FRS102
31 March 2022
By Daniel Martin
March 2022
31 March 2021 saw both higher inflation expectations and lower discount rates compared to a year earlier. This combination resulted in significant increases to pension scheme liabilities. On the other side of the balance sheet investment performance varied by class. An equity heavy portfolio is likely to have performed better than a bond heavy portfolio over this period.
But how does 31 March 2022 compare?
The key drivers of your balance sheet are ultimately out of your control. Bond yields, inflation expectations, longevity trends and asset performance.
Discount rate (the higher the discount rate the lower the liabilities)
FRS102 requires that the discount rate be based on the market yields on high quality corporate bonds. So how has the bond yield moved?
Despite fluctuating during the second half of 2021, bond yields at the end of 2021 were broadly similar to those on 31 March 2021. Since the beginning of the year however, they have been steadily rising and with one month to go, currently sit 0.6% higher than on 31 March 2021. The impact of this on your liabilities will vary depending on their duration, but for a scheme with a 20-year duration you could expect a decrease in liabilities of around 12%.
Inflation (the higher the inflation the higher the liabilities)
The difference in yields between fixed interest bonds and index-linked bonds may be used to give an indication of the expected future rate of inflation and this is likely to be how your inflation assumptions are derived. The Bank of England produces statistics for future inflation derived in this way.
Inflation expectations rose steadily between 31 March 2020 and 31 March 2021. This pattern has broadly continued, with inflation expectations now(1) approximately 0.3% higher than on 31 March 2021. The impact of changes to inflation expectations on your liabilities will vary depending on their duration but also the proportion of them that are inflation linked. For a scheme with a 20-year duration with half of its liabilities linked to inflation you could expect an increase in liabilities of around 3%.
(1) Due to data issues at time of publication the Bank of England were unable to provide yield curve data after 23 February 2022.
Longevity (life expectancies increase, liabilities are higher)
The Continuous Mortality Investigation (CMI) produce improvement tables each year. It is common to update mortality assumptions to reflect the latest version either each year or in line with the valuation cycle (every 3 years).
The impact of updating to CMI_2020 will depend on whether you are currently using the 2017, 2018 or 2019 version of the model. The pattern of falling life expectancies seen in recent model updates changed with the release of the CMI_2019 model.
The CMI_2021 model is expected to be released March 2022. Please note that due to uncertainty regarding the long-term impact of Covid-19 on life expectancies, the default version of the CMI_2020 model ignores mortality experience during 2020. However, it is possible to adjust the default model, including making an allowance for 2020 experience if it is felt appropriate.
Assets
The performance of your assets will vary depending on the mix of asset classes you hold along with the performance of the specific underlying assets. However, as an indication, here is a look at the performance of some of the key asset classes since 31 March 2021.
In summary
The levels of return vary significantly by asset class, meaning the mix of your asset portfolio will have a large impact on the overall performance of your assets. Over this period, pension schemes with an equity heavy portfolio will likely have performed better. On the other side of the balance sheet, liabilities will fall due to the higher discount rates discussed earlier. However, the proportion of your liabilities linked to inflation will determine to what extent this has been offset by higher inflation expectations.
This is clearly a very high-level look at the factors that drive your balance sheet, in reality the specifics of your scheme, such as asset portfolio, liability duration, age profile and benefit structure, will all change the relative impact of each of the items discussed. Scheme experience, like contributions paid during the year, will also be reflected in the final figures.
Please also note that there is still a month until the year-end and a lot can happen in that time.
