Low interest rates continue to create significant challenges
LCP Ireland Pensions Accounting Briefing 2017 Low interest rates continue - a new norm or the calm before the storm?
For further information, please contact Conor Daly in our Dublin office, or alternatively the person who normally advises you.
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This briefing may be reproduced in whole or part, without permission, provided prominent acknowledgement of the source is given. The briefing is not intended to be an exhaustive analysis of companies’ accounting disclosures. Although every effort is made to ensure that the information in this briefing is accurate, Lane Clark & Peacock Ireland Limited accepts no responsibility whatsoever for any errors, or the actions of third parties. Information and conclusions are based on what an informed reader may draw from each company’s annual report and accounts. None of the companies have been contacted to provide additional explanation or further details.
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© Lane Clark & Peacock Ireland Limited November 2017
2 LCP Ireland Pensions Accounting Briefing — 2017 Contents
5 13 Introduction LCP’s analysis of pension accounting 6 disclosures Executive summary 23 Appendices 9 Developments in Irish pension provision in 2017
LCP Ireland Pensions Accounting Briefing — 2017 3 1.5. IntroductionFCA review continued
Just as trustees and employers have started to get to grips with low bond yields, we have potential new legislation and accounting rules to again focus attention on the onerous obligations that come with a defined benefit scheme.
Conor Daly Partner
4 4 LCP IrelandLCP PensionsIreland Pensions Accounting Accounting Briefing Briefing — 2017 — 2017 1. Introduction
Pension disclosures are a significant element of many company accounts. By analysing these disclosures, we aim to measure the exposure of companies to their pension liabilities and highlight the steps that companies are taking to address pension issues in these challenging times.
This briefing covers 15 of the largest companies (by market capitalisation) listed on the Irish Stock Exchange (ISEQ) and other exchanges that have defined benefit pension arrangements in Ireland. All of these companies are required to report under International Accounting Standards (IAS19 for pension costs) in accordance with EU regulations. 15 We have also covered 11 semi-state/state-controlled companies with Number of companies defined benefit pension schemes that have published pension accounting listed on the ISEQ and information for their 2016 financial year. These bodies have reported other exchanges included in this briefing. under IAS19 or the equivalent local standard FRS102 for accounting years 11 beginning on or after 1 January 2015. Number of semi- The information and conclusions in this report are based solely on a state/state-controlled detailed analysis of the information companies have disclosed in their companies included in annual report and accounts for their 2016 financial year and other this briefing. publicly available information. We did not approach companies or their advisers for additional information.
LCP Ireland Pensions Accounting Briefing — 2017 5 2. Executive summary
Pension deficits remain very high Pension scheme deficits Jan 2016 Pension scheme deficits remained extremely high and volatile over 2016. We estimate that the combined deficit was€3.6bn at €2.6bn 31 December 2016. This represents an increase of €1bn from the estimated position at the start of the year. Dec 2016 The increase in estimated deficits occurred despite some significant once-off gains reported by a number of companies €3.6bn (due to liability management exercises, etc) and occurred primarily due to falls in bond yields over 2016. Oct 2017 Long dated Eurozone bond yields were very volatile over 2016 with a sharp fall in the period to 30 September before somewhat €3.3bn of a reversal in the last quarter. Bond yields have remained volatile over 2017 but have eased slightly further and we estimate the deficit for companies analysed has fallen to €3.3bn by 31 October 2017.
While any reduction in the deficit is to be welcomed, the quantum of deficits disclosed for many companies are likely to still be a cause for some considerable concern.
Funding levels remain stubbornly low
The average funding level has remained stubbornly low since the 2007-2009 financial crisis. The average pension scheme funding level disclosed in 2010 annual reports was 86% compared to an average funding level of 85% disclosed in the 2016 annual reports. This is despite a reported €9.6bn in contributions paid to schemes analysed over the period 2010-2016 and very strong stock market performance over the same period.
The main reason for funding levels remaining stubbornly low has been the sharp and prolonged fall in Eurozone bond yields over the same period. Pensions scheme liabilities are valued by reference to bond yields so when bond yields fall, the value of reported liabilities rise.
Pension contributions remain a significant cost Total contributions paid
The companies analysed paid substantial contributions, 2014 over €1.07bn, to their pension schemes in 2016. This follows €1.27bn contributions of €1.16bn in 2015 and €1.27bn in 2014. It is clear that pensions remain one of the most significant costs for these organisations. 2015 In many cases, the employer contributions were significantly €1.16bn higher than the cost of accrual as attempts continue to eliminate past service deficits. 2016 €1.07bn
6 LCP Ireland Pensions Accounting Briefing — 2017 2. Executive summary continued
What have companies been doing Some divergences in assumption to manage their pension liabilities? setting
Many companies have carried out pension The value placed on pension liabilities is liability management exercises over the year. very dependent on market conditions at the
In some cases the accrued benefits for existing valuation date and the assumptions used in the members were cut following agreement with valuation exercise - particularly the discount rate. As pension liabilities tend to be very long the pension scheme trustees (Bord na Mona) term, a small change in the discount rate can while in others (Kerry Group) the Irish scheme was closed for all future accrual. have a very significant impact on the disclosed balance sheet liability. There were also a number of examples of transfer value exercises where members were We have seen evidence of some divergence offered transfers values to another pension in the assumptions adopted by companies arrangement in exchange for their accrued as different interpretations are taken of the appropriate market yield at the valuation date. defined benefitsKerry ( Group, Smurfit Kappa, UDG Healthcare).
