Final salary pension schemes are to adopt a new set of accounting rules in June, which could cause...
Final salary pension schemes are to adopt a new set of accounting rules in June, which could cause changes to investment strategies and discourage employers from providing final salary schemes, according to HSBC actuaries.
The standards, now known as FRS17, were passed by the Accounting Standards Board (ASB) and are intended to make reported pension costs easier to understand and comparisons between companies more valid.
The key objectives are to measure assets and liabilities at fair value and to allow immediate recognition of actuarial gains and losses.
This means that for defined benefit schemes only, the assets of the scheme are to be measured using the market value of those assets at the time the scheme is assessed, typically once a year.
In the past actuaries of pension schemes have been allowed to adjust the value of assets in order to take into account market fluctuations. The new method does not allow for this, according to Audra Windley, an actuary with HSBC Actuaries & Consultants.
In addition, FRS17 will require scheme liabilities to be measured by projecting the value forward and then discounting based on the current yield of an AA corporate bond.
The decision to use a corporate bond yield was taken in order to find a mid-point between gilts and equities as the overall assets were unlikely to fall entirely into either, Windley said.
The pension scheme surplus, or deficit, must then be recorded on the company balance sheet.
Windley said: "FRS17 will probably lead to increased volatility of reported pension costs, since no smoothing of the market value of the assets is allowed.
"The new standard could lead to pressure from employers for changes in scheme investment strategy in order to reduce the volatility of pension costs. This could include pressure for a reduction in the exposure to equities, with undesirable consequences for the scheme's funding position, leading in due course to an increase in required contributions."
The accounting standard is not expected to affect money purchase schemes, which will follow a regime similar to FRS17's predecessor, SSAP24.
SSAP24 requires pension costs to be shown in company accounts as a best estimate.
Windley said: "This left room for subjective judgement, especially in the choice of actuarial assumptions. Views differ widely on best estimate assumptions and accountants have an in-built aversion to subjectivity.
"SSAP24 led to significant inconsistencies in the way in which pension costs are disclosed in different companies' accounts."
The impact of the ASB's standard on final salary schemes is not expected to be realised until it comes into effect on 21 June 2001, as much will depend on how employers and shareholders interpret the figures disclosed, Windley explained.
She added: "The effect of the new standard will depend very much on the individual company's circumstances.
Although it was accepted that SSAP24 needed revising, it may be that the ASB has gone too far and that the undesirable effects of FRS17 may outweigh the advantages of greater clarity and objectivity. We will, however, have to live with it and plan positively how best to respond to it."
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