GRENOBLE GRADUATE SCHOOL OF BUSINESS

Analysis of Pension
Funds
Advanced Financial Statement Analysis
Aashish Hemendra Singh

Synthesis: The Pension Scheme disclosure by Morrisons is the by far the best and the
actuarial losses/gains in Morrisons Pension Fund between 2006-10 are majorly a result
of changes in discount rates over the period and the fair value of Equities in scheme
assets.
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Section One To be completed by the student Please tick as appropriate

Name(s) Aashish Singh....................................................... MBA FT MIB Undergraduate

.................................................................. MBA PT MSc x Diploma Certificate

.......................................................................................... Specialization : - Finance...................................................

.......................................................................................... Intake n°: - 4................................................................

Student ID Number (s)

102186............................................................................... Grenoble main Campus Off site (state which one) x

Subject Advanced Financial Statement Analysis......................................................................... London......................................

Assignment x Oral Presentation Exam Project Proposal Management Project/Dissertation

Title : - Analysis of Pension Funds...........................................................................................................................................

I hereby declare that the attached assignment is my own work and understand that if I am suspected of plagiarism or other
form of cheating; my work will be referred to the Disciplinary Committee which may result in my exclusion from the program.

Signature: - Aashish Singh.................................................... Date 11 April 2011............................................................

Section Two To be completed by the Professor I lecturer

Note below your comments on content, structure and presentation. Comments on specific points should be written on the assignment.
Enter grade out of 20 on the bottom of this page. Please indicate whether this is a first or a second grading.

First grading Second grading

Professor's name................................................................. GRADE

Signature............................................................................
Date received...................................................................... Date returned to student.........................

Comment Form for Assessed Work

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Q.1) From an analyst’s or investor’s viewpoint, which of the three companies

do you consider to provide the best disclosure about the financial impact of its
pension schemes? Give full reasons for your judgement.
I would like to analyze the quality of disclosures of each of the companies independently and then
conclude by stating which company provides the best disclosure in my opinion.

Morrisons

The notes reveal that the Group operates two pension schemes, namely the Morrison and Safeway
schemes, and the plan for the pension schemes is a final salary plan. The closure of the defined benefit
pension scheme to new employees after September 2000 and establishment of a stakeholder pension
scheme (defined contribution pension scheme) in June 2001 has been stated. The composition of the
assets held in the schemes and the assumptions for calculating their fair value are succinctly yet
comprehensively described. The assumptions in calculation of the expected values are provided as
well. The sensitivity of the present value of the benefit obligations to only two assumptions is
disclosed. The purpose of these assets, according to the notes, is only to pay off the liability in the
future and not necessarily to make profits in the immediate future. I believe this is reassuring to the
investor.
The detailed disclosure of the movement of the fair value of plan assets and the present value of the
defined benefit obligation over the year is present. As required by IAS 19 the effect of the 1% change
with regards to the assumptions of the life expectancy and discount factor are shown. The actuarial
gain/loss has been recognized in the Income Statement along with information on the sub-headings to
which it has been broken down and charged to. The movement of the fair value of the scheme assets
and present value of liabilities has been provided. The notes include financial information for 3
consecutive years for each point unlike its competitors which provide just two. An estimate of the
expected contribution by the employer in the next financial year has been provided.

Tesco

It has been stated that Tesco has a variety of post-employment benefit arrangements, covering funded
defined contribution schemes and funded and unfunded defined benefit pension schemes, most
significant of which is the funded defined pension scheme in the UK and Republic of Ireland. A
detailed description of the plan such as information on the plan type (flat salary plan or final salary
pension plan) has not been provided. Tesco has explained the contents of the defined benefit plans
well, the highlights being a detailed description of its principal plan, the Tesco PLC Pension scheme,
and also the merger of One Stop Executive Pension scheme into its principal plan. The most
significant overseas scheme, namely the defined benefit scheme in the Republic of Ireland, is also
briefly discussed. The main assumptions are described in detail. For example, the life expectations of
a member retiring at age 65 and of a member reaching the age 65 in 25 years’ time are given after a
brief explanation for the same. The detailed combination of the scheme assets and their fair values has
been provided alongside their expected nominal rate of return. The movement in the fair value of the
plan assets and of the present value of the defined benefit obligations has been provided.
The charges to the Group Income statement are disclosed but the lines to which they are charged to
have not been given. The summary of movements in the scheme over the year and over the last 5
years has been provided. In accordance with IAS 19, the liability of the health care benefits has been
disclosed and the effect of 1% change in healthcare costs has been provided. It however does not
provide the trend of these rates or the accumulated post-retirement benefit obligation of the healthcare
costs. The expected contribution that the group will have to make in the following year based on the
actuarial valuation of the liabilities is mentioned.

