SHPS and SHAPS: how has financial reporting moved this year?

How does DB accounting work?

Despite the detailed actuarial calculations of pension liabilities being very complex, the high-level principles underlying these are relatively straightforward. Accounting for liabilities on a full DB accounting basis involves placing a value on the net pension scheme obligation and there are three key elements: projecting expected benefit payments into the future for all scheme members, discounting those projected payments back to today to place a current value on the liabilities, and obtaining the market value of the scheme’s assets.

Projecting benefit payments

There are a number of financial and demographic assumptions that drive the projection of the benefit payments into the future, including life expectancy, pay increases, retirement timing and whether the member takes cash on retirement.

However, one of the key drivers in the projection is the market’s view of future price inflation. The higher the inflation assumption adopted in the liability calculations, the higher the projected pension payments and therefore the greater the value placed on the liabilities (all else being equal).

“A small change in assumption can actually lead to a large impact on overall surplus or deficit”

Discounting projected payments

A discount rate assumption is adopted to discount projected benefit payments back to the accounting date. The discount rate can be thought of as a credit for future investment returns. If a higher assumption is adopted, benefits will be discounted more and therefore the liability value placed on the benefits decreases.

For DB accounting, the discount rate is set as the yield available on high-quality (AA-rated) corporate bonds at the relevant date, although a range of actual rates is possible.

Typically, changing one of the financial assumptions (price inflation or discount rate) by 0.1 per cent per annum would impact the liabilities by around two per cent (given the average benefit payment term of 20 years). The precise impact will vary from employer to employer based on their membership demographic. A small change in assumption can actually lead to a large impact on overall surplus or deficit.

For example, if we assume an employer has liabilities of £10m and a share of scheme assets of £8m, the overall deficit is £2m. Lowering the discount rate assumption by just 0.1 per cent per annum increases the DB liabilities by two per cent to £10.2m. This two per cent increase in liabilities gives rise to a 10 per cent increase in deficit to £2.2m.

“This volatility will have impacted the assessed liabilities at each month-end for individual employers to varying degrees depending on the profile and maturity of each employer’s membership”

Market value of assets

Finally, the market value of assets held by the scheme is obtained at the accounting date. Asset values are dependent on investment returns plus money paid in and out of the scheme via contributions and benefit payments.

Comparing with the present value of the liabilities determines the overall surplus or deficit in the scheme – this is the net balance sheet position in the financial statements.

Movement since 31 March 2019

The movement in the future price inflation and discount rate assumptions has been volatile since 31 March 2019. The graph (right axis) demonstrates this volatility for an average employer in SHPS for each month up to 30 November 2019, with the trend for SHAPS following the same curve.

This volatility will have impacted the assessed liabilities at each month-end for individual employers to varying degrees depending on the profile and maturity of each employer’s membership.

Assets in both SHPS and SHAPS have again performed well. Investment returns in both schemes have been in excess of five per cent over the eight-month period. However, returns have varied month on month in line with market movements.

The resulting movement in the deficit across all employers in SHPS is also shown (see bar graph). In general, the observed increase in total scheme liabilities, arising because of lower discount rates derived from the financial markets, has been offset by the strong asset performance throughout the year, but this will vary by employer and may also change between now and 31 March 2020.

31 March 2020 year-end

SHPS and SHAPS employers will again be able to use TPT’s online DB accounting tool to prepare their DB pension scheme FRS 102 accounting disclosure at their year-end.

For the vast majority of SHPS and SHAPS employers, their next accounting year-end is 31 March 2020. The online tool is scheduled to be ready for employers to log in and prepare disclosures by 13 May 2020. TPT will be in touch with employers to provide confirmation of any action required prior to the accounting date, including how to inform TPT of any relevant corporate activity throughout the year that may affect the accounting disclosures.

TPT will send an email to all applicable users of the online tool as soon as the March year-end disclosures are available to prepare, and will provide a link to the externally assessed ISAE 3402 Type II assurance report. Support will be available for any queries relating to the March year-end accounts.

Andy O’Regan, head of professional services, TPT Retirement Solutions