Solving the pensions controls problem

The UK Government has recently made it clear that companies who must apply the UK Corporate Governance Code (the Code) will be required to strengthen their controls over financial reporting (and operation and compliance systems). Pensions reporting in the financial statements will be included, which brings the lack of controls into sharp focus and will result in many companies having to improve their pension controls and processes, including those around the calculation of pension liabilities under IAS 19.

Pensions are often a material financial risk, with investors wary of deficits and higher cash contributions emerging. Whilst companies may point to controls reports covering administrative practices around data and assets, there is usually nothing covering the actuarial calculation of the liabilities. This is despite this being a highly complex area, with most of the detail seemingly buried in a black box understood only by the actuary. And where they use a centralised delivery team, often offshore, that detail may not be complete.

As a result of the new requirements in the Code, companies will most likely have to document and test the processes and controls that were undertaken to try to ensure that the pension scheme assets and liabilities are materially correct. Assembling the IAS 19 numbers can feel like a painful project management exercise - having strong controls in place will help to ease this pain as it will reduce the numbers of issues arising. This is true for all companies, not just those who will be covered by the Code.

Directors have a choice: challenge their actuaries on the models and roll-forward approaches they use or request that controls documentation covering the calculation of pensions liabilities is produced. Either way, this could lead to a greater need for internal actuarial expertise where pension risks are material or, if this is not available, using an independent, external firm to provide expert input.

Another area of focus that we are seeing is around the setting of pensions assumptions. These are the responsibility of the directors but it is becoming increasingly common for auditors to ask companies to show how they are comfortable with the assumptions proposed by their advisers, and to provide accompanying documentation and analysis, often to a surprising level of detail. This takes up management time, often at a critical time in the financial reporting timetable.

Setting inflation assumptions is a good example of this complexity. Price inflation is at a 30-year high. This will undoubtedly lead to higher pension cash flows in the future where benefits are linked to inflation. 2020 also saw the announcement on RPI reform, the market views of which remain difficult to unpick. One example of a control in respect of setting assumptions would be the process by which the company understands and challenges what their actuaries are doing in this area.

With the increased requirements around controls, we recommend that companies covered by the Code review the controls that they, and their actuary, have in place around their year-end pensions financial reporting process and challenge their actuary to demonstrate that their approach is robust. Following this approach can reduce the risk of nasty surprises in the frenetic scramble to finalise accounts.