Introduction
1. Summary
2. Introduction and main findings
3. FRS17 to replace SSAP24
4. Market value methods
5. The continued defined contribution trend
6. Detailed analysis of Reports and Accounts
6.1 Disclosures
6.2 Actuarial assumptions
Appendix 1 - Glossary of terms*
Appendix 2 - Detailed disclosure listing
Appendix 3 - Summary of FRS17
Accounting for Pensions Survey 2001
Detailed analysis of Reports and Accounts - Actuarial assumptions
SSAP24 does not specify what assumptions should be disclosed referring only to "a brief description of the main actuarial assumptions". It is widely accepted that full disclosure should include the rates of:
Assumptions can either be disclosed as absolute amounts, for example:
For the 79 companies who were analysed in detail the assumptions were disclosed as follows:
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| Investment return |
The level of investment return assumed depends to some extent on the actuarial method employed. Where a traditional method is used, under which assets are valued by discounting the income they are expected to produce, the investment return is the long-term expected return. Where a market value basis is used for the assets, the investment return should be determined from market conditions at the valuation date and will very often differ from the assumed long-term return used in discounted income valuations. We have therefore separated the two types of valuation in our analysis. |
| Split investment returns |
Sometimes the long-term investment return is divided between one return before retirement and another after retirement, reflecting a prudent view that as the liability for pensions in payment increases it will be matched by investment in bonds instead of equities. In such cases we have used the pre-retirement investment return. This was also used to determine the gap between investment return and salary growth, whereas the post-retirement return was used in assessing the gap between investment return and pension increases. The range of investment returns assumed is shown in the charts below.   One cannot help but notice the marked shift downwards in assumed investment returns from the traditional to the market value methods. The average assumption is some 1% pa lower for market value methods. Some of this fall is to be expected, as in recent years actuaries using traditional methods would almost invariably assume that market values were above their long-term trend. It also reflects just how much market conditions have changed; gilt yields have fallen from over 8% pa to around 5% pa in only five years, with the results that pensions have generally become more expensive to provide, a fact that companies are now recognising. |
| Investment return over salary growth |
The rate of salary growth assumed can, and does, have a significant effect on the eventual pension cost. The smaller the "gap" between the assumed rates of investment return and salary growth, the more conservative the assumptions. The difference between the investment return and assumed salary growth could be analysed for 78 companies. The difference varied from 1% to over 3%.   If investment returns and salary growth were considered to be unrelated, then the full 1% fall in assumed investment returns would also impact on this difference. However, this has not occurred. The average difference was only 0.4% lower for valuations carried out on a market value basis (1.9%) than for traditional valuations (2.3%) - in isolation this change helps to mitigate the fact that defined benefit pensions have become more expensive to provide. |
| Halifax |
Halifax state that they have used a market-related basis for their valuations at 31st March 1999 and 31st March 2000. The difference between the assumed rate of investment return and salary growth was 2.25% pa in the 1999 valuation but this was increased to 2.75% pa for the 2000 valuation. The disclosed funding level improved from 108% in 1999 to 119% a year later. It should be noted that some companies will have allowed for promotional salary growth in addition to the general increases to which their disclosures relate. Few companies disclose details of promotional salary scales and this makes comparison more difficult. |
| Investment return over pension increase |
73 companies disclosed sufficient information to enable the difference between the assumed rates of investment return and pension increase to be determined.  These graphs clearly indicate the downward shift in the gap between assumed rates of investment return and pension increases, reflecting lower real investment returns, for more recent market-based valuations. This is consistent with the fact that assets are no longer being taken into account at below market value (as has typically been the case under traditional methods). It is important to note that the assumption made for pension increases will reflect the increases actually awarded under the scheme. Falling yields have particularly hit schemes where pensions do not increase or increase at a fixed rate. |
| Assumptions used to value assets |
Under a traditional valuation method, the value of the assets is highly sensitive to the difference between the investment return and the dividend growth rate. 36 companies using the discounted income method gave sufficient information for us to determine the difference between the assumed rates of investment return and dividend growth. The chart also shows the same figures from our 2000 survey. The assumptions show a marked decrease from last year. The reduction in this "gap" from around 4% to a little over 3.5% would increase the equity part of the asset value by about 15%.  It is clear that the dividend growth assumption has increased (and hence the gap has reduced) to reflect the current economic environment. This change represents some stripping away of a margin for prudence. This may well be justified as SSAP24 calls for assumptions to be best estimates, but it further illustrates how the traditional methods are coming under pressure. |
| What does it all mean? |
With the marked changes in financial conditions seen in recent years, we would have been surprised if we had not seen equally marked changes in actuarial assumptions. However, it must always be borne in mind that the underlying cost of a pension scheme is not determined by the method and assumptions adopted by the actuary; the cost is equal to the contributions paid to meet the benefits paid out to members (and the expenses of administration). In addition, this underlying cost is being pushed ever upwards by improving mortality. This contrasts with the future nature of pension costs in company accounts which will fundamentally change with the introduction of FRS17. In particular, for the first time, the actuarial assumptions adopted will determine once and for all the company pension charge against profits. To the extent that these crucial assumptions are not borne out in practice, adjustments will subsequently be recognised outside the Profit and Loss account, in the STRGL. Another impact of FRS17 will be the unprecedented access to pension scheme information from the improved disclosure. The most apparent consequence of FRS17, however, will be the increase in costs recognised against operating profit, including the capitalised costs of any improvements to benefits. What remains to be seen is how much of an increase in pension costs - both in underlying terms and for accounting purposes - companies will put up with before throwing in the towel on defined benefit schemes altogether. |
