Market Volatility Caused by Eurozone Woes Puts £50bn on UK Pension Deficits in a Month

June 05, 2012 /
  • Falling bond yields in May increase pension liabilities by £35bn and market falls wipe £15bn off pension scheme assets
  • And forthcoming accounting changes are set to hit profits and dividends, according to KPMG’s 2012 Pensions Accounting Survey

The current Eurozone uncertainty is playing havoc with pension positions recorded in company accounts, according to research by KPMG in the UK.  Due to a combination of real yields on AA corporate bonds falling to their lowest ever level and volatile equity markets sparked by uncertainty around Greece’s membership of the currency union, KPMG estimates that pension deficits on UK company balance sheets have deteriorated by £50 billion over the course of May.  Adding to the short term market volatility, forthcoming accounting changes will make the financial reporting of pensions even more challenging.

Mike Smedley, pensions partner at KPMG in the UK, said: “Our analysis suggests that the current turmoil in the Eurozone has led to a £50 billion increase in UK pension deficits as a result of falling equity markets and depressed interest rates.  This is currently an accounting hit rather than a true business cost, but illustrates the challenges faced by corporate sponsors in managing these liabilities.  Should current market conditions persist, then these losses will start to crystallise in year end accounts and in cash funding plans.  The biggest problem for pension schemes is the continuing uncertainty and the position will look very different once the Eurozone issues are resolved. In the meantime, the position is hugely volatile from one day to the next, for example there was a positive swing on just one day (22 May) of £20 billion.”

KPMG analysis shows that the average interest rate used to value pension liabilities on corporate balance sheets fell by 0.4% over May 2012, leading to a c£35 billion increase in accounting liabilities under the international standard IAS19.  Alongside this, due to market volatility, the analysis shows that UK private sector pension assets are likely to have fallen in value by around £15 billion over May 2012.

Changes to pensions accounting standards to hit reported profits by £10bn and potentially block dividend payments

Meanwhile, changes being introduced to the pensions accounting standard IAS19 from 2013 will reduce reported profits for most UK corporates by removing the current accounting “reward” for investment in return seeking assets.  KPMG estimates that this will reduce reported profits for UK plc by £10bn, due to a typical expected return on a fund portfolio currently some 1% above liability discount rates.

Naz Peralta, Director in KPMG’s Pensions accounting team, said: “Companies should not underestimate either the impact or the cost of complying with the new standard.  Whilst the headline amendment to the expected return credit is reasonably well understood, there are other changes which may require accounts to be restated and which may hit operating profits, and plenty of disclosure requirements requiring additional figures to be calculated.”

Separately, compounding the pension challenge already facing corporates, proposed changes due to UK GAAP from 2015 mean that some companies may find themselves in a position whereby dividends cannot be paid out due to a requirement to recognise defined benefit pension deficits on the balance sheet of at least one group company.

The changes to UK GAAP are currently at Exposure Draft stage.  Large and medium sized UK corporates not applying EU IFRS accounting will be required to apply FRS102 “The Financial Reporting Standard applicable in the UK and Republic of Ireland”.  FRS102 is expected to apply for accounting periods beginning on or after 1 January 2015.

Naz Peralta explained: “Current accounting exemptions available to some corporates are due to be replaced with the need to record full pension deficits on individual company balance sheets, thus reducing reserves available for distribution.  Corporates will need to start thinking about how to address this in order to minimise the risk of future dividend blocks, for example by restructuring the group or by creating additional distributable reserves.  This accounting headache is in addition to the Pensions Regulator’s tough stance on dividend payouts to shareholders where a company still has a pension deficit to plug.”

But the “good” news is that we are not living much longer!

On a more positive note for defined benefit scheme sponsors, KPMG’s Pensions Accounting Survey 2012 shows that the assumed life expectancy of pension scheme members has not increased significantly over the past year.  Despite this, with an average assumed life expectancy of nearly 89 years for a current employee, and the UK Government facing significant budget challenges, the burden of ensuring adequate retirement provision will increasingly move to the individual.

Mike Smedley concluded:  “It’s a strange state of affairs when no significant increase in life expectancy is seen as a positive development.  But rising mortality assumptions have caused liabilities to increase by around 10 percent since our survey began in 2004, so life expectancy reaching a plateau is very welcome indeed for scheme sponsors.”



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