Dreaming of surpluses: IFRIC’s pension dilemma

IT HAS to be at least a little ironic that in an era where UK pension fund deficits continue to be massive and pervasive, the International Financial Reporting Interpretations Committee (IFRIC) is currently pondering the question of whether there actually is such a thing as a pensions surplus, and if there is, when it might appropriately be reflected as an asset in the company’s balance sheet.

At first sight this pessimism over whether there is such a thing as a pensions surplus might seem odd. Surpluses are perfectly possible if the scheme assets outperform expectations, so that they close any deficit then go on to build a substantial surplus. Or a company might put an alternative asset into the fund, such as the profits from a particular division, in order to keep the Pensions Regulator and the trustees happy, then discover that the division is shooting the lights out and generating a massive surplus.

Yes, fanciful in this day and age but it could happen, so why the head scratching on the part of IFRIC? The problem, says Simon Robinson, a principal at Aon Hewitt, is that the premise in the pensions accounting standard, IAS19, that dictates when companies can take a significant surplus in the pension fund onto the company balance sheet as an asset, is fatally flawed.

“The idea in IAS19 is that when the last member of the scheme has died and the last benefit has been paid out, all funds in the scheme revert back to the ownership of the company, which will have fully discharged its obligations to the scheme, the trustees and the members (with all of the latter, deceased). This vision of reality, however, is a fantasy,” Robinson says.

Confronting facts

What IFRIC is confronting is the very sensible and solidly realistic fact that trustees in just about any scheme that has a sufficient surplus will almost inevitably seek to close that scheme via a buyout to an insurance company long before the last member of the scheme yields to mortality. Since they will do so as soon as there is sufficient funds in the scheme to make a buyout a viable proposition, the notion of a surplus fades out the picture.

“What prompted IFRIC to act was that people said it was not clear, from IAS 19, quite when it would be possible for a company to seek to get economic value from any surplus in its pension scheme. It would be unsatisfactory for a potential surplus in the company scheme to just keep on growing if the additional surplus has no value to the company or to the members as beneficiaries,” Robinson points out. This last point comes into play since most schemes have rules which say that the scheme trustees cannot unilaterally increase benefits to members from any surplus.

Robinson says that there are likely to be at least two major outcomes from IFRIC’s deliberations. The first is that calculations by Aon Hewitt show that not being allowed to take pensions surpluses onto the balance sheet could wipe some £25bn off the balance sheets of FTSE 350 companies and reduce their profits by £1bn. The second outcome has to do with the fact that IFRIC’s deliberations are not just about surpluses. The logical implication is that if anything should appear on the balance sheet it is the liability that results from any ad hoc funding arrangement reached between the company and the trustees, compiled to reflect its total value up to the scheme’s last payout. That could be a number large enough to make a finance director’s eyes water.

The ‘no surplus’ rule

Coupled with the “no surplus” rule one can plausibly argue that this will make finance directors of companies with defined benefit pension schemes very unwilling to enter into new funding arrangements until prodded heftily by the Pensions Regulator.

Eric Steedman, a senior consultant in Towers Watson’s international consulting practice agrees, that for some sponsoring companies, a contributions agreement could in future have a very significant liability impact on the balance sheet, assuming IFRIC continues on the road it is on. “There are lots of “ifs and buts” about this. Does IFRIC see it through to its logical conclusion is one, and what is your particular scheme’s funding position, would be another,” he says.

The other point of interest in IAS 19 generally, Steedman says, is the treatment of special events and particularly how the P&L charge for the current year is worked out after the special event has happened. “Say you buy an annuity for some of the members in the first half of the year, do you calculate the P&L for the second half of the year on the new position, or on the position you started the year with? Up until now it has been generally accepted that the start position is the basis for the calculation, but that could change,” he says. However, this is a relatively technical change and pales into insignificance alongside the £25bn hit that is pending on IFRIC’s decision over surpluses.

“The response from the finance directors we have been talking to has been very various. There are not that many surpluses around or the problem would be even more acute,” Steedman says. He reckons that IFRIC’s decision is probably months away rather than weeks or years away.