The Pension Research Accountants Group Analysis of responses to Pension SORP Exposure Draft (ED), PRAG SORP Working Party (SWP) considerations and actions There were 55 responses to the ED. The respondents comprised: Actuarial institutions and societies 3 Accounting institutions 5 Pension schemes 14 Pension Administrators 11 Audit firms 12 Actuarial firms 4 Individuals 3 Others 3 Total 55 The full responses can be viewed on the PRAG website at www.prag.org.uk. Annuities FRS 102 requires annuities to be reported at the amount of the related obligation. What practical issues do you see arising from this requirement? The Draft SORP envisages the annuity value will be based on the trustee perspective of the related obligation and therefore most likely determined by the Scheme Actuary. Do you agree with this approach (3.12.18 and 3.12.22)? Summary of responses 45 respondents addressed this area. There were a wide range of comments arising: 20 respondents felt that the existing approach of including annuities at nil value should be permissible for all of some types of annuity; 9 respondents supported valuing some or all annuities; 9 respondents felt that bulk annuities should be included at a value but individual annuities should not be included; 11 respondents raised the situation of annuities purchased in the trustee name in DC schemes, some arguing these should not be included at a value and some seeking clarification on whether the SORP/FRS 102 applies to annuities in DC schemes; 12 respondents felt that there would be record keeping issues as a results of historical individual annuity records not being readily available, although a small number of respondents recognised the benefit to scheme governance of the requirement to include annuities at a value improving record keeping; 26 respondents expressed the view that there would be additional costs involved if annuities were to be included at a valuation; 10 respondents sought guidance on what would be regarded as significant in relation to determining whether annuities should be valued and a smaller number sought guidance on what benefits arose when considering the cost/benefit of disclosure. 6 respondents expressed the view that the specific reference to significant/materiality should be removed.
10 respondents supported the value being provided by the scheme actuary, 2 respondents suggested a more flexible approach, for example, by a suitably qualified actuary or the annuity provider 5 respondents expressed the view that a more flexible approach to the valuation would be helpful, for example, not suggesting a preferred approach such as the scheme funding valuation; 9 respondents commented either on the possible timing complications of the actuarial valuation being completed after the annual audited financial statements are due to be completed 9 respondents suggested inclusion of a simplified roll forward approach to valuations between formal triennial actuarial valuations 6 respondents commented that the scheme actuary may exclude the value of annuities from scheme assets when carrying out the actuarial valuation; 4 respondents suggested disclosing collateral and credit risk for annuities would be useful 7 respondents asked if it was possible to exclude annuities from the financial statements by reference to a cut-off date, for example, only including annuities from FRS 102 effective date of 1 January 2015, or by reference to PPF guidance. 4 respondents were in favour of narrative disclosure rather than reporting a value for annuities 3 respondents commented that some annuities are not a perfect match and where this is the case some suggested disclosure of the benefits covered 2 respondents commented on the treatment of annuity income, in particular whether it is permissible to take all to sale proceeds. The SWP noted that the economic use of the annuity value in the financial statements was limited given the scheme actuary will typically not use it for scheme valuation purposes. Against this background it was agreed to provide maximum flexibility in terms of approach to the valuation and accounting for annuities within the limits imposed by FRS 102 in order to minimise the additional costs that would arise. It was agreed: - To refer to a suitably qualified person providing the valuation rather than the scheme actuary; - To provide greater freedom to the trustees in determining the valuation basis, but noting the basis should be disclosed and applied consistently; - Incorporate guidance on a roll-forward approach to valuations in between full valuations;; - Disclose collateral arrangements for annuities; - Disclose the nature of the benefits covered; - Remove the references to significance of annuities to the financial statement and cost/benefit analysis; - Increase the flexibility in reporting cash flows received from annuities as either income or capital. Some further considerations and actions of the SWP were: - Feedback to the FRC the comments on maintaining the existing approach of NIL value for consideration when FRS 102 is reviewed; - Since none of the SWP were familiar with DC schemes that purchased annuities in the name of the trustees enquiries have been made to a couple of the respondents who
raised DC scheme annuities to understand the background to these arrangements. It has been established that these appear to relate to old administration practices that no longer continue and are likely to be few in number. The SWP agreed that FRS 102 did not allow the exclusion of annuities purchased in the name of the trustees from DC arrangements or schemes as they are assets of the scheme; - Review the existing guidance on valuation of insurance policies in the current SORP to see if the bases included therein are appropriate (note: the current SORP includes actuarial value (broadly consistent with the Scheme Funding Valuation approach set out in the ED, the premium value (which includes insurer s margins and is broadly equivalent to replacement cost), modified premium value (which excludes insurer s margins, could be broadly equivalent to a trustee buy out valuation ) and surrender value; and - Agreed it was not appropriate to exclude annuities based on a cut-off date since all annuities held in the name of the trustees are scheme assets.