Equity holdings remain relatively high
The average allocation to equities for the companies analysed fell from 43% to 41% over the year. This is consistent with the trend seen in recent years with the overall allocation to equities down 24% over the last nine years of our reporting. However, while there are some notable exceptions, the overall 41% proportion of Irish scheme assets in equities (41%) remains high Average equity when compared to other jurisdictions. For example, defined allocation in benefit pension schemes operated by FTSE 100 companies in the Irish survey UK now hold on average just 26% of their assets in equities.1 26% Average allocation in While the prevailing low bond yields are no doubt a contributory (UK) LCP Accounting factor in the reluctance to switch from equities to bonds, it would for Pensions 2017 be most regrettable if trustees continue to feel obliged to take survey. risks with undue equity exposure to seek outperformance in order to deliver members’ benefits.
1 (UK) LCP Accounting for Pensions 2017
LCP Ireland Pensions Accounting Briefing — 2017 7 1.5. IntroductionFCA review continued
While the proportion of assets held in equities continues to fall, it is still noticeably higher (41%) for the schemes analysed in this report compared to the average equity holding across all Irish defined benefit pension schemes (32.5%), as reported by the Pensions Authority in August 2017. On the face of it, this suggests the larger schemes may be taking more investment risk than the average scheme.
Roma Burke Partner
8 8 LCP IrelandLCP PensionsIreland Pensions Accounting Accounting Briefing Briefing — 2017 — 2017 3. Developments in Irish pension provision in 2017
3.1. Pension reform is on the political agenda
The Minister for Social Protection signalled potentially important changes to the pensions landscape at the Pensions Authority Conference on 2 March 2017. In particular, it was proposed that sponsoring employers should be required to give a minimum of 12 months' notice to trustees to cease contributions, irrespective of the provisions included in the Scheme Trust Deed & Rules.
However, the subsequent Social Welfare, Pensions & Civil Registration Bill 2017 which was published in July 2017, dropped the majority of the proposed changes including the proposal for mandatory wind up notice periods.
Indications are that the Government intends to reintroduce these provisions at a later stage. These provisions, if implemented, would provide for much stronger protections for members of defined benefit schemes, but also expose many employers to potentially significant additional contribution demands. The inclusion of these proposals in the original heads followed by their subsequent removal was most unwelcome and increased uncertainty. This uncertainty continues and makes it difficult for trustees and companies alike to manage their schemes.
LCP’s view has always been that where a viable scheme is wound up, this is unlikely to be in the best interests of members, particularly those that have not yet retired. Care therefore needs to be taken with any proposed legislation measure so as to avoid any unintended consequences.
The revised Bill included a proposed reduction in the timescale for submission to the Pensions Authority of actuarial funding certificates and funding proposals from nine months to six months. These timescales, if implemented, will be very onerous for many trustees and employers – particularly in cases where there is a significant need for negotiations and discussions following the presentation of funding results.
LCP Ireland Pensions Accounting Briefing — 2017 9 3. Developments in Irish pension provision in 2017 continued
3.2. Pensions Act Funding Standard
Irish defined benefit pension schemes are subject to the Pensions Act Funding Standard (in addition to the Funding Standard Reserve). The Pensions Authority confirmed that of the largest 50 schemes subject to the funding standard, only 28 of them are meeting the standard as of August 2017.
Many of the companies analysed have implemented funding proposals which were agreed with the Pensions Authority and pension scheme trustees and were designed to eliminate a deficit on the Pensions Act Funding Standard over a designated period.
Notwithstanding the slight increase in bond yields during 2017 to date, yields remain persistently low. Low bond yields are a continued strain on all schemes, especially those in funding proposals and where liabilities are mature (ie a significant proportion of pensions in payment). 3.3. Changes to accounting standards on the horizon? The rules around accounting for pensions for companies listed on EU exchanges are set out in IAS19.
In 2015 and 2016 the International Accounting Standards Board (IASB), proposed some changes to the way liabilities are calculated. In short, while at present the balance sheet amount disclosed can be significantly less than the value of future contributions, the proposals would require a significant number of companies to disclose the higher amount with a potentially very significant impact on those companies’ balance sheets.
Exactly which companies would be affected is not clear and will depend more often than not on a ‘small print legal lottery’ of the detail in a plan’s rules.
Changes were due to be finalised early in 2018 and then implemented with effect from 1 January 2019. At its meeting in September 2017, the IASB agreed to hit the pause button – at least for the time being. The IASB recognised that any benefit of these changes might not exceed the cost, and will carry out further work to assess the potential impact.
This should represent a welcome stay of execution for companies and trustees, and there is now more time and opportunity to identify and address the issues.
LCP recommend companies identify whether the proposed changes would impact their defined benefit pension scheme and identify opportunities and solutions to remove the potential problem, which will likely involve working collaboratively with the relevant trustee boards.
10 LCP Ireland Pensions Accounting Briefing — 2017 3. Developments in Irish pension provision in 2017 continued
3.4. Enhanced transfer value options
We have seen continuing evidence of enhanced transfer value (ETV) exercises being used by employers to manage their ongoing defined benefit liabilities. An ETV exercise generally involves the company offering an incentive of a top up to the standard transfer values payable to members if they agree to transfer out their benefits from a defined benefit plan within a designated period.
Such exercises can be attractive to companies as a method to eliminate a proportion of the defined benefit liability completely, often with the additional benefit of an improvement in the company’s balance sheet. A well run ETV exercise can result in an improved outcome for some members and the company. However, the LCP view is that such exercises are not without their own risks and exposures and we would recommend that considerable care should be taken to ensure that new risks are not introduced by such an exercise.
We recommend the following key principles be adopted in any ETV exercise so as to minimise the risk of future issues arising:
• While the trustees may not necessarily be a direct party to an ETV offer, the detail of an offer and any member communications on the offer should be shared with the trustees and the trustees given sufficient time to make observations. • Actuarial and legal advice provided to the company on the operation of such exercises should be independent (different firms) from the advice provided to the trustees and conflicts avoided. • Enhancements should be as top ups to the transfer value only and not 'cash in pocket.' • Members should have access to independent financial advice prior to making a decision to take up any offer. • Communications with members should be easy to understand and unbiased.
