Accounting implications of running-on a DB pension scheme

Employers and Trustees are being encouraged by the Pensions Regulator (TPR) to consider the full range of options as part of their defined benefit (DB) endgame planning. One of those options, running-on, can look attractive, potentially offering a combination of discretionary benefit increases for members and refunds of surplus for employers.

Accounting standards may, however, initially be seen to take some of the shine off this strategy. From the employer’s perspective when accounting under IAS 19 or FRS 102:

• Refunds of surplus improve cashflow but do nothing to P&L as they are essentially negative contributions, leaving net assets unaffected.
• However, discretionary benefit increases for members do have an immediate P&L cost unless they have already been pre-loaded into the accounting liabilities.

A run-on strategy therefore threatens to land the employer with a future stream of P&L charges unless they can be incorporated into the accounting liabilities. But the act of agreeing a run-on strategy which includes a surplus sharing mechanism might require the accounting liabilities to be increased. The amount of the increase would be the value of a best estimate of all the future discretionary increases anticipated by that mechanism.

Including that extra value in the accounting liabilities has its own accounting implications:

• There will be an immediate P&L charge equal to extra liability value.
• The pension asset on the balance sheet will reduce by the same amount (unless it is already limited by the asset ceiling) and that will lead to a lower net interest income from that point onwards.

So, there are some negative P&L implications if the strategy is to award discretionary increases during run-on. For some employers the prospect of accessing surplus in run-on will be enough trade-off. Where P&L is a more sensitive issue there are some potential mitigations to consider:

• Carefully consider the design features of a surplus sharing mechanism and how that influences the accounting calculation of the best estimate value of future discretionary increases. A mechanism which more generously shares more of the unexpected future surplus with members could have a lighter P&L footprint than one that shares existing or even expected future surplus.
• Educate investors that accounting standards do not accurately reflect the economic realities of mature UK DB pension schemes. In particular a P&L charge from granting discretionary increase does not reflect the underlying performance of the business. Those charges are an enabler to access surplus cash generated by a pension scheme during run-on that would otherwise pass to an insurance company in a buyout transaction.

Take that a step further and consider reporting Management-defined Performance Measures (MPMs) that are adjusted to better reflect the economic relationship between the employer and the scheme. The incoming IFRS 18 will place more focus on MPMs from 2027, so now is a good time to consider pensions in any IFRS 18 preparatory work.

Author

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Andrew Mandley

Director, GB Retirement

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