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Accounting for Pension Costs Under FRS17 - 2005 Survey
Introduction
This is our 5th annual survey of the assumptions adopted by FTSE100 companies for determining the value of their pension liabilities for accounting purposes.
This survey is based on the data in the published accounts of FTSE100 companies with financial years that ended on 31 December 2005. At the time of writing, 42 companies had published results, 41 of which also appeared in last year's survey.
Discount Rate
The discount rates used by the companies in our survey are set out below.
At 31 December 2005, the average yield on over 15 year, AA-rated corporate bonds was approximately 4.75% (2004: 5.3%) and it can be seen that the majority of companies used a discount rate at, or very close to, this level.
Inflation Rate
The difference in yields on index-linked and fixed interest gilts was approximately 2.9% at 31 December 2005 (2004: 2.9%). Most companies assumed that inflation would be slightly lower, with the average at 2.75%.
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). The average real salary growth has fallen to 1.4% in 2005 from 1.5% in 2004.
Surplus/Deficit
Despite the increase in equity asset values during 2005, the average IAS19 funding level for the companies in our surveys remained broadly unchanged at approximately 86% at 31 December 2005 compared to 84% at 31 December 2004. This was due to the offsetting effect of a reduction in discount rates and perhaps an increase in assumed life expectancy.
Mortality Assumption
Although the accounting standards do not explicitly require the disclosure of mortality assumptions, more and more companies are choosing to do so. Well over one-half of the companies in this year's survey disclosed information on the mortality assumption, either referring to the mortality tables used or presenting the implied average life expectancy.
Insurance companies are now disclosing the annuity values they have used in their valuations for sample ages and perhaps the accounting standards will develop along similar lines.
Expected Investment Returns
The expected returns on equities disclosed at 31 December 2005 are set out below.
The average expected equity return was 7.5%, compared to the average yield on long-dated gilts of 4.1% and so implying an average "Equity Risk Premium" of 3.4% per annum (2004: 3.2%).
Given the substantial return on equities during 2005, one might expect the percentage expected return to be reduced at 31 December 2005. Indeed most companies either reduced or left the equity return assumption unchanged from 2004, however one company 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 shows the percentage of assets invested in equities for companies in the 2005 survey, and compares this with the percentage invested in equities by the same companies in the 2004 survey. The straight line represents an unchanged equity weighting from 2004 to 2005. Those companies that fall below the line have reduced their equity weighting.
Generally, the equity weighting has reduced or remained broadly unchanged. The high increase in equity values over the year implies that there has been some switching away from equities.
Credit Ratings
The following charts compare the IAS19 funding level and discount rate against the company's Standard & Poor's ("S&P") credit rating.
There are many factors that influence a company's credit rating and so it is difficult to draw any firm conclusions from these charts.
We hope that this analysis is helpful to companies in formulating their own assumptions under IAS19 (or FRS17 for non-listed companies).
Please contact your usual Barnett Waddingham consultant to discuss any of the above.
Barnett Waddingham LLP, June 2006.