Investment risk disclosures Has the Draft SORP taken the right approach to risk disclosures? (Section 3.16). In particular is the approach to pooled investment vehicles and the look through and asset class approaches considered appropriate? (3.16.1 to 3.16.15). Is the approach to direct credit risk for pooled investment vehicles, which recommends disclosing an analysis of types of pooled vehicle held, appropriate? (3.16.10-3.16.13). Are there alternative approaches that could be considered? Summary of responses 42 respondents addressed this area: 26 respondents disagreed with the approach, with 19 suggesting a more top down narrative approach. Others suggested the financial statements were not the place to disclose investment risks and investment risk management with a number noting that suitable information to members was already provided in the Statement of Investment Principles or the trustee report. 2 respondents supported a more numerical tabular approach; 7 respondents supported the investment risk disclosure approach; 22 respondents thought the extra disclosures would result in increased costs for producing and auditing the financial statements; 17 respondents said there would be additional information requirements from investment managers and 9 respondents commented that the additional information may not be readily available from existing arrangements; 12 respondents disagreed with the look through approach for pooled investment vehicles. Reasons cited included trustee risk management was not operated at this level and readers would not understand the approach. Of these 2 respondents supported look through for 100% invested funds; 6 respondents supported the look through approach, although many noted it would incur additional costs; 9 respondents commented that scheme level risk disclosures were not relevant/ of no value to DC scheme members; 8 respondents commented that there were wider risks to be taken into consideration and investment risk disclosure was too narrow and disclosures would be disproportionate. 4 respondents commented that the risks required to be disclosed were too simplistic and for example did not reflect the underlying interrelated complexities in an investment portfolio; 5 respondents disagreed with the approach of setting risk disclosures for pooled vehicles at the look through or asset class level based on trustee intent, reasons included inconsistency, inappropriate to disclose based on intent rather than underlying risks and difficulty in defining asset class ; and 3 respondents disagreed with the approach taken to disclosing credit risk for pooled investment vehicles. The SWP noted the high level of concern over the extent of additional disclosure and related costs. There was discussion over how a narrative approach could achieve the required
disclosure of the extent of credit risk and market risk arising from financial instruments.at the end of the reporting period required by FRS 102. It was noted that FRS 102 requires narrative disclosure on the exposure to risks, the objectives, policies and processes for managing risk and the methods used to measure risk. This would convey much of the information respondents appeared to regard as appropriate under a narrative approach. It was also noted that wider IFRS has a specific requirement to disclose amounts and the IMA SORP requires numerical analysis where risks are significant. It was also discussed that a narrative approach that used percentages would require amounts to be determined in order to provide the percentage. It was also discussed whether disclosing the strategic allocations would be sufficient but it was felt that the requirement to disclose extent at the end of the reporting period would require consistency with the actual exposures at the year-end which may not be fully in line with policy. It was agreed to revisit the example accounts to see if further streamlining could be achieved whilst still meeting the requirement to disclose extent at the end of the reporting period. The SWP noted the number of respondents who disagreed with the look through approach for pooled vehicles and the number of respondents who thought this particular requirement would result in extra costs. The SWP also noted the comments in relation to the limited relevance of scheme level risk disclosures for DC schemes. It was agreed to make the asset class approach the default disclosure in relation to pooled investment vehicles, recommend look through for funds where the trustees controlled the investment mandate of the fund and make look through an optional disclosure approach for other pooled vehicles. It was felt that this would also go some way to dealing with the concerns over the extra disclosures and numerical analyses since using an asset class approach would remove the need for the extra work to determine exposures on a look through basis and would also reduce disclosures through cross referencing to numbers already disclosed in the financial statements. The SWP noted the comments in relation to wider or more complex risk disclosures. Given the aim of not generally extending the SORP s reporting requirements beyond the requirements of FRS 102 it was agreed not to recommend wider or more complex risk disclosures in the SORP. In relation to the comments received in relation to credit risk disclosures the SWP considered the need to require disclosure of pooled vehicle by type and agreed that an approach of requiring the disclosure of how trustees manage the direct credit risk would not necessarily require the numerical analysis by type of vehicle therefore this disclose will not be recommended. Instead a description of the nature of the pooled funds invested in will be recommended and the example financial statements updated accordingly. It was noted that the reporting to PPF/tPR and ONS mentioned by some respondents appeared to require more detailed analysis than that required by FRS 102 and the Draft SORP therefore it was agreed not to incorporate this into the SORP.
