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New study questions accounting for pensions

07 September 2011

The accounting standards currently used to calculate companies’ pensions assets and liabilities are undermining pensions provision in the UK, according to a report published today.

The National Association of Pension Funds (NAPF) commissioned the report “Accounting for Pensions” from Leeds University Business School to expose the true impact of mark-to-market accounting and to identify a more appropriate approach to accounting for pensions.

The report argued that the current standards are not only inappropriate for assessing the long-term liabilities of pension funds, but can also lead to unintended consequences.

The key thrust of the authors’ argument is that by valuing assets based on market prices, the current accounting standards introduce short- term volatility into the measurement of companies’ pension surpluses and deficits. This is at odds with the long-term nature of pension schemes, whose position in economic terms changes only gradually over time.

According to the report, this volatility has led companies to close perfectly viable pension schemes, and has encouraged schemes to adopt extremely cautious investment policies. This in turn has led to an increase in the cost of pension provision and a misallocation of investment in the economy through excessive investment in low return government bonds.

Lindsay Tomlinson, Chairman of the NAPF, said:

“The recent turmoil in the global stock markets has highlighted, more than ever, the inadequacy of mark-to-market accounting to evaluate the long-term liabilities of pensions.

“The current standards are not appropriate for the long-term nature of pensions. They allow short-term stock market volatility to perversely

affect pensions and their long-term strategy by presenting large deficits which may prove inaccurate in the long-run.

“This can have serious repercussions for pensions provision, retirement saving and the economy. Employers who are faced with these allegedly large deficits may decide to close their defined benefit pension schemes to existing and future members.

“And by choosing to invest into low return assets such as bonds rather than equities, pension schemes are not only likely to be following a sub optimal investment strategy, but will also support the economy less at a time when it is risking a double dip recession.

“For too long accounting standard setters have focused on the theory rather than practice and there has been a vacuum of accountability. Accounting standard setters, both in the UK and internationally, need to have a real world approach that truly takes into account the economic consequences of their actions.”

The report recommended:

• Pension liabilities should be valued as the discounted present value of future net asset/liability cash flows, thereby allowing for the asset/liability interaction that occurs over the life of a pension scheme.

• Pension disclosures should include the actual cash contributions that a corporate sponsor is committed to as a result of negotiation with scheme trustees and/or the Pensions Regulator.

• The recognition of a discounted cash flow model of pension accounting through the accounts of the firm can be viewed as the long-term position of the scheme. To make this number useful, company accounts should also disclose the market value of scheme assets relative to a discounted pension liability.

Notes to Editors:

1. The authors of the report are Dr Iain Clacher, Lecturer in Accounting and Finance, and Professor Peter Moizer, Dean and Professor of Accounting, both from Leeds University Business School.

2. Dr Iain Clacher is available for interview.

3. Download a copy of the report here.

4. The NAPF is the leading voice of workplace pensions in the UK. It speaks for 1,200 pension schemes with some 15 million members and assets of around £800 billion.

Contact:

Christian Zarro, Press Officer, NAPF, 020 7601 1718 or 07825 171 446, [email protected]