Measuring Change: the impact of FRS 17

Previously, non-execs have acted mainly on the basis of whatever information happened to be presented to them by the board. This resulted in a largely dormant non-execs role in terms of the management and servicing of company pension schemes. The introduction of new UK pensions rule FRS17, currently on hold, therefore came as quite a shock to many and access to huge annual deficit figures has inevitably led to numerous probing questions and a heightened need for data related to pension scheme solvency.

Indeed a significant proportion of FTSE100 non-execs have now raised their concerns over pensions solvency with the board. The few who are lucky enough to be working with a company which hasn’t reported huge deficits are likely to have also worked in companies which have. There is no escaping the fact that FRS17 has highlighted some unsavoury pension scheme trends and it’s the non-execs who want to know more.

While most companies have opted to stick with the previous rule SSAP24, FRS17 disclosures show the pensions problems facing a company and have brought a fresh consistency to pensions reporting. This allows analysts and credit rating companies to assess pension liabilities of companies on a consistent basis. FRS17 may not have been adopted yet but it only takes the switching of two numbers from disclosures to financial statements to see the impact of a realistic assessment of pensions liabilities.

There is then a compelling case for the regular monitoring and financial assessment of pensions schemes across the UK. FRS17 will undoubtedly prove a beneficial source of information for corporate analysts but will go little way to satisfying the needs of employers and trustees alike. Reaction to FRS17 shocks in the form of the closure of schemes to new members and the thinning of future benefits, has frequently proven to be simply too little and too late. Such actions will not ease future calls on cash flow, they will merely address problems in the here and now. Further, the practice of annual certification means that brokers and credit agencies form their own judgements based on limited data, potentially adversely affecting the company’s share price and lowering credit ratings.

So what steps can companies take to mitigate their liabilities here?

Unfortunately there’s no panacea. What companies, non-execs and trustees should have at their disposal, however, are mechanisms that will allow them to know the scale of the problem they are set to face and one which will allow them time for a number of pre-emptive actions to be taken in the light of this knowledge. Software solutions which project the last full valuation forward can identify appropriate changes in valuation, thus representing a precious internal management tool. While regular checks can’t make the problems disappear, such tools can certainly act as a vital strategic aid.

This is hardly a revelation. It would be absurd to suggest bank debt should be reviewed on an annual basis and so why should pensions schemes be treated in a different way?

For example, one year an annual solvency review may reveal a #1m shortfall in a pension scheme and the company will adjust its contributions accordingly.

However, this shortfall could jump to #5m by the next review – a jump that was neither predicted nor catered for. Such swings in deficiency can wipe out a company’s entire profits and force it to obtain additional finance in short periods at unattractive rates. Regular monitoring allows companies to quickly identify trends and, where appropriate, take more drastic measures to cut risks.

Such monitoring also directly benefits the trustees. Regular assessments allow them to identify a defined level of benefits payments that won’t prejudice the interests of other members. It is also not in the trustees’ interest to present the company with something it cannot afford. Rather the trustees and the company need to work together to assess exactly what can be afforded and what the long-term strategy should be.

It is certainly not my assertion that corrective measures need to be taken across the board but simply that regular monitoring will establish the facts and an appreciation of the risks from which appropriate action may or may not be taken. The costs of such reviews needn’t be high. As with many actuarial tools, there’s an element of mysticism here.

The reality is, however, clear. There are products available which employ mechanical, number-crunching processes and which can be operated internally, giving a general overview of scheme solvency in 10 minutes.

Most FTSE companies reported significant increases in pension deficits this year. A handful have felt the impact of this with a credit down-grading.

Regular pension solvency monitoring may well encourage this trend as checks will inevitably unearth flaws. However, it is time for companies and non-executive directors to approach the regular internal monitoring of pension schemes as a consideration of risk and an example of best practice.

  • Rob Dales, Director at UBSL, a joint venture between Higham Group and and the UBSi Group.

Related reading