More accurate accounting calculations can lead to smaller pension liabilities in company accounts, according to a Towers Watson study.
A seemingly technical decision over which bond yields to use in calculations could change a typical defined benefit (DB) scheme's liabilities disclosed to investors by around 10%, said Towers Watson
By more accurately reflecting how much time will elapse before pensions must be paid out, companies have been able to disclose smaller pension liabilities, the consultant said.
Towers Watson senior consultant Neil Crombie said: "The explanation for this is that many companies are not just looking at an index; they are going for more precision by weighting bond yields according to when their pension payments fall due.
"Until the past couple of years, the approach used would not have made much difference, but going for greater accuracy currently works in a company's favour. This is because very long-dated bonds now pay higher rates of interest than bonds that are merely quite long-dated. Even with an index of long-dated bonds, the average duration will be shorter than a typical company's pension liabilities.
"The discount rate is the most important assumption that a company must make when preparing pension numbers for its accounts and seemingly technical decisions can make a big difference to the balance sheet. While many do this already, all companies will in future have to highlight to investors how sensitive the results are to the assumptions chosen."
Under the IAS19 accounting standard, expected future pension payments should be converted into a single liability number using the yields on high quality corporate bonds of a duration that is consistent with the company's pension commitments.
The consultant said that higher yields make liabilities look smaller in its study of the assumptions used to calculate the pension numbers in the accounts of FTSE 350 companies with 31 December year-ends.
As a result of Tower Watson's latest study, the consultant also warned that when 2012 accounts are restated to reflect new accounting rules, the pre-tax profits of companies with DB schemes will fall by an average of around 3%, or around £5bn, for the FTSE 350 as a whole.
The revisions mean that the credit on pension fund assets must be the same as the discount rate.
Previously, Towers Watson said that if the company's expected return from their pension scheme's assets was higher than the discount rate, this would lead to higher profits being recorded.
As a whole, the FTSE 350 companies who disclosed an average return on assets in their 2012 accounts exceeded the discount rate by an average of 0.8%, which would be around £5bn of pre-tax profits for companies with DB schemes.
"We don't think that the ability to record bigger profits by investing in riskier assets was acting as a significant brake on pension scheme asset de-risking. Most companies were already more interested in trying to reduce the volatility of the pension numbers on their balance sheets," said Crombie.
First published 11.06.2013
monique_simpson@wilmington.co.uk