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Sainsbury

According to the notes, Sainsbury’s retirement benefit obligations consist of two funded defined
benefit schemes, the J Sainsbury Pension and Death Benefit Scheme and the J Sainsbury Executive
Pension Scheme, and an unfunded pension liability relating to senior employees. The type of plan for
the benefit obligation is not revealed. The closure of the defined benefit schemes to new employees
from 31st January 2002 has been noted. A disclosure regarding a scheme offered to new employees, if
any, is not provided The assumptions for valuing the scheme assets are not disclosed but the fact that
they are treated differently from the Group’s assets is merely stated. The detailed disclosure of the
movement of the fair value of plan assets and the present value of the defined benefit obligation over
the year is present.
However an allocation of the defined benefit obligation to various schemes is not provided. The
summary of movements in the scheme over the year and over the last 5 years has been provided. The
actuarial gain/loss has been recognized in the Income Statement along with information on the sub-
headings to which it has been broken down and charged to. Composition of the plan assets and the
explanation for the expected value of the same is too concise in my opinion. The bases for the
assumptions for calculating present value of the obligations are not provided, except for the discount
rate, though the sensitivities of the assumptions have been provided. The expected contribution that
the group will have to make in the following year based on the actuarial valuation of the liabilities is
disclosed.

Conclusion

The notes of Morrison are detailed and very straightforward. They provide sufficient information to
do a complete analysis of the pension funds of Morrisons. The disclosure of Tesco is almost
sufficient. It seems to be detailed on most elements of pension funds such as the longevity of the
scheme and the liability of the healthcare benefits. However it fails to provide some key data like the
detailed impact on the income statement of the group and the details of the actual return on plan
assets. The disclosure by Morrisons is only numerical and detailed explanations are almost absent. It
looks very difficult to analyse as key explanations to justify certain assumptions and valuations are
not provided. All 3 fail to disclose certain elements required by IAS 19 such as a detailed description
of the plans. Also certain elements of IAS 19 are unique to few companies, like Tesco is unique in the
fact that it provides healthcare benefits.
Thus comparatively speaking, I would say Morrisons provide the best disclosure about their pension
funds, followed by Tesco and then Sainsbury’s.

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Q.2.)For Morrisons only, produce a tabulated analysis of all its actuarial

gains and losses for the five years 2006 – 2010, and provide your own
explanation of the probable reasons for the most significant actuarial gains
and losses recorded during this period.
Actuarial gain or loss
Actuarial gain or loss is a gain or loss arising from the difference between estimates and actual
experience in a company’s pension plan. Actuarial gains and losses are used when accounting for
pension plans because of the need to make assumptions about the future rate of salary increases, the
length of employee tenure, an appropriate discount rate for the plan obligations and the expected rate
of return on plan assets.

There are two main reasons that lead to an actuarial gain or loss is:
 Alterations in actuarial assumptions that are used in determining the present value of the
benefit obligation
 Differences between the expected and actual returns on scheme assets

Analysis of Morrisons Pension fund for the period 2006-10:

There are quite a few assumptions that are required to be made in order to arrive at the present value
of the Benefit obligation. As there is no independent body that sets these assumptions the companies
are free to make their own assumptions. As seen above the explanation for these at times is not even
provided. However the reason why they have to be looked at closely is that they can be changed by
the company every year to account for changes in the economic and social environment. These
assumptions are often made on mortality rates, retirement age, compensations, discount rates,
inflation, healthcare costs, etc. The investor needs to analyze whether these changes are manipulations
or consistent modifications.
In the notes regarding Pension Schemes, Morrisons has 3 main categories of assumptions, namely
expected return on assets, financial and longevity.

