All I got for Easter was a chocolate coated balance sheet deficit

Richard Smith

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At the risk of showing both my age and my teenage self’s film preferences, I have to confess I enjoyed a bit of Bill & Ted and their musical adventures through time. One of the scenes I recall from the second film was an evil Easter Bunny, pursuing our terrified heroes through the underworld. It was incongruous how a loveable character could be portrayed in such a scary manner. But what’s that got to do with pensions accounting?

Back in November I wrote a blog about my expectations for accounting disclosures for companies reporting at the calendar year-end. Many recent events have proved the foolishness of attempting to predict the future, but (unfortunately perhaps in this case) taking an educated guess at the broad size of upcoming accounting deficits was fairly straightforward back then. Sadly, it made uncomfortable reading, and I predicted that pensions deficits would be an unpleasant surprise in the FD’s Christmas stocking.

Now we are nearing the end of March, a fresh group of companies are gearing themselves up to reporting their pension deficits. What can they expect to see? Well, I could pretty much take my previous blog, replace the words “Christmas stocking” with “Easter basket” and re-issue. Whilst there continues to be an expectation of rising inflation over coming years, the market indicators that feed into pensions accounting calculations have been largely stable over the last few months and so the value of liabilities now will be similar to that at the calendar year end. Unfortunately, because things deteriorated somewhat earlier on last year, that means that companies reporting now will be facing up to disclosing significantly larger liabilities on their balance sheets than this time last year. On the flip side, the last few months have generally been positive for asset values, but not enough to offset the liability increases seen last year.

This will flow through to an increase in balance sheet deficits, which could cause a number of unwelcome effects, such as increasing PPF levies, less flexible and/or more expensive financing costs, impact on dividend payments or even technical insolvencies.

So what can be done?

First – review your assumptions. The accounting standards allow a certain degree of flexibility when setting these. Your actuary will provide advice in this area – make sure that he or she understands your objectives and how you wish to make use of these flexibilities. Ultimately however, the decision of what assumptions to adopt is one for the Directors, not the actuary.

Second – the accounting disclosures simply show a snapshot of the financial health of the pension scheme at a point in time. It does not represent the actual cost of the scheme – this will only be known when the last member dies, or the scheme is wound up – and so changing the assumptions, whilst potentially providing some relief from the negative effects I mentioned earlier, will not actually change the fundamentals of the pension scheme. For that, a more thorough review of the pension risks is required, with consideration of the three levers (funding, investment and liability management) available to the company.

Many companies might be preparing themselves for a Bill & Ted-style Easter Bunny bringing chaos and unwelcome pension disclosures next month. Whilst unlikely to be able to improve the position sufficiently to convert this into a basket of delicious chocolate (in the same way that I am unlikely to be able to effectively stretch the analogy this far!), with some proactive action, the situation doesn’t need to be as bad as it might first appear.

Richard Smith

Post by Richard Smith

Experienced pensions actuary and expert in accounting for pension costs, liability management exercises, dealing with the pensions issues arising from M&A activity and scheme funding.