It has become a difficult time for even well funded pension funds recently. Any increase in assets is often more than covered by an increase in liabilities. Different sponsoring companies and their pension funds however react in different ways.
In the UK, the new Accounting Standard FRS17 has started to have a dramatic effect, even before it has been officially implemented. Companies are still trying to change the standard and recently a few of the ones most affected have even managed to persuade the Accounting Standards Board (ASB) and other regulatory bodies to start discussing possible changes to the controversial new pensions standard. Unfortunately, the board looks like it will stand firm.
Frustrated companies are hoping the ASB amends the standard as they fear stock market volatility in the value of their funds will have disastrous affects on their ability to pay shareholders’ dividends. FRS 17 is very prescriptive and is replacing the previous very lax standard SSAP 24 as the basis of accounting for a company’s pension fund assets and liabilities.
As things stand at the present time, the new standard will force UK companies, for the first time, to disclose in their accounts any shortfall in their final salary pension scheme. Companies are already starting to cut their dividends in order to save cash to make up the expected shortfall the standard will reveal. Many companies, especially in industries with long-standing pension schemes, may well be forced to wind-up their final salary pension fund.
However, the majority of UK companies are not going to make a decision until they actually have to reveal their figures. The introduction of FRS17 comes at a time when the market is down and this is going to be very damaging to those companies whose pension fund is worth more than the company.
The irony of the current situation for the UK corporate sector is that these changes were introduced in a desire to bring UK accounting standards up to international levels and, in particular, up to levels supposedly practised in the US. But one of the biggest concerns of US investors at the moment is the way that company profitability is being manipulated by companies using over-optimistic investment return assumptions for their pension funds. I was staggered to see that a company as reputable as IBM has recently increased its return expectation for its pension fund to 10% from 9.5%. Unfortunately, IBM is not alone apparently with 34 companies raising their pension fund earning expectations last year. A year, in Europe at least, in which pension funds began to appreciate that the returns they experienced in the past are just that, well and truly in the past.
So, while UK companies are forced to face reality, US companies can still report increased profits without actually having to earn them. In a wonderful piece of understatement, Warren Buffett recently called such US company expectations ‘heroic’ in an article in
Fortune magazine. Of course, not all US companies use such, shall we say, optimistic earnings expectations. General Electric has reduced its assumption from 9.5% last time to 8.5%. Even this figure is seen by many commentators as being fairly optimistic.
With this as a background, is it any wonder that UK finance directors are questioning the need for the UK ASB to be so dogmatic as to introduce a standard that allows no smoothing and insists that a company import a notional deficit in its pension funds, based upon a market value at a single point of time, straight into its corporate accounts? The company may not even have to pay anything extra into its pension scheme.
So, the reporting is entirely notional, just as it is with the opposite effect in the US. The position can be summarised as being very confused with a significant impact on a number of companies in the short-term but often with absolutely no impact on cash. So much for standardised company account reporting!
But what is it that is causing so much trouble in the UK? I think the biggest problem is that while assets are measured at market value at a single date, liabilities are effectively discounted at a corporate bond rate.
Last year, of course, this combination and especially the falling equity values, made life very difficult for pension funds. The net recoverable surplus – or deficit – has to be reported in the balance sheet with immediate recognition of these actuarial gains and losses. Trustees have, of course, faced falling equity markets before but the long term nature of pension fund liabilities meant that no one worried unduly.
Now, however, pension funds are that much more mature. A strict, short-term perspective will therefore force corporate finance directors to pressurise trustees to take short-term actions which, I fear, may not be in the long-term interest of pension fund members.

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