www.pwc.co.uk/pensions
Pensions Focus
Market trends in
pension accounting
assumptions
Volatility in the markets over 2011 has had a considerable impact on accounting
for pensions. Corporate bond yields are at an all-time low with the impact of this
only partially offset by the fall in long-term Retail Price Index (RPI) inflation
expectations over 2011. As a result many companies, in particular those with
schemes heavily invested in equities, will have seen their pension accounting
balance sheet worsen over the year.
The main trends

Average discount rates have fallen by 0.7% p.a. over the year from 5.5% p.a. to 4.8%
p.a. There is a wider spread of commonly used discount rates in December 2011
compared to December 2010.

Expectations in long-term RPI inflation have also fallen by 0.4% p.a. over the year
with the average assumption falling from 3.4% p.a. to 3.0% p.a. The spread of RPI
assumptions around the average has narrowed over the year.

The median ‘real’ discount rate (difference between discount rate and RPI inflation)
has decreased over the year by 0.3% p.a. from 2.0% p.a. to 1.7% p.a.

The most common deduction made from the RPI inflation assumption to set the
Consumer Price Index (CPI) inflation assumption has been 1.0% p.a. at 31
December 2011, compared to predominantly 0.5% p.a. or 0.7% p.a. at 31 December
2010.

Following years of gradual increases, the average life expectancy assumption has
remained unchanged over 2011.

