Where next for scheme accounting measures?

The new accounting standard, IAS 19, made an attempt to report the true and fair extent of defined benefit scheme assets and liabilities on British companies' financial statements.

When £400bn in deficits suddenly appeared, it was clear how much risk the UK’s companies were carrying in their DB schemes.

However, the actuarial profession’s reaction was pretty nonchalant. They seemed amused by the accounting profession’s attempt to put a consistent measure on DB schemes' assets and liabilities, and actuaries claimed IAS 19 would produce overly prudent results and cause unnecessary panic. 

Elevated importance

The status of the accounting deficit soon changed from a note in the accounts to a long-term liability. 

But this elevation did not really affect companies' profit and loss statements, due to consistently optimistic expected return assumptions, while the actual damage was being put quietly through the reserves.

The accounting standard rose in significance in 2005 as it became clear the IAS 19 deficit could be used as a reference point to help the corporate finance marketplace avoid the newly created 'moral hazard' powers. 

The then-stakeholders, or bidders, could “buy clearance” from these powers by settling the IAS 19 deficit as part of any materially detrimental transaction. 

Over the course of the credit crunch and subsequent quantitative easing, the IAS 19 deficit has gone from being 'too prudent' an accounting measure that no one cared about to an irrelevancy as an economic marker

But it did not take long for the Pensions Regulator to abandon IAS 19, seeing it as a blunt, if effective, reference point for understanding DB deficits.

Instead, the regulator introduced the technical provisions deficit, which was based on the triennial negotiation between the employer and the trustee based on the strength of the sponsor’s covenant.

Consequently, the technical provisions deficit is the one that really matters – IAS 19 has had its day.

What is interesting is that over the course of the credit crunch and subsequent quantitative easing, the IAS 19 deficit has gone from being 'too prudent' an accounting measure that no one cared about to an irrelevancy as an economic marker.

This is because the majority of UK companies with DB schemes now have technical provisions materially in excess of the equivalent IAS 19 figure.

What was the point of IAS 19? 

IAS 19 was an attempt to standardise a complicated calculation with innumerable variables to allow the readers of accounts to compare and contrast companies that have DB schemes. 

The accounting standard was never going to be the right answer but over the past 10 to 15 years it has allowed a gentle education to non-mathematicians on the legacy that underpins the £1tn DB pension hole in our UK economy.

More importantly, it also allows readers of accounts with some limited actuarial knowledge to estimate the two most important measures outside of technical provisions, which are the 'best estimate deficit' and the 'insurance company buyout' deficit. 

The best estimate assumes no prudency whatsoever in the returns being made on the assets and often leads to no deficit at all – a bit like the old days.

The buyout measure is the price that an insurance company would charge a company to get rid of its pension scheme. 

It is sad that the three deficits, which are key to understanding the full extent of a company’s exposure to its DB scheme, are either only disclosed partially or not at all. 

IAS 19 was a great step forward but the next one needs to be a leap.

Richard Farr is head of pensions advisory at BDO LLP