DB endgame options: when strategy meets accounting reality

As funding levels improve, sponsors are exploring a broader range of endgame options than ever before. While strategic discussions often focus on risk, funding and member outcomes, understanding the accounting implications of each option is becoming an increasingly important part of the decision-making process. While the strategic benefits are clear, the accounting implications can be complex and the impact significant.  

In some cases, the accounting standards may appear misaligned with intended strategic outcomes and UK policy objectives. Early consideration of the accounting implications, supported by proactive auditor engagement, can help sponsors avoid surprises and ensure the chosen strategy is reflected appropriately in their financial reporting. 

In this blog, we explore the key endgame options for defined benefits (DB) schemes, their typical accounting treatments under IAS19 and FRS102, auditor perspectives and considerations sponsors should keep in mind. 

The accounting outcome will depend on the route chosen, whether that is buy-in, buy-out, superfund transfer, run-on or another form of external capital support. 

Accounting treatment 

For buy-ins, buy-outs and superfund transactions, the scheme pays a third party to assume some or all of its liabilities. The accounting impact is typically the difference between the amount paid and the value of those liabilities in the accounts. As transaction pricing is usually based on more prudent assumptions, this difference can be material. The accounting treatment then depends on whether the assets and liabilities remain on the balance sheet. If they do, the impact will generally be recognised through Other Comprehensive Income (OCI); if they’re removed, it will typically be recognised through Profit and Loss (P&L). 

Buy-ins 

• Partial buy-ins for a subset of members are generally treated as an asset transaction. The impact flows through OCI. 
• Full scheme buy-ins can be treated differently depending on the nature of the transaction. If a buy-out isn’t expected in the short term, the transaction may be treated in the same way as a partial buy-in through OCI. If a buy-out is imminent, it may be treated as a settlement, resulting in a P&L impact.  

Buy-outs 

• Buy-outs are treated as settlements. The liabilities and plan assets are reduced to nil, and the difference is recognised immediately in P&L. If a buy-in took place previously, this P&L item may be nil, or negligible tidying up of residual assets and liabilities. 

Superfunds 

• Accounting treatment is still evolving. Typically, the transfer is treated as a settlement, with liabilities removed and assets derecognised. The difference is recognised in P&L. This reflects that there’s no intermediate stage equivalent to the buy-in for an insurance policy.  
• Immediate recognition of an impact through P&L can create challenges for sponsors. A significant accounting charge may deter sponsors from pursuing an otherwise attractive risk-reduction strategy. It is therefore important to prepare stakeholders for these potential impacts in advance. 

Run-on 

The accounting impact of run-on will depend on the detail of the strategy. Constructive obligations around surplus sharing and discretionary benefits can create accounting implications. If a surplus-sharing mechanism is agreed, accounting liabilities may need to increase to reflect expected future benefit enhancements. 

• Surplus refunds are treated as negative contributions so affect cash flow but don’t affect P&L. 
• Benefit enhancements are likely to affect P&L, equal to the additional liability value of the enhancement.  

Surplus sharing under run-on can create a positive outcome for both sponsors and members. However, sponsors need to understand the potential P&L impacts. If this deters sponsors from considering run-on, it could work against the government’s ambitions to support growth investment by removing barriers to surplus extraction. Careful structuring of the sharing mechanism can mitigate this impact.  

Our previous blog explored the accounting implications of surplus sharing in more detail: 

Read here

What should sponsors consider? 

Different endgame options can lead to very different accounting outcomes. Understanding the implications early can help sponsors make informed decisions, engage effectively with stakeholders and avoid surprises later in the process. 

1. Early engagement: Sponsors should consult auditors before finalising transactions to avoid surprises and align the accounting treatment.  
2. Documentation: The strategy should be carefully documented. Auditors may request evidence of the strategic intent behind the chosen approach to support the accounting treatment. Examples of this could range from management correspondence or meeting minutes to a formal Memorandum of Understanding that sets out the purpose, timings and future plans for the transaction. 
3. P&L sensitivity: Consider the impact of discretionary increases or settlements and explore mitigations. For example, discretionary benefits that are contingent on future events may have a lower impact than immediate use of existing surplus assets to fund discretionary benefits.  
4. Regulatory alignment: Stay informed on evolving legislative changes and guidance.  
5. Investor education: Help stakeholders understand the strategic rationale behind the decision. Any accounting impact may not reflect underlying business performance, and the transaction may still deliver positive strategic outcomes despite the accounting result.   

Final thoughts 

Endgame options for DB pension schemes are becoming increasingly relevant as schemes mature and funding levels improve. Accounting standards can be complex and, in some cases, may appear misaligned with intended objectives and economic outcomes of a transaction. It would be helpful if these standards evolved to reduce outcomes that may act as a barrier to sound economic decisions.  

In the absence of change, companies will need to navigate the current landscape carefully. Early engagement with auditors is key to ensuring the chosen approach is reflected appropriately in financial statements and supported by the necessary documentation. By understanding the implications upfront, sponsors can make informed decisions and focus on the strategic benefits of their chosen endgame route. 

Accounting shouldn't determine your endgame strategy, but it should form part of the evaluation process. If you'd like to discuss how the accounting implications of different endgame options could affect your organisation, we'd be happy to help. Please get in touch. 

 

This blog is based upon our understanding of events as at the date of publication. It is a general summary of topical matters and should not be regarded as financial advice. It should not be considered a substitute for professional advice on specific circumstances and objectives. Where this blog refers to legal matters please note that Hymans Robertson LLP is not qualified to provide legal opinion and therefore you may wish to obtain independent legal advice to consider any relevant law and/or regulation. Please read our Terms of Use.