Profits could take massive hit from final salary changes

Companies that offer final salary pension schemes are likely to be reviewing their decision to keep their schemes open before the planned rule change from the IASB takes affect, probably in 2011, according to pension specialist Aon Consulting.

Under current rules, companies estimate the surplus or deficit on their final salary schemes a year in advance. They use this to calculate the profit and loss charge for the scheme for the following year.

Companies can allocate from pension fund asset losses through the statement of recognised income and expense in accounts, meaning corporate profits are not hit by a fall in their scheme’s assets.

However, the International Accounting Standards Board last week proposed that companies should report the surplus or deficit of the final schemes at the end of each year, rather than estimate assets one year in advance.

These proposals would have turned a £25bn credit of expected returns on pension scheme assets for the top 200 final salary pension schemes last year into a £60bn asset loss – a net loss of £85bn, according to Aon.

Anne McGeachin, senior project manager at the IASB, said: ‘The [final salary] proposals simply seek to provide investors with a more informative assessment of the effect of the surplus or deficit of a pension scheme.’

Companies blame longer life expectancy, low inflation, falling stock markets and an increased regulations burden for closing final salary schemes, saying it has made the schemes too costly to administer.

One option for reducing final salary pension scheme liabilities is to offer selected members, usually the more highly paid staff, a package deal to transfer out of the final salary scheme.

However, companies need to handle this carefully in order to reduce the risk of subsequent litigation from disgruntled employees.

Pension schemes are a growing problem for UK companies. The pension schemes of the FTSE 350 companies recorded a funding level of 92% equal to a deficit of £33bn in the final quarter of last year, according to Mercer, a consultancy and investment services specialist.

The figure compares to the £13bn deficit reported in 31 December 2007 and illustrates the impact of market volatility on company balance sheets.

Meanwhile, British companies are likely to see their defined pension liabilities rise from 2011 due to Chancellor Alistair Darling's VAT cut in November, according to another pension expert.

This is because a return to the original rate of 17.5% in 2011 will lead to higher inflation and therefore higher payouts on inflation-linked benefits for those who have retired.