The UK Accounting Standards Board (ASB) has commenced a consultation exercise on the FRS 17 accounting treatment of changing the inflation measure for future pension increases from the Retail Price Index (RPI) to the Consumer Price Index (CPI). It is generally accepted that a change to CPI from RPI will reduce the value of pension scheme liabilities, possibly by upwards of 10 per cent.
The ASB’s Urgent Issues Task Force (UITF) correctly steers away from the precise implications of the government announcements and concentrates on the accounting implications of any changes that may occur.
In my view, unless the scheme documentation refers specifically to legislation rather than to RPI, private sector schemes will be stuck with RPI, barring further intervention by the government. You will note I am deliberately using the phrase “scheme documentation” loosely, as the weight given to historic rules, booklets and other communications may have an impact on whether the switch to CPI can ever be automatic. Indeed, the consultation makes reference to the influence of other documentation in determining whether a change from RPI to CPI will be permissible. That being said, case law suggests that the scheme rules are over-riding in most circumstances. The changes are, however, automatic for public sector schemes.
The UITF consultation proposes that: “where there is a change in obligation to the member, there is a benefit change which is accounted for as a past service cost. Where the obligation to the member has not changed, any change in the scheme liabilities arises from a change in assumptions”. The latter is therefore treated as an actuarial gain through the Statement of Total Recognised Gains and Losses.
The consensus reached by the UITF is that a past service cost arises where there is a current obligation to increase benefits at least in line with RPI, such that any change to CPI would require trustee or member consent. I acknowledge that a member can agree to reduce his or her benefit entitlement. However, the chances of members agreeing en masse to reduce their benefits is highly unlikely to say the least. Can the trustees agree for benefits to be reduced? Maybe (assuming Section 67 of the 1995 Pensions Act is not breached), but their consent cannot be taken for granted.
Therefore, the most realistic avenue open to the change being treated as a past service cost is if the Government decides it will amend legislation to allow schemes to make the change irrespective of scheme documentation. There has been no sign of such an announcement being forthcoming and, even if it was announced, it would leave scheme trustees in a very difficult position as to whether to protect current benefits or improve security for all members by possibly cutting back the value of benefits.
In absence of government intervention, the default accounting treatment would be as an assumption change allowed for via the Statement of Total Recognised Gains and Losses. I note further that the view of the UITF seems to be at odds with initial views I was advised of in respect of Local Government Pension Schemes. The change was recommended to be considered as a credit to an organisation’s profit & loss account even though the consent of members or administering authorities was not required and any reference to RPI in other documentation was set aside.
It will only become possible for the accounting treatment to be absolutely clear when the impact on individual schemes is known. Hopefully more light will be shed on this key point sooner rather than later.