Fitch Ratings warns that persistently low returns on pension assets are a far greater threat to European companies than changes to International Accounting Standards.
Low returns increase the cash companies are forced to put into the schemes to keep them funded, with a direct effect on credit quality. The IAS changes will themselves cause many companies to report higher deficits and weaken their income statements – but not change the underlying economics of the pension schemes.
December 2007-December 2011 data from the UK’s Pension Protection Fund shows an average annual increase of pension plan assets of around 3.6% – much of which will have been accounted for by company contributions above payments rather than asset returns. This compares with an assumed return of 6.4% in 2007 for BT Group, which runs the country’s largest private-sector defined-benefit pension scheme, for example.
The difference between the two growth rates over the period represents £113bn additional funding the UK corporate sector will have to find (using December 2011 actual assets of £1,019bn).
In addition, amendments to IAS 19 “Employee Benefits” will have an adverse effect on some companies’ results. The removal of the corridor approach – an option under the current standard that allows companies to smooth movements in their reported deficits – will increase reported deficits in the vast majority of cases where this option is used.
The other major change, which will apply to all companies with pensions, is that the rate at which expected returns on assets can be booked will be required to equal the ‘AA’ bond yields used to discount liabilities. In most cases this will be lower than current assumed returns. This will result in lower financial income recognised in the income statement.
The effect could be material. For example, BT Group had a blended expected return on assets in the year to March 2011 of 6.35%. This compares with the rate used to discount liabilities of 5.5%. Reducing BT’s asset returns for a year by 0.85% gives a fall in profit of GBP303m – 15% of pre-tax profit.
For details see Fitch: Returns not Accounting Real Threat from European Pensions