• Members should have a 'cooling off period' after accepting the offer to change their minds. 3.5. Budget 2018 The State Pension (Contributory) is increasing by €5 per week from late March 2018. A consequence of the increase is the small reduction in liabilities for defined benefit schemes that are integrated with the State Pension.
This follows increases of €5 per week in 2017 and €3 per week in 2016. The State Pension (Contributory) is paid to people from the age of 66 who made the required Irish social insurance contributions.
LCP Ireland Pensions Accounting Briefing — 2017 11 1.5. IntroductionFCA review continued
While the pace of pension scheme wind ups has reduced considerably, there is evidence of companies completing liability management exercises that limit the size and volatility of the remaining schemes.
Martin Haugh Partner
12 12 LCP IrelandLCP PensionsIreland Pensions Accounting Accounting Briefing Briefing — 2017 — 2017 4. LCP’s analysis of pension accounting disclosures
4.1. Introduction
We have analysed the financial position of 26 companies’ defined benefit pension schemes. A full list of the companies can be found in Appendix 1.
We took the 30 largest companies (by market capitalisation) on the ISEQ and analysed the 11 companies with material defined benefit pension arrangements. The companies analysed are unchanged from last year’s report.
In a similar manner to previous years, we have also included DCC, Grafton, Greencore and UDG Healthcare (these companies are listed on other exchanges, but operate significant defined benefit pension schemes in Ireland) and analysed the largest pension schemes for semi-state/state-controlled companies that publish accounts.
We have reported on the financial position of the defined benefit pension arrangements sponsored by these companies and, where possible, we have excluded liabilities relating to post-retirement healthcare from our analysis. The figures analysed include all defined benefit pension arrangements (including overseas arrangements, if applicable), except where indicated. 4.2. Reported funding levels
The accounting standards look at the pension scheme assets and funded liabilities at the accounting date. Of the companies analysed in this survey, only two reported sufficient assets to meet its funded liabilitiesAIB ( and Kingspan). 85% DCC was also very close to being fully funded. Last year Kingspan was the only The average funding level (assets as a proportion of company which reported sufficient assets to meet its funded liabilities. funded liabilities) for the Kingspan disclosed the highest funding level (110%), while four companies (Central companies analysed was 85% in 2016. Bank of Ireland, CIE, Coillte and Ornua) disclosed funding levels of less than 75%.
The average funding level for the schemes analysed decreased from 88% in 2015 to 85% in 2016. The following chart shows how funding levels have changed over the year for the companies analysed.
Ratio of assets to funded liabilities (%)
14 2015 12 2016 s e
i 10 a n p
m 8 o c
f o 6 r e b
m 4 u N 2
0 under 70% 70% - 79% 80% - 89% 90% - 99% over 100%
LCP Ireland Pensions Accounting Briefing — 2017 13
Jan 17 Feb 17 Mar 17 Apr 17 May 17 Jun 17 Jul 17 Aug 17 Sep 17 Oct 17
-0.5 t €bn
i -1 c i f e D
-1.5 /
s u l
p -2 r
S u -2.5
-3
-3.5 State-owned companies -4 Listed companies
6
2015 5 2016 s e i 4 a n p m o c
f
o 3
r e b m
u 2 N
1
0 under 5% 5% - 14% 15% - 24% 25% - 49% 50% - 74% 75% + 100% - 125%
7 2015 6 2016 5 s e i
a n 4 p m o c
f 3 o
r e b
m 2 u N 1
0 <50% <100% <150% <200% <250% <300% <350% >350%
Ratio of contributions paid to benefits earned (%)
10 s
e 2015 i 8 a n 2016 p m o c 6 f o
r e b
m 4 u N 2
0 1.70% 1.90% 2.10% 2.30% 2.50% 2.70%
10 9 Male 8 s e
i Female 7 a n p
m 6 o c
f 5 o
r
e 4 b m
u 3 N 2 1 0 85 86 87 88 89 90 91
Age at death (rounded to nearest age) 4. LCP’s analysis of pension accounting disclosures continued
This fall in funding levels was primarily due to the fall in yields on high quality corporate bonds (used to place a value on the accounting liabilities) in 2016 which increased the liabilities. The increase in liabilities has been offset somewhat by the strong rise in assets (equities and bonds) in 2016.
In some specific cases the funding position disclosed at the year-end was better than would have been expected having regard to market movements alone. There were a variety of factors contributing to this including significant contribution payments and agreed benefit reductions. 4.3. Development of pension scheme deficits during 2017
We have also considered the movement in the pension scheme balance sheet positions during 2017.
