Accounting for Pensions Survey 2002
Detailed analysis of FRS17 disclosures


  The transitional requirements of FRS17 came into force on 22nd June 2001. Only 57 companies reporting in 2001 have disclosed FRS17 information. Many companies offer post-retirement healthcare provision, which we have excluded from our analysis where possible. As with our SSAP24 analysis, overseas pension arrangements have been included.
FRS17 results and key assumptions
FRS17
Results		 FRS17 takes a snapshot of the surplus or deficit at the company’s year-end and, once adopted, this appears directly on the balance sheet. Of the companies analysed broadly half show a surplus and half show a deficit. However, as the vast majority of these companies have not yet adopted FRS17 in full, their balance sheets are as yet unaffected by the standard.

A full list of the disclosed surpluses and deficits is set out in Appendix 2. The two charts below show the range of results, expressed both as a ratio of assets to liabilities and in absolute terms.

Graph: Reported FRS17 results - Ratio of assets to liabilities

Graph: Reported FRS17 results - Deficit/Surplus (£M)

Ratios of assets to liabilities in excess of 120% are very much the exception rather than the norm. With knowledge of what has happened in the markets so far this year, we currently expect a gloomier picture for companies reporting in 2002.
Discount rate The discount rate under FRS17 is the annual rate at which the projected future liabilities are discounted back to the present date. If available, FRS17 requires the use of a discount rate equal to the yield on a AA-rated bond of equivalent term and currency to the liabilities. However, due to the very long term nature of pension liabilities, it is frequently the case that a suitable yield cannot be derived directly from the market. This means that an appropriate “proxy” for the AA-rated bond yield must be derived.

We have found considerable variation in the discount rates adopted. A movement of as little as ¼% in the discount rate could easily change the value of the liabilities by as much as 5%. This could be enough to turn a disclosed deficit into a surplus, and vice-versa.

The chart below shows the discount rates used by companies reporting in December 2001.

Graph: Discount rates used in December 2001

Of those reporting in December, the highest and lowest discount rates were used by P&O Princess Cruises (6.25% pa) and Reed International (5.5% pa).
Compass Compass reported at 30th September 2001 and revealed one of the lowest FRS17 ratios in our survey (with assets covering just 74% of liabilities). Yet they used a discount rate of only 5.5% pa while other companies reporting at the same date used a discount rate of 6% pa or more.

The story has another twist, however, as Compass’ pension commitments are small relative to the company (this is shown in Appendix 3). This illustrates the importance of viewing all of the disclosure items in conjunction with the size of the scheme and company, in order to put them into perspective - rather than assuming that the final surplus or deficit is the whole story.

Details of the discount rates used (in the UK where the company operates pension schemes in more than one country) are set out in Appendix 2.
Expected
return on
equities		 Under FRS17, the expected investment return on the assets held is an entry in the financing line of the profit & loss account. The more optimistic (ie higher) the assumed return, the smaller the overall charge to profits.

The accounts are expected to show the directors’ best estimate of the long-term return on each asset class held, the most subjective of which is the expected return on equities. Unsurprisingly, there is a wide variation in the assumed long-term return from equities, from 6.5% pa to 9% pa, although the general consensus seems to be an assumption of 7% pa to 8% pa.

Details of the expected return on equities (in the UK where the company operates pension schemes in more than one country) are set out in Appendix 2.

Graph: Expected return on equities

Under FRS17 there appears to be nothing to gain from being anything other than at the optimistic end of a best estimate range, regarding the assumed return on equities. A higher assumed return directly increases disclosed profits. If the assets fail to match expectations, profits are not affected and the loss washes through the STRGL.
Lack of disclosure If FRS17 is fully implemented, it will become necessary to disclose the expected return on the assets held by the scheme at each balance sheet date for the forthcoming year.

We consider it best practice to have disclosed the expected return in the initial FRS17 disclosure and most companies have done so. However, the following companies did not: AstraZeneca, Celltech, CGNU, Enterprise Oil, P&O Princess Cruises and Prudential. Standard Chartered disclosed an aggregate expected return, which will need to be broken down according to the various asset types held for next year’s disclosure.