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Accounting for Pension Costs Under FRS17 - 2004 Survey
Introduction
This is our 4th annual survey of the assumptions adopted by FTSE100 companies for determining the value of their pension liabilities under the Financial Reporting Standard, FRS17.
This survey is based on the data in the published accounts of 44 FTSE100 companies with financial years that ended on 31 December 2004. Of these 44 companies, 42 were also contained within last year's survey.
Discount Rate
The discount rates used by the companies in our survey are set out below.
At 31 December 2004, the average yield on over 15 year, AA-rated corporate bonds was approximately 5.3% (2003: 5.4%) and it can be seen that the majority of companies used a discount rate at the average rate or 0.1% above the average.
Inflation Rate
The difference in yields on index-linked and fixed interest gilts was approximately 2.9% at 31 December 2004 (2003: 2.8%). Most companies assumed that inflation would be slightly lower, perhaps due to some concerns that the yields on index-linked gilts were suppressed due to their scarcity.
Salary Increases
Some companies may use a scale for promotional salary increases in addition to a general salary growth assumption and therefore a comparison of the disclosed salary increase rates may not be a like-for-like comparison in all cases. We have nevertheless shown below the disclosed salary increase assumption relative to the assumed rate of price inflation (i.e. real salary growth).
Surplus/Deficit
Despite the increase in equity asset values during 2004, the average FRS17 funding level for the companies in our surveys remained unchanged at approximately 84% from 31 December 2003 to 31 December 2004. This was due to the offsetting effect of a reduction in discount rates, the increase in assumed inflation and perhaps an increase in assumed life expectancy (FRS17 does not explicitly require the disclosure of mortality tables, so we are unable to detect any changes).
Mortality Assumption
As mentioned above, FRS17 does not explicitly require the disclosure of mortality assumptions. We find this a surprising omission given its potential impact on the FRS17 deficit: for example, a change to the latest published mortality tables from the previous tables (i.e. PMA80 to PMA92) could be equivalent to a change of around 0.5% per annum in the discount rate. Including allowance for the cohort projections could be equivalent to a further discount rate change of 0.25%.
Expected Investment Returns
The expected returns on equities disclosed at 31 December 2004 are set out below.
The above data imply an average Equity Risk Premium (defined as the excess of expected equity return over the gilt yield) of 3.2% per annum, a rise from 3.1% as at 31 December 2003.
Given the substantial return on equities during 2004, one would expect the percentage expected return to be reduced at 31 December 2004. Indeed most companies either reduced or left the equity return assumption unchanged from 2003, however a few companies chose to increase the assumption, as illustrated in the chart below.
The assumed expected return from bonds was less variable between companies, as shown below.
Asset Allocation
The chart below compares the percentage of assets invested in equities for companies in the 2004 survey, and compares this with the percentage invested in equities by the same companies in the 2003 survey. The straight line represents an unchanged equity weighting from 2003 to 2004.
The chart shows that although the majority of companies have kept broadly similar equity weightings, there is a noticeable trend of reducing equity weightings over the year. Given the strong performance of equities over 2004 this suggests that schemes have generally been switching out of equities. Three companies reduced their equity weighting by more than 50%.
Credit Ratings
This year we have included a comparison of the FRS17 funding level and discount rate against the company's Standard & Poor's credit rating, as shown below.
These charts do not reveal any correlation. Hence, there is no evidence from our survey to suggest that the size of the FRS17 deficit affects a company's credit rating, nor any strong evidence to suggest that companies with poorer credit ratings used higher discount rates in order to disclose lower FRS17 deficits.
We hope that this analysis is helpful to companies in formulating their own FRS17 assumptions.
Please contact your usual Barnett Waddingham consultant to discuss any of the above.
Barnett Waddingham LLP, July 2005.