Fair value hierarchy Is the distinction of investments valued using a valuation approach (Category C investments) between those using market observable data (C(i) and non-observable data (C(ii)) considered helpful? Summary of responses 42 respondents answered this question: 18 respondents noted that FRS 102 s fair value hierarchy was not consistent with IFRS and this would result in extra costs for providers of this information and confusion amongst users of accounts. 15 respondents supported the distinction of category C into two sub-sections; 11 respondents did not think the distinction of category C into two sub-sections was helpful. A number of respondents expressed concern that weekly priced funds would switch between category (a) and (b) depending on when their year-end fell. A number of respondents also felt that weekly priced funds should be included in category (a). A number of respondents also pointed out the lack of guidance on what constitutes a recent transaction. In the light of the mixed response for support for the distinction of category C into two subsections, and mindful of the need not to impose disclosures over and above FRS 102 the SWP agreed to make the extra disclosure optional. It was noted that this may reduce the meaningfulness of the disclosure but on balance the SWP felt that the option to follow FRS 102 and not extend disclosure beyond FRS 102 was helpful. The SWP agreed that the Draft SORP would be amended to make it clear that weekly priced funds would fall into category (b) even when the pricing date of the fund fell on the scheme s reporting date. The SWP considered the categorisation of pooled funds. It was noted there is guidance in this area for IFRS levelling purposes but none currently for the FRS 102 fair value hierarchy. It was noted that the IMA SORP generally expects pooled funds to be reported in Category (b). It was also noted that guidance on interpreting IFRS levels normally recommends level 2 or 3 for pooled funds although some guidance recommends level 1 for daily priced funds that are actively traded. It was noted the IMA/PRAG working party on investment reporting was considering this area in detail. The SWP considered that detailed guidance on disclosure of pooled funds in the fair value hierarchy would be helpful to preparers of financial statements. However, given the development stage of detailed guidance and the absence of practical experience of financial reporting under the FRS 102 hierarchy it was felt more appropriate for the SORP to refer to the need to have regard to the terms of the participation in the pool and the nature and characteristics of the pooled investment vehicle, setting out examples of the characteristics that could be considered rather than prescriptive guidance that may become out of date or contradicted as further guidance and practice is developed. SWP agreed not to provide a guide as to the meaning of recent transaction, noting in doing so that FRS 102 and IFRS does not provide any such guidance, noting that this is also an area that will develop as practice becomes established and industry guidance is developed.
One respondent suggested using the IFRS level 1,2,3 hierarchy instead of the FRS 102 hierarchy so that pension scheme reporting was consistent with IFRS. There was also some discussion amongst the SWP as to whether it would be possible to adopt the IFRS levelling whilst complying with the rest of FRS 102. It was agreed that it would not be possible to mix and match FRS 102 and IFRS. It was noted that it would be possible for pension schemes to report under full IFRS, but this would bring additional requirements, particularly in relation to investment risk disclosures. It was agreed the SWP will feedback to the FRC the comments on consistency of levelling between IFRS and FRS102 and stress the need to bring into line with each other.