Global equity markets rose in early 2017 (in € terms) helped by the strength of the US dollar against the Euro. North American equities, in particular, continued 14 their rise following the election of Donald Trump in November 2016. Global2015 equities,12 as measured by the FTSE World Index, were up approximately 8%2016 in s
2017e to the end of October. i 10 a n p
Onm the8 liability side, high quality corporate bond yields as at the end of October o c
f
2017o were marginally higher on average than as at the end of 2016. These higher 6 r e yieldsb mean that IAS19 liability values have fallen slightly during 2017 (as pension m 4 u
schemeN liabilities are calculated by reference to these yields for accounting purposes).2 0 LCP estimatesunder that70% the aggregate70% - 79% pension80% deficit - 89% for the90% Irish - 99% fundedo vschemeser 100% of the companies analysed stood at €3.3bn as at 31 October 2017 (€3.6bn at 31 December 2016). Projected aggregate pension deficit
Jan 17 Feb 17 Mar 17 Apr 17 May 17 Jun 17 Jul 17 Aug 17 Sep 17 Oct 17
-0.5 t €bn
i -1 c i f e D
-1.5 /
s u l
p -2 r
S u -2.5
-3
-3.5 State-owned companies -4 Listed companies
14 LCP Ireland Pensions Accounting Briefing — 2017
6
2015 5 2016 s e i 4 a n p m o c
f
o 3
r e b m
u 2 N
1
0 under 5% 5% - 14% 15% - 24% 25% - 49% 50% - 74% 75% + 100% - 125%
7 2015 6 2016 5 s e i
a n 4 p m o c
f 3 o
r e b
m 2 u N 1
0 <50% <100% <150% <200% <250% <300% <350% >350%
Ratio of contributions paid to benefits earned (%)
10 s
e 2015 i 8 a n 2016 p m o c 6 f o
r e b
m 4 u N 2
0 1.70% 1.90% 2.10% 2.30% 2.50% 2.70%
10 9 Male 8 s e
i Female 7 a n p
m 6 o c
f 5 o
r
e 4 b m
u 3 N 2 1 0 85 86 87 88 89 90 91
Age at death (rounded to nearest age) 14 2015 12 2016 s e
i 10 a n p
m 8 o c
f o 6 r e b
m 4 u N 2
0 4. LCP’s uanalysisnder 70% of pension70% - 79% accounting80% - 89% disclosures90% - 99% over 100% continued
Jan 17 Feb 17 Mar 17 Apr 17 May 17 Jun 17 Jul 17 Aug 17 Sep 17 Oct 17
-0.5 t €bn
i -1 c i f e D
-1.5 /
s u l
Note:p -2 Data is for the Irish funded pension arrangements of the companies r
analysedS u -2.5 and has been estimated from the pensions disclosures in their published company accounts.2 -3
As the-3.5 graph demonstrates, there can be significant volatility in the level of deficits from month to month as equity values andS tabondte-ow nyieldsed com pfluctuate.anies -4 Indeed, when deficits hit their lowest in June 2017,L itist eisd cestimatedompanies that the aggregate pension deficit was only €0.9bn. 4.4. Company exposure to pension schemes
Funded accounting liabilities as a proportion of market capitalisation (%)
6
2015 5 2016 s e i 4 a n p m o c
f
o 3
r e b m
u 2 N 25% The total funded pension 1 scheme liabilities expressed as a proportion of market 0 capitalisation for the under 5% 5% - 14% 15% - 24% 25% - 49% 50% - 74% 75% + 100% - 125% companies analysed was 25%.
The chart above shows the size of the pension accounting liabilities relative to
market7 capitalisations for the companies analysed (AIB has been excluded from this analysis as its disclosed market capitalisation is distorted by the limited2015 6 amount of stock actively traded). The total pension liability, expressed as 2016a proportion5 of market capitalisation, increased over the year (from 22% in 2015 s e toi 25% in 2016). a n 4 p m o
Thec following lists the companies with the largest pension scheme liabilities
f 3 o
r
expressede as a percentage of their market capitalisation at their 2016 year end b
m 2
dates:u N • Bank1 of Ireland: 102% (69% in 2015)
• Greencore0 : 47% (43% in 2015) <50% <100% <150% <200% <250% <300% <350% >350% • Smurfit Kappa: 45% (40% in 2015). Ratio of contributions paid to benefits earned (%)
2 Projected deficits calculated using LCP's daily online scheme monitoring tool LCP Visualise
LCP Ireland Pensions Accounting Briefing — 2017 15
10 s
e 2015 i 8 a n 2016 p m o c 6 f o
r e b
m 4 u N 2
0 1.70% 1.90% 2.10% 2.30% 2.50% 2.70%
10 9 Male 8 s e
i Female 7 a n p
m 6 o c
f 5 o
r
e 4 b m
u 3 N 2 1 0 85 86 87 88 89 90 91
Age at death (rounded to nearest age) 14 2015 12 2016 s e
i 10 a n p
m 8 o c
f o 6 r e b
m 4 u N 2
0 under 70% 70% - 79% 80% - 89% 90% - 99% over 100%
Jan 17 Feb 17 Mar 17 Apr 17 May 17 Jun 17 Jul 17 Aug 17 Sep 17 Oct 17
-0.5 t €bn
i -1 c i f e D
-1.5 /
s u
4. LCP’s analysis of pensionl accounting disclosures
p -2 r
continued S u -2.5
-3
-3.5 State-owned companies -4 Listed companies
4.5. Contributions compared to benefits earned
We have analysed how the employer contributions compare with the expected
cost of6 benefits earned:
• The cost of benefits earned under IAS19 is determined by the assumptions2015 at 5 the start of the accounting year. 2016 s e i • Typically,4 employer contributions are set following recommendations by the a n p
m Scheme Actuary and are designed to ensure that there are sufficient assets to o c
f meet benefit payments as they fall due.
o 3
r e b m
Ouru analysis2 of the accounting disclosures shows that the majority of companies N pay contributions that are in excess of the cost of benefit accrual under IAS19 as attempts1 are made to reduce past service deficits. On average, companies paid contributions of just over 2.1 times (2015: 2.3 times) the cost of benefit accrual 0 on the accountingunder 5% basis.5% - 1 4% 15% - 24% 25% - 49% 50% - 74% 75% + 100% - 125%
Employer contributions compared to benefits earned
7 2015 6 2016 5 s e i
a n 4 p m o c
f 3 o
r e b
m 2 u N 1
0 <50% <100% <150% <200% <250% <300% <350% >350%
Ratio of contributions paid to benefits earned (%)
The contributions made by Kerry Group and C&C Group were over five times the cost of benefit accrual under IAS19.
Aryzta, Central Bank, Ervia and NTMA paid contributions that were less than the estimated cost to cover benefits earned during the year on the accounting basis.
