Time to start thinking again, I think

Lindsay Tomlinson is calling for a summit to change the way pension costs are calculated in company accounts. As chairman of the National Association of Pension Funds, Tomlinson would say that, wouldn’t he? Except that Lindsay Tomlinson is also a director of the Financial Reporting Council, the parent body for the UK’s accounting standard-setters.

The only thing wrong with an urgent re-think is that it should have happened a long time ago.

I don’t doubt that UK pension schemes have turned out to be more expensive than we were told to expect when they were originally set up. But changes in the accounting rules have exacerbated the uncertainties. We have seen assets valued at panic prices and liabilities discounted at a rate which lost all touch with reality. The difference between those two numbers – the scheme’s surplus or deficit – has fluctuated wildly, at times seeming to be quite unreal. Often, because it was.

This concern is compounded by a macro-economic effect. The current standards, FRS 17 and its international equivalent, IAS 19, influenced many pension schemes to prefer bonds to equities in an attempt to stabilise the costs and liabilities in the employer’s accounts. But there weren’t enough bonds (literally) to satisfy the increased demand, which drove the prices up – and the yields down. In other words, the accounting treatment not only influenced decisions, it actually changed the real economic cost of funding pensions on a national scale.

The new (lower) yield fed through into the calculation of pension liabilities and pushed the value higher. Even schemes that didn’t change their investment strategy had to discount their liabilities using the reduced bond yields caused, in part, by those schemes that did switch into bonds.

This goes way beyond the simple point that showing a true and fair view might cause management to change behaviour for their own business. Looking at pension costs through the FRS 17/IAS 19 lens caused the economic costs to rise.

However relaxed a standard-setter might be in the face of behavioural change on the introduction of a new standard, one has to ask whether it is right that accounting standards can affect the economic cost of pensions nationally.

Time we had a re-think? I’m with Lindsay.