Financial statement presentation Do the example financial statements provide sufficient practical guidance on the application of the Draft SORPs new disclosures? Is the alternative combined presentation of investment risk and derivative notes to the example financial statements helpful? Is having a choice of examples helpful? Are there better alternative approaches? Summary of responses 37 respondents replied to this area: 12 respondents believed the example financial statements provided sufficient guidance; 4 respondents believed the example financial statements did not provide sufficient guidance, for example, more complex derivative disclosures, including more alternatives, information on index linked gilts, longevity swaps and SPVs; 13 respondents preferred not to include alternative presentations; 11 respondents supported the provision of alternative presentations; 8 respondents questioned why employer and employee contributions are reported on the face of the revenue account and in the notes; 7 respondents questioned why investments are reported by class on the face of the net asset statement and in the notes; 7 respondents disagreed or questioned the need to include comparative information for DB and DC arrangements in hybrid schemes; 7 respondents requested the example accounts to include a transfer between sections ; 7 respondents requested the example accounts include more analysis of administration expenses; 5 respondents questioned why the tax note had moved from the trustee report to the accounts; 5 respondents asked for the example accounts to include repurchase transactions (repos and reverse repos); 4 respondents asked why the net asset statement had been renamed Statement of Net Assets (available for benefits); 5 respondents commented on inconsistency of including the compliance report in the trustee report but also making reference to it being included as a separate statement; 4 respondents commented that the Draft SORP may raise issues for reporting ringfenced DB arrangements; and 3 respondents commented on providing a simple level SORP for small straightforward schemes. The SWP discussed the provision of alternative presentations and in the light of comments received agreed to simplify the example accounts by removing the alternative presentation. The wording in the SORP in relation to the alternative presentation will remain. In terms of changing the example accounts for comments received it was agreed: - To leave employer and employee contributions on the face of the revenue account; - To leave investments by asset class on the face of the net asset statement; - To leave the approach to comparatives unchanged;
- To leave the tax note in the financial statements; and - To leave the title of the statement of net assets unchanged. The above points were agreed on the basis these were all required by FRS 102. It was also agreed to: - Not increase the disclosure of administration costs as this would extend the SORP beyond FRS 102 for relatively immaterial amounts and it was always an option for trustees to include more disclosure than less if desired; - include repos in the example financial statements; - include a transfer between sections in the example financial statements ; - remove the ambiguity about the treatment of the compliance section of the trustee report; - leave the commentary on approach to ring fenced DB arrangements unchanged as the circumstances for each scheme will need to be assessed by the trustees; - not increase the number of examples to deal with simple schemes to avoid providing alternatives that may confuse. It was also agreed to clarify the wording of the SORP to make it clear there is no longer a recommendation for a separate compliance statement as part of the trustee report.
Auto-enrolment Do you agree with the approach taken by the Draft SORP in relation to accounting for the first contribution arising from employees who are auto-enrolled? (3.8.2) Summary of responses 35 respondents answered this question: 29 respondents agreed with some or all of the Draft SORP s proposals in relation to accounting for contributions arising on auto-enrolment; 2 respondents disagreed with recognising contributions whilst employees were in the opt-out period; a number of respondents suggested that alternative approaches should be allowed where schemes consider that employees who are in the opt-out period are not members of the scheme; a number of respondents suggested opt-out payments back to the employer should be reported as a deduction from contributions; and a number of respondents also pointed out that the remittance arrangements for autoenrolled employees were changed in November 2013 such that the first three months contributions can be remitted by the 22 nd of the fourth month. The SWP agreed to amend the Draft SORP to reflect the changed remittance period and to future-proof by including a reference to statutory requirements going forward. It was also agreed to amend the SORP to accrue for contributions retained by the employer once the opt out period had expired and the employee had not notified their intention to opt out. The SWP agreed not to adopt the net approach advocated by some respondents in the light of FRS 102 offset requirements. There was some discussion about the status of employees who are auto-enrolled and are within the opt-out period. The SWP agreed the accounting would remain as set out in the Draft SORP as the employee is making contributions and their pensionable service starts from the date they are auto-enrolled. Also, the trustees have a fiduciary responsibility in relation to monies received from employees during the opt-out period. If an employee notifies the scheme that they wish to opt-out the legislation requires the scheme to treat the employee as never having been a member, which presupposes they were a member prior to the opt-out notification. The SWP agreed that reference will be made to disclosing the approach taken to dealing with opt-outs in the membership reconciliation table, if provided.
Legislative disclosure requirements Do you agree with PRAG s view that the legislative disclosure requirements in relation to investment classifications as set out in the Audited Accounts Regulations are updated to come into line with FRS 102 and the Draft SORP? Summary of responses 33 respondents answered this question and were unanimous in support for bringing the Audited Accounts Regulations into line with FRS 102 and the SORP. It was noted that the DWP had indicated support for a change in legislation but that the current workload would not allow legislative amendments to be made to the Audited Accounts Regulations until after the General Election in 2015. It was noted that the first accounting periods which will have to comply with FRS 102 and the revised SORP will be for years ending 31 December 2015 and these financial statements will typically be prepared in the Spring of 2016. Therefore so long as legislative change is made before the end of 2015 or early in 2016, and with immediate effect, the revised SORP can continue the approach of noting the legislative disclosure requirements set out in the Audited Accounts Regulations in an appendix and not provide guidance on how to meet them. It was agreed to notify the DWP of the responses to the ED and request early amendment to legislation.
