The pension renovation

Everyone who runs their firm's pension scheme knows that 2006 is a busy year. Over the last few months the focus of the national press has been on A-Day and the reshaping of the personal pensions environment that came into effect on 6 April 2006.

This overhaul mainly affects individuals. However, there has been less coverage of other pensions developments, especially those affecting businesses with defined benefit (or final salary) pension schemes.

A defined benefit scheme is a promise to pay pensions to staff in the future. That promise normally relates to an individual's salary and years of service.

By contrast, a defined contribution scheme (such as a personal pension plan) makes no promises at all about future benefits. Instead, the scheme will report the value of the "pot" each year and the individual will find out what income that capital sum will buy when he/she retires.

From an employer's perspective, defined contribution schemes are straightforward - the employer makes an agreed contribution to the "pot". For employers with defined benefit schemes, however, there has been a stream of surprises.

Living longer

FRS 17 now requires companies and LLPs to bring their defined benefit scheme surplus or deficit ‘on-balance sheet’

During the 1990s it became clear that the assumptions on which scheme funding had been based would have to be revised - for example, life expectancy.

For members of a defined benefit scheme, this means their pension is worth more. It also means the pension scheme's obligation is bigger and therefore the cost of funding it is higher.

Furthermore, for those employers with defined benefit schemes, 2006 is the year of the double whammy. First, because the Pensions Protection Fund (PPF) has got into its stride (see right). The PPF is designed to be a central pot of funding to meet defined benefit pension scheme liabilities in the event of a company's failure. The PPF levy therefore means extra costs for pension schemes, many of which pass those extra costs on to the employer.

This levy, however, could be higher than it should be, because of lack of information about the employer's financial position. For example, if there are no filed accounts as the employer is a partnership, or if there appears to be a short credit history because it has recently converted to LLP. All employers must ensure the PPF has full information on their financial position.

There is a second hit for limited companies or LLPs if they have a defined benefit pension scheme that is in deficit: accounting standard FRS 17.

The PPF levy means extra costs for schemes, many of which pass those extra costs on to the employer

Transparency

The standard was issued in 2000 and initially required (by way of notes in the annual accounts) much more information about the pension scheme's financial position than had been the case previously.

Disclosure of this information is one factor that has brought pension scheme deficits "up the agenda" in recent years, as pension scheme trustees and company directors began to appreciate the scale of the numbers that could be involved.

FRS 17 now requires companies and LLPs to bring their defined benefit scheme surplus or deficit "on-balance sheet".

The balance sheet can therefore change significantly and the look of the annual accounts is often different as a result. Finance directors will worry about how suppliers might view the business, or whether prospective clients may question the firm's financial stability.

In the real world, nothing has changed. What was always a liability - the commitment to fund the pension scheme - is still there. It's just more visible than it was before.