FRS102
31 March 2023
By Daniel Martin
March 2023
Liabilities on 31 March 2022 were generally lower than a year earlier. Higher bond yields resulted in higher discount rates, lowering liabilities, with this only partially offset by increases in inflation expectations. However, changes on the asset side were often more significant. Investment performance varied hugely, meaning the gains described above were added to by strong investment returns in some cases, but asset losses were also possible that offset the liability gains to varying degrees depending on the specific assets held.
But how does 31 March 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 have fluctuated hugely over the last year reaching highs of above 6%, however, while they have fallen back to some extent, they continue to be significantly higher than on 31 March 2022, 2.1% higher as at 28 February 2023. 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 34%.
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.
Like bond yields, inflation expectations have been incredibly volatile. However, unlike bond yields the trend overall has been downwards. One month from the year-end, inflation expectations are approximately 0.5% lower than on 31 March 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 5%.
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. Meaning that updating to the latest version of the default model has little impact on liabilities. However, it is possible to adjust the default models, including making an allowance for 2020 and 2021 experience if it is felt appropriate.
The CMI_2022 model is expected to be released June 2023. This model is expected to make some allowance for 2022 experience in the default version and it is anticipated that life expectancies will be lower as a result.
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 2022.
In summary
While experience on the asset side has generally been negative, the increase in bond yields, and the resulting fall in liabilities, is likely to be the most significant factor when comparing 31 March 2023 balance sheets to a year earlier. While returns do vary significantly by asset class, overall, a similar or improved balance sheet is most likely, with investment strategies that more closely match movements in the liabilities faring less well over this period.
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.