On Friday the credit rating agency Moody’s downgraded UK sovereign debt from AAA to AA1. The move was widely expected. As a result of the downgrade, the only major industrialised nations to retain a AAA rating are Germany and Canada.
John Broome Saunders, Actuarial Director at BROADSTONE, believes that the systematic downgrading of much sovereign debt over the last few years may have implications for pension accounting. “Balance sheet pension liabilities must be calculated using a discount rate based on ‘high quality’ bonds. But is ‘high quality’ meant to be a relative or absolute measure? Historically, this has generally been interpreted as bonds carrying a AA rating – but with credit ratings falling across the board, there’s a growing view that, in the current climate, maybe single-A rated bonds are good enough to be 'high quality’”.
Broome Saunders explains that such a change has an immediate impact on perceived liabilities. “Single-A bonds generally have a higher yield than AA bonds. And using a higher discount rate leads to lower liabilities, and smaller deficits. Because these financial assessments are highly sensitive to the assumptions used, such a change could easily halve the size of a scheme’s apparent balance sheet deficit. Of course, one needs to remember that this is all a bit of actuarial smoke and mirrors – the real cost of providing these benefits hasn’t changed.”
John Broome Saunders