A new regulation that forces companies to declare pension fund values is causing headaches in the insurance industry. Jason Woolfe reports
When Jardine Lloyd Thompson (JLT) told the world it had a £72m deficit in its pension fund, it wasn't out of choice. The broker disclosed the shortfall because of FRS17 - the not-so snappy name for a controversial new pensions accounting standard.
The rule forced JLT to not only disclose its pension liability, but also to work out the value of its pension fund in a new way.
And we are currently only in a transitionary period before FRS17 takes full effect in June 2003, when companies will have to record the surplus or deficit of their pension funds on their balance sheets.
Fortunately for JLT, a tax credit of £22m brought the net deficit down to £51m. This coincided with its results showing profits up by 18% and turnover up by 22%. So the pill was not quite so bitter.
But for many insurance companies, FRS17 comes just as they are labouring with huge losses from 11 September, asbestosis and poor underwriting. On top of that reinsurers are demanding higher prices for their services.
And if that wasn't enough, the stock market downturn last year is giving insurers poor investment returns and pension funds have lost 20% of their value over the past two years because of their exposure to equities.
The Folgate Partnership chief executive Andy Homer says the downturn made a bad situation worse - and could cause significant pain for some.
"You have to recognise it's in your profit and loss account, so short-term annual earnings have to recognise any pension deficit.
"It exacerbates difficulties that insurers face already, such as levels of solvency. I'm not sure that it's a nail in the coffin, but the financial integrity of some insurance companies will be threatened.
"A number of chief executives have much to contend with this year. It's a difficult year with all these things coming together."
And it's not just the senior executives who dislike FRS17. Union leaders are fighting the standard because they believe it is encouraging companies to abandon the defined benefit pension schemes they want for their members.
Amicus general secretary Roger Lyons urged the government to intervene to avoid employees losing out because of the new standard.
The introduction of FRS17 coincides with a trend for companies to ditch defined benefit schemes and opt instead for money purchase schemes, widely recognised as being cheaper for the employer.
The root of the problem for FRS17's enemies is its insistence on liabilities appearing on company balance sheets. And, since this affects only schemes offering defined benefits, it makes any alternative look a better bet.
But is there really a causal link? Homer says not. "FRS17 coincides with a number of employers taking that decision. But I don't think FRS17 itself is the reason why defined benefits are going to be halted.
"The problem is uncertainty. You have to anticipate wage inflation and investment returns, and the uncertainty attaching to that is difficult for many people to cope with.
"I don't think there is a causal link, although it is arguable both ways."
HSBC strategist Steve Russell concludes that pension fund bosses would switch out of equities in order to avoid the sort of volatility likely to produce burdens on the balance sheet under the FRS17 rules.
But, he warns, this could lead to a vicious circle for equities. And any downturn for equities is bad for UK insurers, which together account for about a fifth of the stock market.
High ratio
When HSBC drew up a table of companies most at risk, JLT was listed as having a pension funded at 107% and representing 6% of employment costs.
By comparison the other insurance-related company quoted is Close Brothers, which owns Close Premium Finance. It was listed as having its pension funded at 85% of its liabilities and representing 3.6% of employment costs.
HSBC picked out JLT and Royal & SunAlliance (R&SA) as having a high ratio of pension costs to profits. It used data available last year, before the recent results were published, and listed both companies' pensions at 13% of pre-tax profit.
This is significant because any increase in pension cost - such as having to make top-up payments to correct a deficit - will immediately hit earnings.
R&SA UK managing director Duncan Boyle says: "Clearly there are some fairly severe implications [with FRS17] for the industry and pension buyers."
Accountant Lane Clark & Peacock conclude that in extreme conditions, FRS17 could put dividends at risk. It raises the prospect that dividend cuts, such as those announced earlier this month by CGNU, could become more common. N
How FRS17 works
