GLOBAL - Changes to international accounting rule IAS19 pension rules could force many sponsors and corporates to encourage lower risk pension strategies, as reforms could mean they are no longer rewarded for taking risks under the ‘expected return on assets' portion of their profit and loss accounts.

Analysis presented by consultancy firm Mercer suggests a proposed change to IAS19 will replace the current ‘expected return on assets' within the pensions component of the profit and loss account and will wipe any benefit gained from suggesting equities will perform better than bonds.

More specifically, the alteration will lead to a significant hit on corporate profits in cases where the pension fund is taking sizeable risk with its investment strategy, whereas pension funds adopting lower risk strategies - such as through high bond allocation to match movements in liabilities - could actually improve profits if the IAS19 discount rate is higher than the returns they earn from assets held.

"This proposal effectively means that, in their profit and loss, companies would no longer automatically rewarded for taking investment risks through their pension plan assets," said Warren Singer, head of UK pension accounting at Mercer.

"Currently, a pension plan that is heavily invested in equities will report a higher expected return on assets and a lower pension charge to profit or loss than a plan taking no investment risk - even if the actual return on equities over the accounting period is poor. The proposed change would mean a removal of this incentive for CFOs to support investment in equities," argued Singer.

At this stage, Mercer has focused its attentions on the impact this rule change could have on the UK pension market, and found a potential £8.7bn (€9.64bn) could be wiped off UK company balance sheets, under the current asset allocation of pension funds.

These calculations were made by assuming the £870bn in UK pension scheme assets is held in 50% equities and 25% bonds, and assumes corporate bonds return 1% above government bonds while equities return 3.5% about gilts.

The position would be worse and approximately £17.5bn would be knocked off profit margins if UK pension schemes moved all of their assets into low-risk government bonds, according to Mercer.

However, the ramifications are likely to impact beyond UK borders and the proposals could require firms to use a revised format for the statement of comprehensive income, as actual gains and losses on pension fund assets would be immediately recognised outside the current  profit and loss measure of earnings.

The International Accounting Standards Board is expected to consult on this issue over the coming months, as part of its ongoing project to update accounting standards on employee benefits by 2013.

If you have any comments you would like to add to this or any other story, contact Julie Henderson on + 44 (0)20 7261 4602 or email julie.henderson@ipe.com

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