AVERAGE IAS19 DISCOUNT RATES used by FTSE 100 companies to calculate pensions deficits have risen for the first time in five years.
Research from Barnett Waddingham found a 0.1 percentage point increase in this key accounting assumption, to 4.5% per annum (pa), contributed to a fall in pension deficits in 2013. A discount rate is the assumed investment return used in a present value calculation of assets.
However, while the average funding level improved across listed companies, funds climbed 3 percentage points to 91% last year, it still falls short of its pre-financial crisis peak.
“We have seen a small increase in corporate bond yields over the year and this has been reflected in an average increase in discount rate used for accounting purposes,” Barnett Waddingham associate Martin Hooper said.
“This, coupled with strong returns from equity investments, has seen an improvement in funding levels of pension schemes run by the UK’s largest companies. In the recent past, we have seen a decline in discount rates, contributing to increasing pension deficits. The reversal of this trend is certainly a welcome change.”
The FTSE 100 pensions accounting assumptions survey found 46 of the 51 top companies that disclosed discount rate assumptions applied a rate between 4.4% and 4.6% p.a., with the full range of assumptions ranging from 4.0% and 4.7%.
Yields on the iBoxx and Merrill Lynch over 15-year AA-rated corporate bond indices were both 4.4% p.a. in 2013, rising from 4.1% in 2012. Most companies maintained the same discount rate as last year, with a small 0.1% p.a. increase reflecting improving yields.
While the report welcomed the rise in yields and discount rate assumptions, it warned companies to “carefully consider” their approach towards assumptions, particularly as those using an index yield approach may overstate their accounting liabilities. Selecting an appropriate duration for scheme liabilities is key, it added.
In addition to discount rate, future inflation rate is also key to calculating liabilities under FRS17 (UK listed), IAS19 (EU listed) and FAS158 (US listed) accounting standards. The research found an increase in average retail price index (RPI) inflation assumptions across the FTSE 100, to 3.4% in 2013 from 3% in 2012. By comparison, the Bank of England implied RPI inflation spot rate at 20 years, which measures the difference between fixed-interest and index-linked gilts stood at 3.7% p.a. in 2013.
Hooper said deductions from market-implied future inflation expectations were historically made to adjust true demand for index-linked gilts. However, Hooper argued there has been less justification for this in recent years as quantitative easing and other factors fueled higher demand for gilts. Despite this, FTSE 100 companies still seem to be allowing for this inflation risk premium in their assumptions.
Typically, increases in inflation assumptions over and above increases in the discount rate would ramp up liabilities and potentially damage funding levels. Despite this, funding levels improved from 88% average in 2012 to 91% in 2013. Around 35% of FTSE 100 businesses were more than 95% funded last year, compared to 30% in 2012 and a 10pp increase on 2010.
By comparison, FTSE 350 pension deficits grew to £97bn in 2013, up £25bn and equivalent to an 85% funding level, according to Mercer’s Pensions Risk Survey published in January.