Accounting for Pensions Survey 2001
Market value methods


Increased
use		 Some 27 companies, or a third of those analysed, now use what we interpret as a market value method to determine their pension cost under SSAP24. This is a large increase over the 11 who used such a method last year and reflects the fact that newer valuations are tending to be carried out on a market value basis rather than on a traditional long-term basis.

Traditional methods use long-term expected rates of return to discount liabilities and then apply these discount rates to the expected income from the Scheme's assets, giving a consistent valuation of assets and liabilities. The difficulty with such methods is that they depend heavily on an assumption for dividend growth and the UK equity market has seen some fundamental changes in recent years which have pushed dividend levels to an historic low. The challenge for actuaries is judging just what an appropriate assumption for dividend growth should be.

As a result of these issues, and because of the international use of market values in accounting, market value methods have increased in popularity. Under a market value method, assets are taken at market value and liabilities are discounted using interest rates derived from market conditions.

To the extent that equities are held and are expected to give higher returns than gilts, it is necessary to make an assumption about the future return from those equities. This is often taken to be the yield available on gilts at the time of the valuation plus a margin (the "Equity Premium") to reflect the extra return expected.
Equity
premium		 Analysis of the disclosures where a market value method has been used shows a wide variation in the Equity Premium assumption. Some use an Equity Premium of nil, effectively valuing all the liabilities by reference to gilts. For others, the Equity Premium could be 3% pa or more.

Imperial Tobacco have disclosed extremely prudent assumptions - an assumed investment return of only 5.4% pa at a time when the yield on conventional gilts was just under 6% pa. Quite why this assumption is so prudent is not clear.
Impact on results There are a number of consequences for the accounts when a market value method is adopted. Typically, the regular cost of benefits being earned is higher than under a traditional basis and also the surplus figure is more volatile due to market movements. The way in which these currently come through to the accounting figures will vary from case to case, depending on the smoothing mechanisms employed under SSAP24. However, as no such smoothing is permitted under FRS17, the full volatility of market value methods will be felt going forwards.
Prudence On average, in the cases we analysed, pre-retirement liabilities were discounted at around 1.5% pa over gilt yields. This appears low, and hence prudent, when compared with the historical outperformance of equities over long periods. Whilst under SSAP24 such conservatism will merely delay the recognition of company profit, prudence under the new standard, FRS17, will produce credits in the STRGL which never come through the Profit and Loss account. It remains to be seen whether all actuarial assumptions that are prudent under SSAP24 will be changed to become less prudent on adoption of FRS17.

The market value methods used are very different to the method that will be required under FRS17. Under FRS17, liabilities are discounted by reference to bond yields; any additional return expected from the Equity Premium comes though after operating profit as an offset to the pension cost.