16 LCP Ireland Pensions Accounting Briefing — 2017
10 s
e 2015 i 8 a n 2016 p m o c 6 f o
r e b
m 4 u N 2
0 1.70% 1.90% 2.10% 2.30% 2.50% 2.70%
10 9 Male 8 s e
i Female 7 a n p
m 6 o c
f 5 o
r
e 4 b m
u 3 N 2 1 0 85 86 87 88 89 90 91
Age at death (rounded to nearest age) 4. LCP’s analysis of pension accounting disclosures continued
4.6. Trends in asset allocations
Where companies disclose a breakdown of their Irish or Eurozone Trustees are clearly pension scheme asset allocation, this is the one which we have analysed. showing signs of
The average level of exposure to equities fell from 43% in 2015 to 41% in more sophisticated 2016. The average allocation to bonds was unchanged from 36% and the active management allocation to other asset classes increased from 21% to 23%. of investment risk in We have also analysed the allocation to other asset classes. The majority their schemes with of companies disclosed an allocation to property assets. The average allocation to equities allocation was 7% in 2016 for those with property assets (6% in 2015). down 24% and Some companies also disclosed an allocation to cash assets – the average allocation to other allocation was 6% in 2016 for those with cash assets (5% in 2015). assets up 10% over
Five companies disclosed an allocation to Liability Driven Investment – the last 9 years of with Kingspan (33%) and Bank of Ireland (32%) disclosing the highest our reporting. allocations. Fergus Collis, Three companies disclosed an allocation to hedge funds – Diageo (10%) Senior Consultant disclosing the highest allocation.
The average split of assets for the pension schemes analysed is shown in the following chart. 2016 Asset allocation 41% The average equity allocation 23% for the pension schemes analysed fell during 2016. This is still significantly higher than 36% Equity pension schemes in other jurisdictions. Bond
Other
41%
Companies who reported the highest equity holdings were Kingspan (67%), Ornua (65%) and Grafton (64%). On the other end of the spectrum, CRH (21%), Bank of Ireland (23%) and AIB (26%) disclosed the lowest equity holdings.
LCP Ireland Pensions Accounting Briefing — 2017 17 4. LCP’s analysis of pension accounting disclosures continued
The Pensions Authority has commented that investment strategies which rely on equities to outperform bonds in order to meet pension scheme liabilities entail considerable risk, which, in their view, will fall particularly on the younger members. To address this, the Authority has said that it intends to raise this directly with defined benefit pension scheme trustees as part of their programme of increased direct engagement.
There is evidence that a number of trustee boards are continuing to actively review their investments and in many cases implement de-risking strategies or alter the mix of their return seeking portfolios. We expect this trend to continue as many schemes review their asset strategies as part of their funding proposals.
The shift from equities is particularly evident at an individual company level with some accounts showing significant reductions in equity allocations during 2016:
• DCC: equity holding reduced from 39% to 28% • CRH: equity holding reduced from 30% to 21% • UDG Healthcare: equity holding reduced from 56% to 50%.
Some companies reported increases in equity holdings. For example, Kingspan reported an increase in its equity holdings of 4%. Ervia, An Post and Bord na Mona all report an increase of 2% over 2016.
In previous years we reported that Irish pension schemes had higher than average allocations to equities when compared to other jurisdictions. Our current analysis would continue to support this assertion. For example, in the UK, approximately 26% of pension scheme assets were allocated to equities at the 2016 year-end compared with 41% for the Irish scheme assets in this report.
The largest reported increases in bond holdings were as follows:
• DCC: bond holding increased from 54% to 61% • Aryzta: bond holding increased from 40% to 45% • UDG Healthcare: bond holding increased from 19% to 23%.
The referral of the investment consulting industry in the UK to the competition authority should encourage Irish plcs to consider the importance of the advice they currently receive in relation to their pension arrangements.
Oliver Kelly Head of Investment Consulting Ireland
18 LCP Ireland Pensions Accounting Briefing — 2017 14 2015 12 2016 s e
i 10 a n p
m 8 o c
f o 6 r e b
m 4 u N 2
0 under 70% 70% - 79% 80% - 89% 90% - 99% over 100%
Jan 17 Feb 17 Mar 17 Apr 17 May 17 Jun 17 Jul 17 Aug 17 Sep 17 Oct 17
-0.5 t €bn
i -1 c i f e D
-1.5 /
s u l
p -2 r
S u -2.5
-3
-3.5 State-owned companies -4 Listed companies
6
2015 5 2016 s e i 4 a n p m o c
f
o 3
r 4.e LCP’s analysis of pension accounting disclosures b m continuedu 2 N
1
0 under 5% 5% - 14% 15% - 24% 25% - 49% 50% - 74% 75% + 100% - 125%
7 Some companies reported reductions in bond holdings. For example, Smurfit2015 6 Kappa and Bank of Ireland both reported a reduction in bond holdings of2016 9% 5 whiles the Central Bank of Ireland reported a reduction of 8%. e i
a n 4 Aryztap and Total Produce reported the highest property holdings: m o c
f 3 o • Aryzta: property holding increased from 21% to 23% r e b
• m Total2 Produce: property holding remained at 16%. u N The highest1 reported cash holdings were UDG Healthcare (25%) and Bord na Mona0 (15%). This was a decrease from Bord na Mona’s cash holding the previous year<50% (19%).<100% <150% <200% <250% <300% <350% >350% 4.7. Key assumptionsRatio of contributions paid to benefits earned (%)
We consider below the various assumptions used to place a value on pension benefits for accounting purposes. Where a company operates pension schemes 1.9%pa in more than one country, we have considered the assumptions used for Ireland The average discount rate or the Eurozone (if available). Where a company has disclosed a range of adopted by the companies assumptions, we have used our judgement to estimate the relevant point in the in this report fell from 2.5% range for the Irish pension scheme. in 2015 to 1.9% in 2016. Discount rates
The discount rate is the key assumption used to value pension liabilities. Under IAS19 and FRS102, this assumption is based on the yields available on long- dated high quality (typically AA rated) corporate bonds in the currency of the liability at the valuation date. The yields on high quality corporate bonds, and hence the discount rates, will fluctuate from day to day in line with market conditions.
