Aon Hewitt Says Changes to UK Accounting Standards Could Massively Increase Shortfalls

(June 1, 2011) — The pensions deficit for the UK’s largest companies was stable last month, yet according to Aon Hewitt, major changes to accounting standards could massively increase shortfalls by £10 billion.

The consultancy noted that the aggregate deficit for FTSE350 firms stood at £44 billion on an IAS19 accounting basis at the end of May, up from £41 billion last month. According to Aon Hewitt, changes to accounting standards — expected to be published this month — may require firms to use a predetermined formula to calculate expected returns on scheme assets, which would affect the profit and loss figures for all companies with a defined benefit scheme.

“These changes will affect all companies, producing both winners and losers,” Marcus Hurd, principal and actuary at Aon Hewitt, said. “For example, two pension funds with the same level of assets, but differing styles of investment strategy could fare completely differently when the revised calculations are introduced. A company with a low-risk investment strategy could see an additional annual profit of £15 million, while another company with a more aggressive return-seeking strategy could incur an additional annual P&L charge of £25 million. In aggregate, the total impact on UK companies could be around £10 billion. These changes will affect companies’ accounting, so they all will need to make an individual assessment and prepare accordingly.”

Aon Hewitt noted that the second expected change with regards to changes to accounting standards is the withdrawal of the option to defer gains and losses accrued by their pension scheme from their balance sheet liability, which would only impact 10% to 15% of companies. Longer-term, however, the impact on companies’ corporate balance sheets would be greater.

In the United States, a brief released in early May by the Congressional Budget Office (CBO) suggested that American public pensions should alter the way they calculate plan liabilities, asset values, and funding ratios. According to The Underfunding of State and Local Pension Plans, public pensions should use a fair-value method that incorporates a discount rate used on future cash flows to discern their liabilities to future workers, as opposed to the current GASB guidelines.

“For assets, the fair value is what an investor would be willing to pay for them—that is, the current market value (or an estimate when market values are unavailable); it is not the averaged, or smoothed, market values that are reported under GASB guidelines,” according to the brief. “For pension liabilities, the fair value can be thought of as what a private insurance company operating in a competitive market would charge to assume responsibility for those obligations.”