ASB Pension Accounting Proposals - ACT Response
www.apb.org.uk/asb/press/pub1513.html
The ACT acknowledges that in the field of pension accounting there can be many different arguments and justifications for various different treatments. We believe that the accounting should adopt a pragmatic middle course and accordingly the ACT does not accept the idea that pension liabilities be discounted at the risk free rate rather than a AA bond rate, nor the proposal to take to income account the actual investment returns rather than the expected returns, as at present.
Comments
The Government and other parties are right to be concerned that more pension schemes will be driven towards closure if their liabilities, as shown in company accounts, are measured using the 'risk-free' rate. But the arguments must turn on why the 'risk-free' rate is the wrong rate to use for accounting purposes.
Company accounts include both the assets and the liabilities of the pension fund. The assets are valued using their expected rate of return and it follows that the liabilities should be valued using the same rate. This achieves consistency of valuation between the assets and the liabilities of the fund. It also satisfies other fundamental accounting requirements, such as going concern (that the company will continue in business and meet its pension obligations out of the pension fund), decision usefulness (that accounts should not show deficits when the pension fund is adequately funded on reasonable assumptions) and realism rather than unwarranted prudence (including the need to avoid overstating liabilities).
The 'risk-free' rate satisfies none of these requirements. It is a creature of a legal construct rather than of the reality of funded pension schemes. And there is not even a good theoretical justification for its use. The very name is misleading: pension liabilities calculated using a 'risk-free' rate can still be exceeded if inflation or mortality, to name just two of the key risks, turn out worse than expected.
Funding pension payments which are to be made many years ahead is a risky business and no amount of accounting theory can escape this. It is the job of accounts to present a fair picture so that stakeholders can use them to make well informed decisions.
Christopher Daws