After the best part of a decade in the red, the overall accounting position for the defined benefit schemes run by FTSE 100 companies improved from 95% to 101% in 2017, turning a £31bn deficit into a £4bn surplus by the end of the year. Since that time, the surplus has continued to grow, reaching over £20bn by the end of April 2018.

LCP’s Accounting for Pensions report says the rise in funding levels has been driven by company contributions of £13bn (albeit 25% lower than the record £17.3bn in 2016) and strong investment growth over the year, as well as changes in the approach to longevity and discount rate assumptions which largely offset the impact of worsening financial conditions.

Threequarters of the FTSE 100 are now using the most up-to-date assumptions related to mortality which show that people are not living as long as previously assumed.

However, the firm cautions that the improvements may be shortlived, given the potential impact of looming changes to accounting standards (IFRIC 14).  Under the new provisions FTSE 100 companies could find a significantly worsened balance sheet position, around £50bn overall and well over £1bn for some individual companies. LCP says that for some, this could threaten the ability to pay dividends or raise capital, and may increase regulatory capital requirements in the financial sector.

Further, the announcement in February 2018 of new IAS 19 accounting rules will significantly change how some companies account for ‘special events’ like changes to the benefits offered, in what the firm calls ‘unintuitive and surprising’ ways.

Phil Cuddeford, LCP partner and lead author of the report, said: ‘If balance sheet accounting changes go ahead as feared, the FTSE 100 are likely in for a nasty shock. There are some companies which could be exposed to balance sheet hits of well over £1bn, a stark reality not likely to be well received by either markets or shareholders.’

The firm’s analysis shows FTSE 100 companies have already adopted a significant change in approach because of amendments to accounting standards, with a majority of companies using increasingly sophisticated ways to set the IAS 19 discount rate assumption, improving FTSE 100 balance sheets by around £15bn.

The report reveals the FTSE 100 continued to pay more in shareholder dividends than pension contributions over the year, paying some £80bn in dividends - six times more than the £13bn paid to pension schemes.

Nearly all FTSE 100 companies have a pension deficit on an insurance buyout basis, and for over a third this deficit is material compared to their market capitalisation. Appetite for pension risk continues to fall, with average asset allocation in higher risk equities falling to less than one-quarter (as compared with more than 60% 15 years ago).

LCP warns that some companies may find a pensions accounting surplus brings new challenges. For example, where they are still paying deficit contributions, some company directors will need to clearly communicate the apparent contradiction – between an ‘accounting surplus’ and a ‘funding deficit’– to various stakeholders including credit and equity analysts, regulators and shareholders.

Cuddeford said: ‘For one of the first times in years, FTSE 100 pension schemes have clearly swung into surplus when measured on an accounting basis. Although that’s good news, it is essential that corporate sponsors don’t think they’re out of the woods just yet.

‘History has proven that such accounting surpluses can quickly be wiped out by deteriorating market and economic conditions. On trustees’ typical pension scheme funding basis, significant deficits remain, and the persistent gap between dividend payments and scheme contributions is likely to be scrutinised more intensely in the wake of the high-profile collapses of Carillion and BHS.’

Accounting for Pensions 2018 is here.

Report by Pat Sweet