Concentration of investments In addition to the detailed investment classification disclosures referred to above, the Audited Accounts Regulations also require the disclosure of any investment (other than UK Government securities) in which more than 5% of the total value of the net assets of the scheme is invested. Do you think this disclosure is necessary in the light of the risk disclosures required by FRS 102 (section 3.15) and the separate requirement to disclose employer related investments (section 3.32)? If you think it is required should it apply to investments in pooled investment vehicles at the unit level or should investments held indirectly through pooled investment vehicles be taken into account (the look through approach)? Summary of responses 32 respondents answered this question: 17 respondents supported dropping the concentration of risk disclosure; 15 respondents supported continuing with the disclosure. Of those in favour of the disclosure 9 respondents felt that pooled investment vehicles should be dealt with at unit level; and 2 respondents advocated the look through approach. The SWP consider that the concentration of risk disclosures required by the Audited Accounts Regulations were a useful disclosure and therefore agreed to make it a recommended disclosure in the SORP so that it would continue to be required once the Audited Accounts Regulations are amended (see discussion above).
Other comments There were a number of other comments made by respondents. The most significant are summarised below: 7 respondents asked for more guidance on longevity swaps, including approach to valuing the swap at Nil at inception and using a risk adjusted rate to value the floating leg, clarification of treatment of cash flows under the swap and clarification of when a swap is classified as a derivative or not. 5 respondents did not support the additional disclosures relating to transaction costs; 4 respondents asked for more guidance on Special Purpose Funding vehicles including more disclosure as to the nature and illiquidity of the arrangements, treatment of cash flows and frequency of valuations; 5 respondents commented on the EDs approach to recognising deficit funding contributions when received by the scheme if earlier than required by the schedule of contributions. Most supported the approach but asked for more disclosure. One respondent made the point that if the schedule refers to annual amounts then, even if agreed by employer and trustee they are early payments, they should be deferred to the period in which they fall due under the schedule. 4 respondents commented that the SORP was too long and they would like to see a shorter SORP. Several commented that they would like to see a simplified SORP for smaller schemes. 2 respondents commented that more recent actuarial valuations than the tri-ennial valuation could be used for the report on actuarial liabilities if available; and 2 respondents either disagreed with FRS 102 s approach to consolidation or found it confusing. 1 respondent commented that the ED did not address the forthcoming governance reporting requirements. 1 respondent commented on the accounting treatment of collateral received by pension schemes under swap arrangements. It was agreed to include further guidance on valuation of longevity swaps but at a high level and it was noted this could be an area for further guidance to be issued by PRAG. It was agreed to clarify treatment of cashflows to allow them to be reported as income, capital or allocated between either. It was also agreed to remove the references to longevity swaps being classified as either derivatives or not as this was felt to be confusing. It was agreed to leave the disclosure recommendations on transactions costs as per the Draft SORP, noting that there is a trend towards greater transparency. It was agreed to change the draft SORP to recommend the disclosure of the terms and illiquid nature of SPVs. It was agreed to amend the Draft SORP to recommend disclosure of future deficit funding contributions and to clarify the accounting treatment of deficit funding contributions received early in the light of the schedule of contributions wording. It was noted that a possible solution is to disclose the approach taken and to explain how this relates to the schedule of contributions and whether the schedule, in the light of the early payment, will in due course be amended to reflect the early payment.
It was agreed to review the Draft SORP to make it clear the most recent actuarial valuation need not be the statutory funding valuation if a suitable more recent valuation is available, whilst not inferring that annual valuations are required. It was agreed to leave the Draft SORP approach to consolidation unchanged but to add additional commentary on FRS 102 s requirements in relation to interests held as part of an investment portfolio. It was agreed to include a high level reference to forthcoming governance disclosures in the Draft SORP. It was also agreed to include income draw-down in the Draft SORP given the April Budget changes to pensions that will come into effect next April whilst noting that this is a developing area and will benefit from review once practice becomes established. It was agreed to add additional commentary in the SORP on the accounting treatment for collateral covering instances where the scheme uses the collateral received in its investment activities (re-hypothecation).