The Debate: Dangers of snapshot accounting

Dangers of snapshot accounting

The National Association of Pension Funds recognises that final pay pension schemes are undoubtedly under more pressure now than they have ever been in the past. In addition to long-term factors such as the burden of regulation, increased life expectancy and falling investment returns, FRS17 will force many more companies to reconsider the way they provide pensions for their employees. A total of 95% of NAPF’s members have told us that providing an occupational pension takes up more company resources compared with five years ago.

In its response to the Accounting Standards Board exposure draft, the first point made by the NAPF was that this proposal would have a considerable negative effect on the willingness of company boards to continue to provide defined benefit pension schemes for their employees.

Throughout the consultation period, and during the period until its emergence as a standard, FRS 17, the NAPF continued to impress on the Accounting Standards Board that the introduction of FRS 17 would harm pension schemes and their members.

It is a disappointment that the ASB has so far chosen to ignore our warnings and, as a result, we are now seeing almost daily reports of our warning being born out in practice.

These warnings should not be taken as an indication that the NAPF does not believe in greater openness, transparency or disclosure. We do. We understand that the predecessor to FRS 17, SSAP 24 had its weaknesses and that there was a need for it to be revised. However, for the new standard to be meaningful, it must reflect the long term nature of a pension scheme and its investments. It must acknowledge that the whole ethos of pension scheme funding is based on the long-term, with either smoothing of investment values if surplus and deficits are to be shown in balance sheets, or the transparency being shown as a note to the accounts.

To require companies to become involved in snapshot accounting as to the value of the assets and liabilities of a pension fund is totally at odds with the nature of the pension fund.

By its very design this brings unnecessary volatility into the accounts of the company, with consequential implications for the profitability of the company, and its ability to pay dividends. This, of course, has a knock-on effect to all those pension funds that hold those companies as investments and, therefore, it will also impact their own FRS 17 figures and accounts.

• Peter Thompson is the chairman of the National Association of Pension Funds.

Ready or not, here it comes
For several years, fund managers and analysts have watched six factors driving UK pension schemes towards investing more in bonds and much more in non-gilts. FRS17 is only one factor. The others include: increased scheme maturity (more pensioners, fewer actives); declining mortality (pensioners live longer); decreased risk tolerance (don’t get sued, don’t get fired); weak equity markets and the minimum funding requirement (it’s still the law).

The accelerated demise of defined benefit schemes is no surprise. Employers are responding to increasing costs and risks that have been clear for some time. It is often still a shock to many of the employees directly affected and explains why an accounting standard features in newspaper articles outside the finance pages.

The focus of institutional investors and analysts in considering these factors has been on pension schemes as major investors and on the strategic issues: the prospects for equity returns, the low yield on long gilts, the relative yield attractions of corporate bonds and changing attitudes to the asset allocation split between equities and bonds.

The focus is changing. It is now sharply on individual companies. In the next few weeks, investors, analysts and journalists will be poring over the new disclosures required by FRS 17 for 31 December year-end companies.

The pension notes in the accounts will receive the wide public scrutiny usually reserved for the details of directors’ remuneration.

FRS 17 is a difficult standard. It is easy to misunderstand. The interaction of company law and accounting when assessing the impact of a FRS 17 pension scheme deficit on distributable profits compounds the problem.

The finance director’s job was never going to be easy in 2002. It has now become even tougher. The FD must be ready to explain in detail the impact of the pension scheme on financial condition, earnings and cash flow. The questions will come not just from equity analysts, but from credit analysts, bond investors, banks and rating agencies.

Book a bigger room for the presentation and be well prepared for questions from those new faces in the audience: their understanding of your pension scheme position may well have a material impact on your cost of debt as well as your share price.

• Crispin Southgate is the European credit strategist at Merrill Lynch.