In the following chart, we have analysed companies reporting with December 2016 year-ends. As this shows, there was an increase in the discount rates disclosed compared to last year.
Discount rates used at 31 December (% pa)
10 s
e 2015 i 8 a n 2016 p m o c 6 f o
r e b
m 4 u N 2
0 1.70% 1.90% 2.10% 2.30% 2.50% 2.70%
LCP Ireland Pensions Accounting Briefing — 2017 19 10 9 Male 8 s e
i Female 7 a n p
m 6 o c
f 5 o
r
e 4 b m
u 3 N 2 1 0 85 86 87 88 89 90 91
Age at death (rounded to nearest age) 4. LCP’s analysis of pension accounting disclosures continued
The majority of the companies with December 2016 year-ends disclosed a discount rate in the range 1.8% - 2.0% pa.
The average discount rate for companies reporting at 31 December 2016 was 1.9% pa – a decrease from the average discount rate of 2.5% pa as at 31 December 2015 and reflecting the commensurate fall observed in corporate bond yields over 2016. The highest discount rate was disclosed by Bank of Ireland (2.2%).
The accounting standard (IAS19) requires that the discount rate used is determined by reference to market yields at the end of the reporting period on high quality corporate bonds of a currency and term consistent with the currency and term of the pension scheme liabilities. This is generally interpreted as a discount rate in line with AA rated corporate bonds of appropriate duration.
While in theory, pension schemes with similar durations should be valued using similar discount rates at a particular point in time, in practice, the lack of a deep market in long duration corporate bonds can result in different modelling techniques and some divergences in discount rates.
As pension schemes tend to be long duration, a small change in the discount rate can have a very large impact on the balance sheet position. For example, Kerry Group reported that a decrease of 0.5% pa in the discount rate would increase the scheme liabilities by 12% at the accounting date. Similarly, a decrease of 0.25% in the discount rate used by Total Produce would increase the pension scheme liabilities by 5.6%.
The discount rates used as at 31 December 2016 have been charted against the disclosed durations below for the 12 companies with such disclosures and a year- end at 31 December 2016 and clearly shows some divergences in approach.
Discount rates used at 31 December 2016 by duration
2.30%
2.20%
2.10% e
a t 2.00% r
t n u
o 1.90% c s i d
/
1.80% d l e i Y 1.70%
1.60%
1.50% 15 17 19 21 23 25 27 Duration
20 LCP Ireland Pensions Accounting Briefing — 2017 14 2015 12 2016 s e
i 10 a n p
m 8 o c
f o 6 r e b
m 4 u N 2
0 under 70% 70% - 79% 80% - 89% 90% - 99% over 100%
Jan 17 Feb 17 Mar 17 Apr 17 May 17 Jun 17 Jul 17 Aug 17 Sep 17 Oct 17
-0.5 t €bn
i -1 c i f e D
-1.5 /
s u l
p -2 r
S u -2.5
-3
-3.5 State-owned companies -4 Listed companies
6
2015 5 2016 s e i 4 a n p m o c
f
o 3
r e b m
u 2 N
1
0 under 5% 5% - 14% 15% - 24% 25% - 49% 50% - 74% 75% + 100% - 125%
7 2015 6 2016 5 s e i
a n 4 p m o c
f 3 o
r e b
m 2 u N 1
0 <50% <100% <150% <200% <250% <300% <350% >350%
Ratio of contributions paid to benefits earned (%)
4. LCP’s analysis of pension accounting disclosures continued
10 s
e 2015 Lifei expectancy8 a n 2016 p m o
Allc of the companies analysed have disclosed some information about their life 6 f o
r
expectancye assumption. b
m 4 u
TheN following chart shows the range of life expectancies for males and females assumed2 by the companies analysed for members retiring at age 65 at the balance sheet date in 2016. 0 1.70% 1.90% 2.10% 2.30% 2.50% 2.70% Life expectancy assumption Individuals aged 65 on accounting date
10 9 Male 8 s e
i Female 7 a n p
m 6 o c
f 5 o
r
e 4 b m
u 3 N 2 1 0 85 86 87 88 89 90 91
Age at death (rounded to nearest age)
The average assumption was that male members at age 65 at the accounting date would live to age 87.2 (89.4 for females). This represents a slight increase from last year where the average male life expectancy at age 65 disclosed was 87.1 (89.3 for females). However, this overall average hides some changes where some companies increased their assumed life expectancy and others decreased their assumption.
Aryzta increased the life expectancy for a male aged 65 by 0.8 of a year. However, CRH disclosed a reduction of 0.3 of a year.
An increase in the assumed life expectancy will result in an increase in the value of the liabilities. An increase of one year will broadly lead to an increase of approximately 3% in companies’ disclosed pension liabilities.
LCP Ireland Pensions Accounting Briefing — 2017 21 4. LCP’s analysis of pension accounting disclosures continued
Future improvements in life expectancy
As well as setting assumptions to estimate how long current pensioners will live on average, companies must also decide how quickly life expectancies for future pensioners will increase as a result of improvements in mortality.
Allowing for future improvements will increase pension scheme liabilities and, as a result, deficits on the balance sheet. The majority of companies analysed disclosed sufficient information in their accounts to determine the allowance they were making for future improvements in mortality.
On average, the companies analysed are assuming that, over the next 20 years, the life expectancy of male retirees will increase by approximately 2.2 years. This represents a slight increase to the assumptions made by the companies last year. Long term inflation
While there are some uncertainties when setting the inflation assumption and a number of approaches are available, the average inflation assumption disclosed by companies reporting at 31 December 2016 was 1.6% which was unchanged from last year.
