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Accounting for Pension Costs under FRS17 - 2002 Survey
Barnett Waddingham's report on the financial assumptions used by the FTSE100 companies under FRS17.
Introduction
This is our second annual survey of the assumptions adopted by FTSE100 companies for determining the value of their pension liabilities under the Financial Reporting Standard, FRS17 (please refer to our previous newsletter dated June 2002 for the 2001 survey results).
Our 2002 survey is based on the data in the published accounts of 48 FTSE100 companies with financial years that ended on 31 December 2002.
Discount rate
The discount rates used by the companies in our survey are set out below.
The average yield on over 15 year AA-rated corporate bonds was approximately 5.4% as at 31 December 2002, compared to the average as at 31 December 2001 of approximately 5.8%.
It is interesting to note that only 2 companies out of our survey of 48 used a discount rate at or below this average yield of 5.4%, whereas last year almost half the companies used a discount rate at or below the average at that time of 5.8%.
Hence, there is some evidence that companies generally have slightly increased the discount rate relative to the average AA bond yield, presumably in response to the pressure put on FRS17 deficits by the fall in asset values during 2002.
Inflation rate
FRS17 states that the yields on index-linked bonds relative to those on fixed interest bonds of similar credit standing will give an indication of the expected rate of general inflation. As at 31 December 2002, this difference in yields was approximately 2.3% and the chart below confirms that this was the most popular choice of assumption. This compares to the most popular choice of 2.5% in the 2001 survey.
The assumptions used for price inflation are set out below.
Salary increases
The reporting company will have its own opinion as to the likely future rate of salary increases for its employees. Some companies may use a scale for promotional salary increases in addition to an assumption for general salary inflation and therefore a comparison of the disclosed salary increase rates may not be a like-for-like comparison in all cases. Nevertheless we have shown below the disclosed salary increase assumption relative to the assumed rate of price inflation (i.e. the real rate of salary increases assumed).
It is interesting to look at the change in this assumption for the companies present in both the 2001 and the 2002 surveys. The chart below shows that 9 companies reduced the salary growth assumption, while 4 decided to raise it; on average there was a decrease by 0.10%.
Surplus/Deficit
The calendar year 2002 was a disastrous year for FRS17, with most companies hit by the "double-whammy" of reduced asset values and increased FRS17 liability values. This was reflected by only 4 companies in our 2002 survey reporting an FRS17 surplus (compared to almost half of the companies in our 2001 survey). The average FRS17 funding level for the companies in our surveys reduced from approximately 100% as at 31 December 2001 to approximately 80% as at 31 December 2002.
Expected investment returns
The expected long term investment returns disclosed as at 31 December 2002 are used in the calculation of the pension costs charged to the Profit and Loss (P&L) account for 2003. The higher the expected returns, the lower the 2003 P&L charge. The expected returns on equities disclosed at 31 December 2002 are set out below.
The above data reflects an average Equity Risk Premium (defined as the excess of expected equity return over the gilt yield) of 3.5% per annum, compared to 2.8% per annum as at 31 December 2002.
The chart below shows the relative change in the expected equity return assumptions for the companies present in both our 2001 and 2002 surveys.
Despite the substantial fall in equity values during 2002, it is interesting to note from the previous chart that only half of the companies decided to assume that future equity returns would be higher from 31 December 2002.
As one would expect, the assumed expected return from bonds is less variable between companies, as the chart below demonstrates.
Summary
It is very interesting to see both the areas of consistency between companies and, perhaps even more so, the extent to which companies have chosen different assumptions for reporting under FRS17, given that it was intended to be a fairly prescriptive accounting standard.
This year it is also particularly interesting to see that companies generally have responded to the pressures imposed by the substantial falls in assets values during 2002 by slightly increasing the discount rates relative to average AA bond yields.
We hope that this analysis is helpful to companies in formulating their own assumptions to use for reporting under FRS17.
Please contact your usual Barnett Waddingham consultant to discuss any of the above.
Barnett Waddingham, June 2003.