Sorry end of age-old benefits

This is like kicking pension funds with hobnail boots when they are already lying on their backs with their feet up in the air.' That comment, from Simon Martin, head of research at consultants Aon, sums up the attitude of almost everyone involved in the pension industry about a new accounting standard for company pension schemes.

The standard, FRS17, is being blamed for everything from the current spate of dividend cuts to the demise of final salary pension schemes. Last week, the Confederation of British Industry weighed in. It called for changes to the standard, complaining that it was 'having serious adverse effects on... business competitiveness'.

Meanwhile British Petroleum and GlaxoSmithKline became the latest companies to reveal big deficits in their pension schemes using the valuation processes stipulated by FRS 17.

The Accounting Standards Board is robustly defending FRS17, although it will review it when the international standard on the subject is completed.

But if FRS17 is guilty of anything, it is of being a catalyst. While some may argue with the standard's insistence on valuing its assets - still mainly shares, for most pension funds - on one particular day, and others with the requirement to use top-grade corporate bonds rather than government gilts as the benchmark for valuing the liabilities in the fund, neither of these has any impact on the finances of the pension fund itself.

The only thing the accounting standard changes is the way that companies disclose these details. Decisions on whether to increase pension contributions, switch to a different type of scheme, or change the fund's investment policy, depend not on FRS17 but on the three-yearly scheme valuations, which will continue as normal.

While critics of the standard may argue that FRS17 is changing companies' behaviour, the real issue is that reduced mortality rates and lower stock market returns are increasing the costs of providing a guaranteed level of pensions for employees.

The rises are dramatic. Martin estimates that, 10 years ago, an employer offering a typical scheme giving one sixtieth of salary for every year of service would have had to make annual contributions of around 15 per cent of payroll costs. Now, it would have to put in as much as 20 per cent - a jump of one third in the annual bill.

About a third of that increase is because of the rise in life expectancy, which has been much more dramatic than actuaries were expecting a decade ago. The rest of the rise is for investment reasons: a combination of lower stock market returns, which mean the assets are growing more slowly, and falling gilt yields, which makes the purchase of annuities to fund pensions in payment more expensive.

The rise in contributions is all the more painful because, for much of the last decade, many companies were paying nothing at all. Soaring stock markets and falling workforces during the 1980s and 1990s meant that most pension funds had built up huge surpluses: as long ago as 1985, the London Business School estimated it was as high as £50 billion. Most large companies were enjoying pension fund holidays - which, coincidentally, made their profits look a lot healthier - or improving benefits to members, which have made schemes even costlier today.

Actuaries are reluctant to admit that they were over-optimistic about surpluses in the 1980s. 'It is interesting that, throughout the 1980s and the 1990s, the typical assumptions seemed cautious and prudent given the history of returns from equities and bonds,' said Andrew Green of consultants William Mercer. 'The assumption was that equities would outperform bonds by about 2 per cent while historically the differential had been 4 per cent or more.' Brian Wilson, of Bacon & Woodrow, adds: 'The ability to take a contributions holiday is right and proper. The company takes the investment risk in a final salary scheme. In bad times, they have to put more money in so in good times they should be allowed to take money out.'

The problem is too many companies appear unwilling to put more money in when times are bad. Instead, they simply change the rules to cut costs. BT saved £146 million in 1990 alone in reduced payments to its pension funds. Now, it has a £3bn deficit on its funds, as measured by FRS17, and is closing its final salary pension scheme - which guarantees a set pension depending on an employee's salary and length of service - to new members.

Instead they will be offered a money purchase scheme, where the employer's contribution is fixed and the level of pension depends on how much there is in the pot when the employee retires.

BT is not alone: companies such as Marks & Spencer, Ernst & Young, and Iceland have all decided to shift to money purchase schemes, some of them blaming the move on FRS17.

In fact, switching schemes will make no immediate difference to the deficit or surplus thrown up by FRS17. The scheme will have employees, pensioners, assets and liabilities for years - all of which will have to be reflected in the accounts. The only thing that does change is the level of contribution. Aon's Martin estimates that, on average, employers contribute half as much to a money purchase scheme as they do to a final salary scheme.

Marks & Spencer, for example, is paying between 6 and 12 per cent per cent of salaries into its money purchase scheme compared with 22 per cent into its old final salary scheme. It is these lower employer contributions, not the difference in the schemes themselves, that make money purchase schemes more attractive to employers. '[Whatever the type of scheme] if you put the same money in, you get the same pension out,' said Martin.

Employees are gradually waking up to that. Last month, TUC general secretary John Monk complained that companies were using FRS17 and other pensions changes as a 'smoke screen' and that a review of FRS17 would not halt the flight from final salary schemes.

Employees could, however, have the last laugh. While companies can argue that the assets in a final salary scheme belong to them, as ultimate guarantors of the pension payment, the assets in a money purchase scheme belong to members. If equities race ahead again, companies would not be allowed to take contribution holidays from money purchase schemes: all the surplus would be enjoyed by the pensioners.

Additional research by Chris Tryhorn.

What the new accounting standard says
Pension assets
Have to be valued at the market price at the balance sheet date. The Accounting Standards Board says this is consistent with other items in the balance sheet, which also show the value of the business as a 'snapshot' at a particular date.

Liabilities

Pension obligations to future and current members have to be discounted using the yield on AA corporate bonds.

Net funding position
The results surplus or deficit created by the difference between these must appear as a separate item on the balance sheet.

Actuarial gains and losses

Have to be included in the statement of recognised gains and losses, a supplementary statement to the profit & loss account.