation and salary inflation less 0.25% per annum £1.8 million
Life expectancy reduced by 1 year £0.8 million

*- liabilities are reduced by increasing the discount rate and increased by reducing the discount rate.

There would be corresponding increases in the liability if the opposite changes occur (i.e. reduced discount rate, higher salary and price inflation and higher life expectancy).  Therefore, it is clear that setting assumptions can have a material outcome on the organisation’s balance sheet.  The impact on the pension costs are more difficult to quantify but pension costs are generally lower when liabilities are lower and assets are higher.

My earlier blog entitled “Throw your actuary a curve ball on FRS 17” discusses the impact of changing the underlying assumptions in further detail.

It is worth noting the potential move to using the Consumer Price Index (CPI) as the measure of price inflation for the purposes of regulating occupational pension schemes.  Given that historically, on average, CPI has been around 0.5% per annum lower than RPI, this change places a lower current value on future pension payments and so reduces the liability of organisations in respect of pension benefits.  Typically, this change could reduce overall pension liabilities by around 10%.  If you have year end FRS 17 disclosures coming up, this point should be addressed with your advisor as soon as possible.


It is worth remembering that the assumptions used for FRS17 purposes are no more than assumptions – the assumptions used for the ongoing funding of each scheme will be different and give rise to different costs and liabilities and the costs and liabilities associated with a cessation valuation (the amount an organisation has to pay if it leaves a scheme) will be significantly higher.

If you are part of a multi-employer scheme which makes full FRS 17 disclosures (i.e. the opt-out does not apply), actuaries will provide participants with a briefing note outlining the assumptions they will base the calculations on and these will be carried out on a consistent basis for all participants and will therefore, in most circumstances, not reflect the specific circumstances of the participating organisation and may be more conservative than the organisation might deem to reflect a best estimate approach resulting in higher liabilities, and therefore higher disclosed deficits. Independent advice at an early stage will allow assumptions appropriate to each organisation to be set and ensure that the ultimate results need be run only once.

Alan Collins

‘Ello, I wish to register a complaint.  Much like Monty Python’s famous Norwegian Blue parrot, private sector defined benefit pension schemes are dead.  They are not resting, stunned or even pining for the fjords – they’re stone dead.

I therefore believe the calls by the UK pensions industry to shield defined benefit pension schemes from the effects of Solvency II are somewhat misplaced.  If the only reason for not adopting Solvency II is to prevent the further closures of such schemes, then these calls do not stand up to scrutiny.  Schemes have been closing rapidly under the existing regime and will continue to do so irrespective of European legislation.

Many employers overburdened by regulation and the dawning realisation of the real cost of pension guarantees have called time on defined benefit provision. The adoption of Solvency II may well further hasten this inevitable demise. For a large number of schemes, accepting this now will be a good thing in the long run.

The closure of schemes leaves two main issues: (1) should defined benefits constitute a cast-iron promise to beneficiaries and (2) how do we best close the funding gaps to ensure all liabilities are met?

The magnitude of UK defined benefit obligations have grown over time, often beyond the sponsors’ control. Layer upon layer of legislation, primarily relating to guaranteed indexation, has left employers to fund obligations which were not present or intended when schemes were first set up.  In effect, this has hindered the private sector from delivering pensions which can be guaranteed.

Beneficiaries certainly believe a promise is a promise and fully expect employers to stand behind their obligations irrespective of the above problems.  This feeling is heightened by the fact that fewer and fewer beneficiaries have an ongoing mutual interest in the prospects of the sponsor. However, by allowing measures which rely so heavily on employers, it is also clear that the UK funding regime has never been set up in a way to match the understanding of the beneficiaries.  It is a structure based on hope rather than expectation.

As integration across member states continues and the workforce in the EU becomes increasingly mobile, I would expect that benefit promises made by companies in all EU states will face harmonised regulation and enforcement. UK residents who end up working in other EU states would fully expect benefit promises to be honoured just as our European counterparts would surely expect the same protection working in the UK.

The expectation of benefit promises being honoured seems to make it inevitable that there will be levelling up of pension legislation across the EU, whether by Solvency II or other means.

The National Association of Pension Funds claims that the UK system already provides a strong level of protection for its members through the employer covenant, The Pensions Regulator (tPR) and the Pension Protection Fund. While the current regime is undoubtedly more robust, any inference that the existence of the PPF is a justification for a lower funding target should be discounted.

In support of this view, the Association of Consulting Actuaries believes that the current directive with its requirement for the prudent funding of technical provisions is providing ‘an appropriate balance between protecting members’ benefits and keeping the cost to employers at an affordable level’.  While balance is appropriate, I believe it would be a mistake to retain a lower funding target because it is all that can be afforded in the short-medium term.  It is much better to aim for the right target, even if it is going to take longer to get there.

