The corporate funding problems created for UK company pension plan sponsors by FRS 17, the requirement to account for pension fund liabilities, will not be solved by the rising equity markets. Or so say actuaries Lane Clark & Peacock (LCP), who warn UK CFOs not to automatically assume better equity prices will dent their FRS17 pension shortfalls.
LCP says its analysis suggests that FRS17 values for inflation-linked liabilities have actually risen sharply since January 2003 because yields on corporate bonds, which determine the value of pension liabilities under the accounting standard, have fallen by around 0.5% relative to market expectations about long-term price inflation.
“Recently, there have been some confusing reports about FRS17 deficits – some say deficits have reduced significantly whilst others comment that they are unchanged,” says Francis Fernandes, a partner at LCP. “Two potential reasons for the difference in opinions are the extent to which pension promises are assumed to be linked to inflation and also the allowance in the estimates made for increased pension contributions over 2003. Many CFOs will be hoping that returns on UK shares of around 20% over 2003 will have brought their FRS17 deficits back under control. However, the position is not so rosy for pension schemes with largely inflation-linked pension promises because the reduction in real bond yields could easily have added 10% to the FRS17 liabilities of a year ago. In mid-July 2003, we estimated that the combined shortfall in pension scheme assets for FTSE100 companies was some 55 billion. By the end of 2003, the upturn in equity markets would have tended to improve these numbers but not to the extent that many FDs might have first hoped. The fall in real bond yields over 2003 clearly demonstrates that there are two sides to the FRS17 story – and you can’t predict either.”
Fernandes added: “In any case, FDs mustn’t forget that, although the value placed on pension promises under FRS17 can change from one day to the next and, as we have seen recently, quite often from one commentator to the next, the promises themselves are broadly unaffected. In the end, the money to pay for pensions can only come from two sources: contributions and investment returns – neither of which depends on FRS17.”