Risk, accounting standards and the pensions puzzle

PENSIONS are hitting the news as workers strike and companies stagger under the financial strain, but accounting standards might be making the problem worse.

The National Association of Pension Funds has warned International Financial Reporting Standards are “undermining” schemes and could act as a drag on the economy.

Standard setters the IASB recently finalised IAS 19 Employee Benefits, which changes the way pension scheme assets are valued and does away with ‘smoothing’, used to reduce volatility in pension scheme accounts by taking a long-term view of their financial position.

The new standard uses mark-to-market accounting – whereby assets are valued according to current market prices – on the assumption that this is more transparent.

However, NAPF said this “perversely” affects pensions by linking them to short-term market changes, meaning falling asset values could give the appearance of large deficits that might never materialise.

NAPF chairman Lindsay Tomlinson warned: “Employers who are faced with these allegedly large deficits may decide to close their defined benefit pension schemes to existing and future members.”

Those that do struggle on could switch to low-risk investment strategies for fear of the volatility that higher-risk strategies might unleash on their figures, meaning returns will be sub-optimal and the economy less well supported, she argued.

Brian Peters, partner at PwC, agreed that IAS 19 could have affected investment decisions, and that these “are not necessarily favourable” to some schemes.

However, he argued that the majority of stakeholders have nonetheless applauded the changes and welcomed the enhanced transparency they provide – more on this later.

Margaret de Valois, head of Mazars’ global pension and investment advisory panel, went one step further. She argued that the move to de-risk pension schemes has little to do with the change in accounting standards, and is primarily due to the economic cycle.

During the downturn many investors favoured products such as gilts and government bonds, shifting away from high-risk, high-return assets like equities.

“Pension investors are looking to buy gilts because these match their liabilities better. There is still a place for equities, but less so than before,” de Valois argued.

As many schemes close to new entrants their lifespan can fall to ten years or less, while de-risking deals with banks and insurers mean some have just five years left to run.

With pensions becoming shorter term, de Valois said IAS 19’s mark-to-market model is increasingly relevant, especially those approaching the end of their lifetime.

Returning to the issue of transparency, experts agree that the new accounting standard meets many stakeholders’ appetite for an overview of company risk and finances.

Graeme Young, pensions expert at MacIntyre Hudson, said: “Like it or not, [risks] should be disclosed and the information available to investors.”

Brian Peters agreed, saying pre-IAS 19 lack of transparency meant pension liabilities were poorly understood by investors and companies alike.

Now stakeholders have pierced the pensions veil, what next? Boards can see the costs before them, and are beginning to wonder whether post-work benefit schemes are worth burdening their company with unwieldy risks.

Large pension plans can make company shares more susceptible to stock market volatility, Peters said, as the associated risks make companies less attractive to investors.

For this reason, moves to de-risk pension schemes and palm them off on banks and insurers might have little to do with accounting standards, and everything to do with companies positioning themselves for low-risk future.