The average expected return on equities assumptions has fallen by 0.5% p.a. from
7.6% p.a. at 31 December 2010 to 7.1% p.a. at 31 December 2011. For those reporting
under IFRS, this assumption will no longer be relevant for financial years beginning
on or after 1 January 2013 following amendments made to IAS 19 last June. This is
also expected to be the case under UK Generally Accepted Accounting Principles
(GAAP) for financial years beginning on or after 1 January 2015.
Discount rate
Yields on the main AA-rated corporate bond indices have fallen by around 0.7% p.a. over
the year from 5.4% p.a. to 4.7% p.a. which is broadly consistent with the decrease in
average discount rates adopted by companies. Such a fall in discount rates could increase
a scheme’s liability value by 10% to 20% depending on how mature it is.
Discount rate assumptions adopted by companies
45%
31/12/2011
31/12/2010
40%
35%
% of schemes
30%
25%
20%
15%
10%
5%
0%
4.5 - 4.6 - 4.7 - 4.8 - 4.9 - 5 - 5.1 - 5.2 - 5.3 - 5.4 - 5.5 - 5.6 - 5.7 - 5.8 - 5.9 4.59 4.69 4.79 4.89 4.99 5.09 5.19 5.29 5.39 5.49 5.59 5.69 5.79 5.89 5.99
Discount rate (% p.a.)
Our experience 0f December 2011 reporters indicates that companies with mature
pension schemes generally adopted lower discount rates than those with immature
pension schemes.
RPI inflation
Based on Bank of England data, market implied 20-year future RPI inflation has fallen
from 3.8% p.a. at 31 December 2010 to 3.3% p.a. at 31 December 2011.
This fall has been reflected in the assumptions adopted by companies, with the average
assumption falling from 3.4% p.a. to 3.0% p.a. Such a fall could decrease a company’s
liabilities by up to 10%, depending on the extent to which benefits are linked to RPI
inflation.
As with discount rates, companies with mature pension schemes generally adopted lower
RPI assumptions compared to those with immature pension schemes.
March 2012
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RPI inflation assumptions adopted by companies
45%
31/12/2011
31/12/2010
40%
35%
% of schemes
30%
25%
20%
15%
10%
5%
0%
2.6 - 2.7 - 2.8 - 2.9 - 3 - 3.1 - 3.2 - 3.3 - 3.4 - 3.5 - 3.6 - 3.7 - 3.8 - 3.9 2.69 2.79 2.89 2.99 3.09 3.19 3.29 3.39 3.49 3.59 3.69 3.79 3.89 3.99
RPI inflation (% p.a.)
Over the past few years, companies have typically adjusted market implied inflation
downwards to allow for an ‘inflation risk premium’, which reflects both the premium
required by investors to invest in fixed interest gilts which don’t provide inflation
protection and the high demand for index-linked gilts which do provide cover against
inflation-linked liabilities.
In our experience, inflation risk premiums typically used by companies as at 31
December 2011 have ranged from nil to 0.3% p.a, with some companies lowering the
premium due to lower RPI inflation expectations at that date.
CPI inflation
In July 2010, the UK Government announced that statutory increases to pensions would
be linked to CPI rather than RPI. The actual impact of this change in legislation on
pension schemes depends on scheme-specific facts and circumstances.
At 31 December 2010, most companies with schemes affected by this change set their
CPI inflation assumption at 0.5% p.a. or 0.7% p.a. below their RPI inflation assumption.
Over 2011, most companies have increased the differential between RPI and CPI
inflation assumptions, with a 1.0% p.a. differential being most common at 31 December
2011. The observed widening of the RPI-CPI gap could decrease liabilities by up to 10%.
The increase in the differential over the year reflects the Office for Budget
Responsibility’s (OBR) view that the difference between RPI and CPI inflation is
expected to increase in the long run (as published in their papers dated March and
November 2011).
March 2012
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RPI/CPI differential assumptions adopted by companies
50%
31/12/2011
45%
31/12/2010
40%
35%
% of schemes
30%
25%
20%
15%
10%
5%
0%
0.4 0.49
0.5 0.59
0.6 0.69
0.7 0.79
0.8 0.89
0.9 0.99
1 - 1.09
1.1 1.19
1.2 1.29
1.3 1.39
1.4 1.49
RPI/CPI differential (% p.a.)
Life expectancy
The graph below shows the range and spread of life expectancy assumptions adopted by
companies as at 31 December 201o and 2011 for a current male pensioner. Similar
distributions in life expectancy assumptions were seen for other types of members. Life
expectancy assumptions have remained broadly unchanged during 2011. A one year
increase in life expectancy would increase the liabilities by approximately 2% - 3%.
Male pensioner life expectancies adopted by companies
45%
31/12/2011
31/12/2010
40%
35%
% of schemes
30%
25%
20%
15%
10%
5%
0%
17 17.99
18 18.99
19 19.99
20 20.99
21 21.99
22 22.99
23 23.99
24 24.99
25 25.99
Life expectancy (years)
March 2012
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Expected return on equities
The average expected return on equities assumption has fallen by 0.5% p.a. from 7.6%
p.a. at 31 December 2010 to 7.1% p.a. at 31 December 2011.
Equity return assumptions adopted by companies
30%
31/12/2011
31/12/2010
% of schemes
25%
20%
15%
10%
5%
0%
44.49
4.5 4.99
55.49
5.5 5.99
66.49
6.5 6.99
77.49
7.5 7.99
88.49
8.5 8.99
99.49
9.5 - 10 9.99 10.49
Equity return (% p.a.)
The expected return on equities assumption is typically set with reference to gilt yields
and adding an allowance for equity outperformance, commonly referred to as the equity
risk premium. The average equity risk premium assumption increased over the year by
0.7% from 3.4% p.a. in 2010 to 4.1% p.a. in 2011. Most companies view current market
conditions as temporary and expect markets will soon return to historic levels. Thus, to
compensate for the currently low gilt yields, many companies have increased the
expected margin over gilts in setting equity returns.
Assets
Following the Eurozone crisis in August, equities have been volatile and UK equities fell
by 3.5% over 2011. Corporate bonds and gilts both performed well over the year
(common UK indices showing annual returns of 15% and 25% respectively). As a result,
pension schemes holding a large proportion of bonds are likely to have seen an
improvement in their pension accounting balance sheet whereas schemes holding a large
proportion of equities are likely to have seen a deterioration in their pension accounting
balance sheet.
IAS 19 changes
A revised version of IAS 19 was published in 2011 which is applicable for financial years
beginning on or after 1 January 2013. One of the amendments made to IAS 19 means
that companies will no longer be able to take credit for anticipated equity
outperformance above that of AA-rated corporate bonds in their profit and loss (P&L).
Although accounting methods shouldn’t necessarily drive economic decisions, this
change may cause companies to review their scheme’s investment strategy, in
conjunction with the scheme’s trustees, as there is no longer a P&L benefit to
compensate them for the balance sheet volatility that equity investment presents.
March 2012
Page 5 of 6
Contacts
If you would like to discuss the implications for your organisation, please
contact your usual PwC adviser or:
London
Raj Mody
020 7804 0953
[email protected]
West
Mark Packham
0117 928 1199
[email protected]
Vani Thavarajah
020 7212 3203
[email protected]
North West
Peter McDonald
0161 247 4567
[email protected]
South
Peter Woods
0118 938 3533
[email protected]
North East
Chris Ringrose
0113 289 4320
[email protected]
Midlands
Jeremy May
0121 232 2165
[email protected]
Scotland
Christopher Massey
0131 524 2218
[email protected]
Source of data
This survey looks at market trends in accounting assumptions, based on over 100 of
PwC’s clients with UK defined benefit pension schemes reporting under IFRS or UK
GAAP.
This publication has been prepared for general
guidance on matters of interest only, and does
not constitute professional advice. You should
not act upon the information contained in this
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