As another busy season of 31 December group accounting results are finalised, audited and published, I have reflected on some of the pension areas that appear to have given rise to the greatest areas of challenge for companies, their actuaries and auditors. Complexity presents the opportunity to support and advise clients through these potential stumbling blocks and I’m excited that the KPMG pensions actuarial team are now able to bring their combined pensions actuarial and deep technical accounting expertise to the fore to support companies in these areas.
On the face of it, most would be forgiven for thinking it had been a relatively benign year. Despite some fluctuations over the period corporate bond yields had settled back to close to the rate at the start of the year in marked contrast to the 3% jump in yields over 2022. Similarly, long-term expectations for future inflation had also changed little from the year before and with the headline rate of inflation falling, with much fanfare from government, there hasn’t been the same increase to liabilities from significantly higher increases relative to the assumptions made.
A year ago we were dealing with 30%-40% swings in pensions accounting asset and liability values driven primarily by the rapid increase in bond yields. So, if significant assumptions changes or related asset and liability movements haven’t been the focus, what has been getting actuaries and auditors exercised this year?
Insurance transactions
Firstly, insurance. But not necessarily the accounting for the pensions insurance transaction itself. Although a lot could be (and perhaps at a later date will be) written on the subject of accounting for pensions insurance buy-ins and buy-outs, the area I’ve noticed has come up repeatedly is data and benefit corrections.
The rapid improvements in pension schemes’ funding levels over the last 18 months has driven the much-reported rise in insurance transaction volumes. These transactions, and the planning process leading up to them, brings greater focus and scrutiny on data and benefits and what I’ve seen is a rise in the number of companies reporting changes and corrections to their administration processes or accounting obligations to reflect revisions to the pension benefits. The improved clarity on benefits and their value is clearly a positive from a financial reporting perspective to ensure an accurate reflection of the values. However, the valuation and treatment of any corrections in the financial statements, and whether in the current year or as prior year adjustment, is key and depends on the individual facts and circumstances in each case.
In addition, following a full scheme buy-in, while the value of the insurance policy should be valued in line with the value of the benefits it covers, this may not necessarily be equal to the defined benefit obligation of the scheme if the policy does not cover all benefits fully. Typical items such as unequalised GMP benefits or other benefits or corrections to benefits identified via the data cleanse process noted above may not be fully covered by the insurance policy. Identifying, valuing and disclosing these differences is important to reflect the value of any benefits not covered by insurance.
Some examples of the types of issues identified are the equalisation of benefits not legally binding at the date previously assumed, fundamental differences in benefits being paid and valued versus those under the scheme’s rules and benefits being administered historically at a more generous level than it transpires is required under the rules. In all these cases the accounting treatment comes down to the interpretation of the accounting standards as well as timing and materiality, but could result in prior year adjustments, P&L charges or OCI remeasurements. The point being that this is not always straightforward and requires careful consideration and dialogue between actuaries, accountants and auditors.
With insurance transaction volumes predicted to continue to rise, these types of issue are likely to become more prevalent.
Pensions surplus on the balance sheet
The other recurring area of complexity is the treatment of pensions accounting surpluses. Should the surplus be recognised on the balance sheet, or restricted either in part or completely to a nil net balance? If a surplus is recognised, what is the basis of economic value for recognition and how does that impact the relevant deferred tax treatment?
The application of the various accounting standards and interpretive guidance continues to create differences in views. The accounting position can be far from straightforward and often counter to typical views by companies who might reasonably argue that they never expected to obtain any economic value from a pension surplus in practice, even if the application of the accounting standards indicate that they could.
With the government’s recently published consultation on the options for Defined Benefit Schemes, whose first chapter is in relation to the treatment of scheme surpluses, this is likely an area that will come under greater scrutiny from readers of accounts, auditors and scheme members alike.
As thinking on surplus options develops, accounting implications must also be considered. Take the use of DB surpluses to meet DC contributions within the same Trust. Whilst this represents a cash saving to the sponsor, the DC expense must still be recorded in P&L. In addition, the entity should consider whether this changes the way the entity is deriving economic value from the surplus, and whether this changes narrative disclosures or deferred tax calculations.
In addition, the entity should consider whether this changes the way the entity is deriving economic value from the surplus, and whether this changes narrative disclosures or deferred tax calculations. See also KPMG’s article on the accounting implications of the recent change to the free-standing tax charge applying to authorised surplus payments announced at the Autumn Statement which are now ‘substantively enacted’.
In closing
These are just two areas that have caught my attention in particular. There are of course a wide range of other areas of pensions capturing the headlines (at least in the pensions press) which have or will have implications for accounting results and disclosures including the Virgin Media court case and appeal later this year, the outcome of the government’s consultation on DB pensions and the long-awaited DB pensions funding code to name three. I hope you have found the blog insightful, I’ll return in a few weeks with the second in the series.
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