Schemes and employers need to start looking at the future and developing plans for the removal of defined benefit liabilities from their balance sheet. There will be opportunities and only the best prepared will be able to take advantage of them. John Lynch Partner
22 LCP Ireland Pensions Accounting Briefing — 2017 5. Appendices
Appendix 1 - Accounting disclosure listing Appendix 2 - Accounting risk measures
LCP Ireland Pensions Accounting Briefing — 2017 23 24 Appendix 1 - Accounting disclosureAppendix 1-Accounting listing This table shows the key disclosures made by the companies included in our analysis. The source of the data is each company’s annual report and accounts for the accounting period ending in 2016. The market value of assets and surplus/(deficit) figures relate to the worldwide position of each company, not just the Irish schemes. All figures are rounded to the nearest million LCP Ireland Pensions Accounting Briefing — Ireland Briefing LCP Pensions Accounting Euros. The assumptions for the discount rate and price inflation refer to those disclosed for the companies’ main Irish or Eurozone schemes where available. We have excluded from our survey companies who had no evidence of significant defined benefit provision. Some companies’ 2015 figures may have been restated. The surplus/(deficit) figures allow for any asset ceiling applied.
2016 Surplus/(Deficit) 2015 Surplus/(Deficit) Irish Companies Year-end Market Total Funded Discount Inflation Market Total Funded value of €m schemes rate % pa value of €m schemes assets €m % pa assets €m €m €m
Aryzta Jul 60 (13) (11) 0.19% not 67 (15) (13) stated
2017
Bank of Ireland Dec 7,292 (446) (446) 2.20% 1.55% 6,812 (736) (736)
C&C Group Feb 195 (28) (28) 2.15% 1.50% 203 (34) (34)
CRH Dec 2,556 (591) (444) 1.86% 1.50% 2,399 (588) (449)
DCC Mar 112 (0) (0) 2.00% 1.50% 116 (14) (14)
Diageo Jun 9,878 (1,425) (1,125) 1.40% 1.40% 11,050 (360) (13)
Glanbia Dec 367 (110) (110) 1.80% 1.4-1.5% 353 (87) (87)
Grafton Dec 260 (37) (37) 1.80% 1.30% 253 (23) (23)
Greencore Sep 576 (188) (188) 1.10% 1.20% 536 (154) (154)
Irish Continental Group Dec 275 (13) (13) 1.70% 1.60% 264 (5) (5)
Kerry Group Dec 1,366 (353) (323) 2.00% 1.70% 1,270 (306) (282)
Kingspan Dec 77 (14) 7 1.3%-2.6% 1%-2.2% 75 (7) 8
Smurfit Kappa Dec 1,954 (884) (367) 1.80% 1.50% 1,884 (818) (311)
Total Produce Dec 189 (38) (38) 1.90% 1.50% 179 (17) (17)
UDG Healthcare Sep 63 (6) (6) 1.25% 1.50% 87 (9) (9) Appendix 1 -Accounting disclosure listing continued m (6) € (51) (19) (78) (78) (63) (63) (34) (141) (141) (124) (124) (169) (169) (146) (288) Funded schemes m (6) € (51) (19) (78) (78) (67) (67) (34) (141) (141) Total (124) (124) (169) (169) (146) (288) Surplus/(Deficit) m € 112 137 137 213 272 322 369 369 470 609 6,197 6,197 1,836 assets 2,744 2,744 Market Market value of value 2015 2015 % pa 1.75% 1.25% 1.65% 1.50% 1.50% 1.50% 1.50% 1.90% 1.60% 1.60% 1.00% Inflation rate % pa 1.85% 2.10% 1.50% 1.80% 1.80% 1.80% 1.90% 1.90% 1.90% 1.90% 2.00% Discount Discount 8 €m (27) (27) (42) (45) (30) (129) (159) (159) (108) (333) (283) (730) (730) Funded schemes Surplus/(Deficit) 8 €m (27) (27) (42) (45) (34) Total (129) (159) (159) (108) (333) (283) (730) (730)
€m 131 513 133 235 235 293 293 639 320 403 403 1,987 1,987 6,413 6,413 assets 2,969 2,969 Market Market value of value Mar Dec Dec Dec Dec Dec Dec Dec Dec Dec Dec Year-end 2016 2016 bodies controlled State AIB An Post na Mona Bord Bank of Ireland Central CIE Coillte Ervia Authority Irish Aviation NTMA Ornua VHI This briefing analyses 11 companies of the largest 30 companies on the ISEQ with defined benefit pension arrangements. Company size has been determined by the weighting on the ISEQ by the determined size has been Company arrangements. companies on the ISEQ with defined benefit pension 30 companies of the largest 11 briefing analyses This companies four public and available) were accounts companies/bodies (where owned/controlled state significant the most briefing also analyses The 2016. 31 December at benchmark index as at the end are 2016 figures The and UDG Healthcare). Greencore Grafton, (DCC, Ireland significant defined benefit pension schemes in but who operate on other exchanges listed are that disclosures. accounting from pensions taken were shown period. All figures start of the accounting at the as are figures 2015 The periods ending in 2016. of the accounting year-end company’s at each applicable rate conversion using the Euro accounts and Greencore Grafton Diageo, in the DCC, sterling in pounds provided the figures converted have We (2015: 2016 30 September at 1.1577 Greencore: 1.3553), (2015: 2016 31 December at 1.1720 Grafton: 1.4018), (2015: 30 June 2016 at Diageo: 1.1965 1.3674), (2015: 2016 31 March 1.2626 at (DCC: 1.3621)).
LCP Ireland Pensions Accounting Briefing — 2017 25 Appendix 2 - Accounting risk measures
The tables show the key results of analysis of the 2016 accounting disclosures made by the largest companies on the ISEQ, the largest state-controlled companies/bodies with defined benefit pension arrangements and four other companies who operate significant defined benefit pension schemes in Ireland (DCC, Grafton, Greencore and UDG Healthcare). The pension figures relate to the worldwide position of each company (not just their Irish pension schemes) but exclude healthcare and defined contribution pension arrangements where possible. Equity allocations are based on Irish or Eurozone schemes where disclosed.
