In February's issue of Social Housing, TPT's Head of Professional Services, Andy O'Regan discusses how TPT's innovative approach to SHPS and SHAPS financial accounting has moved this year.
To view the article on Social Housing please click here.
With the year-end for most housing associations looming on the horizon at 31 March 2020, we thought it would be helpful to set out a reminder of pension scheme liability calculations and give an overview of how pension financial reporting figures have moved since 31 March 2019.
Taking a step back, there are four common measures of defined benefit (DB) pension scheme liability, as detailed below:
- ‘Technical Provisions’ (also termed ‘funding’), which drive employer and member contribution levels;
- Solvency, which estimates the debt should an employer wish to withdraw from their obligations in the scheme;
- Pension Protection Fund (PPF), which estimates the liabilities if the scheme were transferred to the PPF (the pensions’ lifeboat arrangement), and drives the annual PPF levy calculation; and
- Accounting basis, which measures the liability for inclusion in employer accounts, in order to comply with the relevant accounting standard.
This article focuses on the last of these, the accounting basis. For financial year-ends from 31 March 2019 TPT Retirement Solutions has provided sufficient information for employers in the Social Housing Pension Scheme (SHPS) and Scottish Housing Associations’ Pension Scheme (SHAPS) to account for their obligations on a ‘defined benefit’ (DB) basis. The two schemes are multi-employer in nature, with combined DB-related assets of over £5.8 billion and more than 500 participating employers linked to the sector. Employers in SHPS and SHAPS were the first to use an online TPT tool to support the preparation of their DB financial statements.
How does DB Accounting work?
Despite the detailed actuarial calculations of pension liabilities being very complex, the high level principles underlying these are relatively straight forward. Accounting for liabilities on a full DB accounting basis involves placing a value on the net pension scheme obligation and there are three key elements:
- Projecting expected benefit payments into the future for all scheme members;
- Discounting those projected payments back to today to place a current value on the liabilities; and
- Obtaining the market value of the scheme’s assets.
Projecting benefit payments
There are a number of financial and demographic assumptions that drive the projection of the benefit payments into the future including life expectancy, pay increases, retirement timing and whether the member takes cash on retirement. However, one of the key drivers in the projection is the market’s view of future price inflation. The higher the inflation assumption adopted in the liability calculations, the higher the projected pension payments and therefore the greater the value placed on the liabilities (all else being equal).
Discounting the projected payments
A discount rate assumption is adopted to discount projected benefit payments back to the accounting date. The discount rate can be thought of as a credit for future investment returns. If a higher assumption is adopted, benefits will be discounted more and therefore the liability value placed on the benefits decreases. For DB accounting, the discount rate is set as the yield available on high quality (AA-rated) corporate bonds at the relevant date, although a range of actual rates is possible.
Typically, changing one of the financial assumptions (price inflation or discount rate) by 0.1% pa would impact the liabilities by around 2% (given the average benefit payment term of 20 years). The precise impact will actually vary from employer to employer based on their membership demographic. A small change in assumption can actually lead to a large impact on overall surplus or deficit. For example, if we assume an employer has liabilities of £10m and a share of scheme assets of £8m, the overall deficit is £2m. Lowering the discount rate assumption by just 0.1% pa increases the DB liabilities by 2% to £10.2m. This 2% increase in liabilities gives rise to a 10% increase in deficit to £2.2m.
Market value of assets
Finally, the market value of assets held by the scheme is obtained at the accounting date. Asset values are dependent on investment returns plus money paid in and out of the scheme via contributions and benefit payments.
Comparing to the present value of the liabilities determines the overall surplus or deficit in the scheme – this is the net balance sheet position in the financial statements.
Movement since 31 March 2019
The movement in the future price inflation and discount rate assumptions has been volatile since 31 March 2019. The above graph demonstrates this volatility for an average employer in SHPS for each month up to 30 November 2019, with trend for SHAPS following the same curve. This volatility will have impacted the assessed liabilities at each month-end for individual employers to varying degrees depending on the profile and maturity of each employer’s membership.
Assets in both SHPS and SHAPS have again performed well. Investment returns in both schemes have been in excess of 5% over the eight month period, however returns have varied month-on-month in line with market movements.
The resulting movement in the deficit across all employers in SHPS is also shown above. In general, the observed increase in total scheme liabilities, arising due to lower discount rates derived from the financial markets, has been offset by the strong asset performance throughout the year, but this will vary by employer and may also change between now and 31 March 2020.
31 March 2020 year-end
SHPS and SHAPS employers will again be able to use TPT’s online DB accounting tool to prepare their DB pension scheme FRS102 accounting disclosure at their year-end. Employers can also prepare reports each month during the year using the latest available monthly assumptions (to help monitor the position) as well as view sensitivity statistics and financial projections.
For the vast majority of SHPS and SHAPS employers, their next accounting year-end is 31 March 2020. The online tool scheduled to be ready for employers to log in and prepare disclosures by 13 May 2020. TPT will be in touch with employers shortly to provide confirmation of any action required prior to the accounting date, including how to inform TPT of any relevant corporate activity throughout the year that may affect the accounting disclosures, e.g. merger activity or a large change in active DB membership.
TPT will send an email to all applicable users of the online tool as soon as the March year-end disclosures are available to prepare, and will also provide a link to the externally assessed ISAE-3402 Type II assurance report. Support will be available should employers or their auditors have any questions or queries relating to their March year-end accounts.