As well as possible directives on Solvency II, there are a number of additional factors which support stronger funding targets such as the views of the Accounting Standards Board; the ultimate legal obligation on employers is already set at buyout; and the dominance of solvency levels in pension related discussions during mergers & acquisitions, where FRS and technical provisions are cast aside.

For all but the very largest of schemes, the only realistic end game is to buy out all of the remaining benefits with an insurance company as soon as it is affordable and efficient to do so.  In the meantime, the need for employer flexibility and the reluctance of tPR to accept very long-term recovery plans have lead to the adoption of weaker funding targets which rely on the ethereal employer covenant.  However this is the system we must work within at the moment.

Whichever way we end up reserving for and funding schemes, the UK pensions industry needs to face up to the fact that its biggest task is dealing with legacy deficits and not propagating the virtues of future benefit accrual.  The private sector defined benefit experiment has failed and the best that can be done is to ensure that current obligations to members are met. It is time to admit that the parrot is truly dead.

Alan Collins

Warning – your actuary could be overstating your FRS 17 liabilities by up to 10% or possibly even more!!

The maturity or ‘term’ of your pension scheme is becoming increasingly important in setting assumptions for actuarial valuations and hence determining the value of the liabilities. In particular, FRS 17 states that scheme liabilities should be discounted at “the current rate of return on a high quality corporate bond (generally accepted to be AA rated bonds) of equivalent currency (£) and term to the scheme liabilities”.

So what about the term? This is the interesting, though unfortunately slightly technical bit!! Until a few years ago bond discount rates were generally unadjusted for term in FRS 17 calculations. The liabilities were therefore wrongly assumed to be of the same term as the maturity of the bond index (usually 12-13 years). Pension schemes are normally of a much longer term nature, from around 20 to 30 years on average. Between 2006 and 2008 where long term interest rates were unusually lower than short term rates, there was a significant push by audit firms for schemes to discount the liabilities using these lower rates – this significantly pushed up the magnitude of FRS 17 liabilities.

Recent movements in the shape of the interest rate yield curve mean that medium to long-term interest rates are now significantly higher than the rates implied by the AA index. For those firms already using a “yield curve” approach to assumption setting, the discount rate appropriate for FRS 17 will now be higher than the index yield and so FRS 17 liabilities will reduce, all else being equal (assuming the auditor agrees of course!!). It may no longer be appropriate to continue using the unadjusted bond index value as the discount rate, as this would currently overstate the pension scheme liabilities. All very easy for me to say you might think but what does this mean?

I estimate that for an average scheme, adopting a yield curve approach now could increase the FRS 17 discount rate by up to 0.5% per annum (or even more at very long terms), which would reduce FRS 17 liabilities by around 10%. So, if you receive FRS 17 assumptions advice or disclosures which stick rigidly to the AA bond index for setting the FRS 17 discount rate, you may wish to ask your advisor to reconsider, or seek separate actuarial advice.

For further information on FRS 17 assumption setting or other matters surrounding your scheme, please contact myself or any other member of the actuarial team at Spence & Partners.

David Davison

I read my colleague Val Hartley’s blog on post code mortality with great interest and it raises a number of important questions such as:

If you run a DB scheme in one of the areas in the first table (or indeed anywhere above the average mortality rating of 10%) and are using standard mortality tables you could well be placing a higher value on the pension liabilities disclosed in your accounts than might be necessary.

Another colleague, Ian Campbell, highlighted in his blog on FRS17, how companies were likely to see a rise in liabilities and deficits when preparing figures in 2010 and experience is proving him to be correct with numerous organisations concerned about the results they are seeing. Often, in the past, companies FRS17 figures have been provided by what is, in effect, the trustees’ adviser, and presented to companies as a fait accompli. However companies are increasingly seeking an independent view on their disclosures and the assumptions used.

Mortality is one of the key assumptions in any actuarial assessment of pension scheme liabilities and it can be worthwhile, and surprisingly cost effective, even for smaller schemes, to obtain a specific post code mortality assessment. Whilst not perfect, a scheme specific mortality rating will provide support for a specific level of mortality assumptions to be used in calculations. This, in turn will give you a better estimate of your liabilities. There is scope within FRS17 to adopt mortality assumptions more specifically aligned to a particular company’s circumstances which can have a material impact on the deficit ultimately disclosed.

The key point is don’t just accept what you’ve been provided with – a bit of digging and a second opinion may prove valuable.

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