The source of the data is each company’s annual report and accounts for the accounting period ending in 2016. Figures provided in company accounts in sterling have been converted to Euro using the conversion rates outlined in Appendix 1.
The assets and liabilities in these tables are as outlined in the accounting disclosures before any adjustment for any asset ceiling. The surplus/(deficit) figures allow for any asset ceiling applied. The surplus/(deficit) figures are before allowing for deferred tax.
Traditionally some companies with overseas pension schemes do not fund them via an external scheme, instead backing the pension scheme with company assets, which may result in a larger total deficit (when including unfunded arrangements) being disclosed.
The source of market capitalisation figures is the ISEQ weightings as at the companies’ year-ends.
All figures shown have been calculated using unrounded numbers. Therefore some metrics shown may differ from those calculated using the rounded figures.
Largest funded liabilities 2016 2015 Company Liabilities €m Liabilities €m Diageo 11,003 11,063 Bank of Ireland 7,738 7,548 AIB 6,153 6,343 An Post 3,252 2,913 CRH 3,000 2,848
Largest funded deficits 2016 2015 Company Deficits €m Deficits €m Diageo 1,125 13 CIE 730 288 Bank of Ireland 446 736 CRH 444 449 Smurfit Kappa 367 311
26 LCP Ireland Pensions Accounting Briefing — 2017 Appendix 2 - Accounting risk measures continued
Largest funded liabilities compared to market capitalisation 2016 Liabilities Market cap Liabilities/ Company €m €m Market cap % Bank of Ireland 7,738 7,573 102% Greencore 764 1,609 47% Smurfit Kappa 2,320 5,151 45% Total Produce 227 630 36% Irish Continental Group 288 846 34%
Largest funded deficits compared to market capitalisation 2016 Deficits Market cap Deficits/ Company €m €m Market cap % Greencore 188 1,609 12% Smurfit Kappa 367 5,151 7% Total Produce 38 630 6% Bank of Ireland 446 7,573 6% Diageo 1,125 36,289 3%
Highest equity allocation 2016 2015 Company Equity allocation % Equity allocation % Kingspan 67% 63% Ornua 65% 65% Grafton 64% 70% Kerry Group 60% 64% Irish Continental Group 50% 50%
Lowest equity allocation 2016 2015 Company Equity allocation % Equity allocation % CRH 21% 30% Bank of Ireland 23% 27% AIB 26% 25% C&C Group 26% 30% Aryzta 28% 28%
LCP Ireland Pensions Accounting Briefing — 2017 27 Appendix 2 - Accounting risk measures continued
Highest (funded) funding level 2016 2016 2016 2015 Assets Liabilities Assets/ Assets/ Company €m €m Liabilities % Liabilities % Kingspan 77 70 110% 112% AIB 6,413 6,153 104% 98% DCC 112 112 100% 89% Irish Continental Group 275 288 95% 98% Bank of Ireland 7,292 7,738 94% 90%
Lowest (funded) Funding Level 2016 2016 2016 2015 Assets Liabilities Assets/ Assets/ Company €m €m Liabilities % Liabilities % Central Bank of Ireland 639 972 66% 81% Coillte 293 401 73% 78% CIE 1,987 2,717 73% 86% Ornua 133 178 75% 80% Greencore 576 764 75% 78%
Largest employer contributions 2016 2015 Company Contributions €m Contributions €m Bank of Ireland 220 302 Diageo 202 258 CRH 133 113 Kerry Group 125 71 Smurfit Kappa 83 85
Largest service cost 2016 2015 Company Service cost €m Service cost €m Diageo 134 168 Bank of Ireland 123 135 CRH 61 63 CIE 46 58 An Post 45 47
28 LCP Ireland Pensions Accounting Briefing — 2017 Appendix 2 - Accounting risk measures continued
Largest employer contributions compared to service cost 2016 Contributions/ 2015 Contributions/ Contributions Service cost Current service cost Current service cost Company €m €m % % Kerry Group 125.4 20.7 606% 252% C&C Group 6.5 1.1 591% 1067% Bord na Mona 14.9 3.1 485% 201% Smurfit Kappa 83.0 25.0 332% 218% UDG Healthcare 6.2 2.2 281% 104%
Largest increase in funding level 2016 2015 Increase in Company Funding level % Funding level % Funding level % DCC 100% 89% 12% Bord na Mona 91% 84% 9% AIB 104% 98% 7% Bank of Ireland 94% 90% 4% C&C Group 87% 86% 2%
Largest decrease in funding level 2016 2015 Decrease in Company Funding level % Funding level % Funding level % Central Bank of Ireland 66% 81% -19% CIE 73% 86% -15% Ervia 76% 88% -14% NTMA 76% 86% -11% Diageo 90% 100% -10%
LCP Ireland Pensions Accounting Briefing — 2017 29 We would like to thank those from LCP who have made this briefing possible:
Roma Burke Tommy Campbell Derrick Chua Fergus Collis Conor Daly Martin Haugh Oliver Kelly Tomás Kirrane David Lane Lorraine Langridge John Lynch Paul Meredith Eoin Mullen Mick O’Byrne Rebeccah Robinson Jamie Rocke James Stanley
30 LCP Ireland Pensions Accounting Briefing — 2017
LCP Accounting for Pensions 2016 LCP Ireland Pensions Accounting Briefing 2017
Conor Daly - Partner John Lynch - Partner
[email protected] [email protected] +353 (0)1 614 4393 +353 (0)1 614 4393
Martin Haugh - Partner Roma Burke - Partner
[email protected] [email protected] +353 (0)1 614 4393 +353 (0)1 614 4393
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