FRS102
31 December 2023
By Daniel Martin
December 2023
Liabilities on 31 December 2022 were lower than a year earlier. Higher bond yields resulted in higher discount rates, lowering liabilities. This fall in liabilities was often the most significant factor when comparing 31 December 2022 balance sheets to a year earlier. While asset returns varied significantly by class, a similar or improved balance sheet was most likely, with investment strategies that more closely matched movements in the liabilities faring less well.
But how does 31 December 2023 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?
Bond yields increased steadily through the first half of 2023. While not to the degree seen in 2022, they have fluctuated more recently but remain 0.35% higher on 30 November 2023 than on 31 December 2022. 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 6%.
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.
After a turbulent 2022, inflation expectations have remained at around the same level throughout 2023. Inflation expectations are less than 0.1% lower on 30 November 2023 than on 31 December 2022. 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 a decrease in liabilities of around 1%.
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).
Please note that due to uncertainty regarding the long-term impact of Covid-19 on life expectancies, the default versions of the CMI_2020 and CMI_2021 models ignore mortality experience during 2020 and 2021. CMI_2022 is the first iteration of the CMI Model that allows for mortality experience after the coronavirus pandemic began. Mortality in 2022 continued to be higher than pre-pandemic levels and updating to the CMI_2022 model will therefore decrease pension scheme liabilities.
The CMI_2023 model is expected to be released early next year. This model is expected to make further allowance for post pandemic experience in the default version.
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 December 2022.
In summary
The liabilities are likely to have fallen due to the combined impact of higher bond yields, lower inflation expectations and lower life expectancy. Investment experience overall is unlikely to be significant unless a large proportion of assets are held in global equity. As such, a month out from the year-end, an improved balance sheet seems likely.
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.