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Straws on camels&#39 backs

As I travel round the UK I talk to a lot of pensions IFAs. A common theme at the moment is a strong interest in Financial Reporting Standard FRS17.

So why are IFAs suddenly so interested in a technical accounting standard? The answer is that, when taken with other developments, it is likely to lead to an acceleration in the move away from defined-benefit pensions by employers of all sizes.

Such a move is advice-intensive from the points of view of the employer, employees and trustees. An employer who did not use IFA help in the context of the defined-benefit scheme may find such help invaluable in the transition to some form of money purchase, and afterwards.

FRS17 affects virtually all employers who offer pensions to their employees, but it affects most those offering defined benefits. In a nutshell, the assets must be valued at market value, the liabilities valued using bond yields, and the result flows through to the company&#39s own accounts.

This introduces volatility into the company&#39s reporting which is very hard for the Finance Director to predict, let alone control. The bigger the value of the pension fund, relative to the value of the company, the greater the potential for stockmarket changes to affect the company&#39s results.

Of course the scheme may minimise the volatility by investing in bonds instead of equities but that also reduces the potential for investment gains in the pension fund.

Some people might think that FRS17 could be ignored in practice. After all, the argument goes, many companies are not listed on the stock exchange. If their accounts are qualified because they ignore FRS17, so what?

A problem with this approach may arise if the company wants to borrow money. What potential lender is not going to start by asking for the company&#39s accounts?

If everything else in the defined-benefit garden were rosy, FRS17 might be merely an irritant. But FRS17 is only one of many straws on the back of the employer with a defined-benefit scheme.

Longevity is an increasing risk, unless and until annuities are bought out with a life office. Investment returns on equities have been highly negative for two years running, with potentially serious implications for current scheme solvency.

Pension fund surpluses have largely disappeared, and with them the possibility of ongoing contribution holidays. Finance directors are once again having to put their hands in their corporate pockets to divert cash flow into the pension scheme.

The new terms for contracting out are, in the judgment of many commentators (including me), not generous. Yet for defined-benefit schemes contracting out is a strategic decision, not a tactical one which can be taken on a one-, two- or five-year look. This is because contracting out is an integral part of a defined-benefit structure.

But perhaps the heaviest straw on the camel&#39s back was Gordon Brown&#39s decision in his first Budget in 1997 to raid pension fund investment returns to the tune of £5bn a year.

This has undermined the confidence of employers who thought they had a long-term understanding with the state. Such confidence is necessary because an employer offering defined benefits may, for a

20-year-old, be making a financial commitment with a duration of 60 or 70 years.

Virtually all employers offering defined benefits must now be reviewing this decision. Hopefully many such camels will be found to have strong backs though they may wish to rearrange the load a bit, for example by strengthening their investments in bonds.

Where the camel is found to have too weak a back for the weight of the straws, big changes will be necessary and pensions IFAs will have a lot to do. Money purchase transfers the investment, longevity, contracting out and tax risks to the employee, but perhaps this is the lesser evil if the alternative is an employer with a broken back.


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