Expected return on scheme assets:

I would like to begin with an analysis of the actuarial gain/loss arising due to the expected return on
plan assets. The plan assets compromise of equities, corporate bonds, gilts (which have replaced
currency management), property, and property related funds and cash.

Any increase in assumptions regarding returns of elements of scheme assets increases the overall
expected return. The assumption on equities is only slightly increased in 2010.The expected corporate
bond rate has increased until 2009(6%) from 2006(4.25%) and finally reduced to 5.65%. The
movement of expected return on property related investments too is similar.
The expected return on cash assets has fallen considerably from a high of 5.5% to 1.5% in 2010.

(But the most important conclusion to be drawn from this is that the structure of scheme assets has
changed and currency management assets have been replaced by gilts. Morrisons has no exposure to
foreign currency (all UK business) and hence the use of currency management assets prior to the
crisis (especially to meet pension liabilities) is highly questionable.)

Equities have been badly affected due to the crisis and hence have been the major reason for the loss
in the value of scheme assets. Their share has notably dropped in the scheme assets. Corporate bonds
and gilts have seen a notable rise in their proportion of scheme assets which is obvious considering

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the risk aversion following the crisis. The real estate market has also crashed which has affected the
fair value of the properties and property related funds. The cash position has been affected possibly
due to the liquidity crisis in the aftermath of the financial crisis.

The analysis of the actuarial gain/loss due to changes in assumptions is analysed below.

Changes in financial and longevity assumptions:

Financial

 Rate of increase in Salaries:

Influence: As salaries increase, irrespective on the plan type (flat salary plan or final salary pension
plan), the benefit obligation increases resulting in an actuarial loss.
Trend & Impact: There has been a rise in the rate of increase of salaries until 2008, after which
Morrisons has adjusted them, probably in light of the Sub-Prime crisis that has affected the global
economy adversely.

 Rate of increase in Pensions in payment and deferred pensions:

Influence: A rise in the rate of increase in pensions in payment and deferred pensions leads to an
actuarial loss as the benefit obligation increases.
Trend & Impact: It is identical to the trend of inflation. These Pension schemes must be inflation
indexed to provide a cover to the employees from losing the purchasing power of their future post-
retirement benefits. It has hovered around the same level. (Approx.3.6%)

 Discount rate applied to scheme liabilities:

Influence: The higher the discount rate the lower is the present value of the benefit obligation. Thus a
higher than necessary discount rate would lead to an actuarial gain.
Trend & Impact: These are benchmarked to high rated corporate bonds. The discount rate has
increased up until 2009. It has then reduced in 2010. The sensitivity of fund present value of benefit
obligation is very high as a 0.1% increase leads to an actuarial gain of £51million.

 Inflation:

Influence: The higher the inflation the higher the present value of the benefit obligation. So an
increase in inflationary expectations results in an actuarial loss.
Trend & Impact: It has remained more or less stable. Hence it has not affected the actuarial gain or
loss.

Longevity:

The longevity assumption basically covers the average life expectancy of members retiring at age 65
and of members retiring at age 65 currently aged 45. It has been unaltered over the period 2008-10.
As age impacts the present value adversely (+1 year leads to actuarial loss of £61 million) it should be
revised in my opinion especially of those currently aged 45 as progress in the field of medicine will
increase the average life expectancy. The source used is actuarial advice and published statistics.

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Comprehensive Summary of actuarial gains/losses for 2006-10:

I - Actuarial gain/(loss) due to difference in expected and actual return

II - Actuarial gain/(loss) due to changes in assumptions
Year I II Opinion
2006 165 (219) Loss due to change in assumptions- discount rate to which the PV is very
sensitive has been changed. Loss partly offset by higher than expected return on
plan assets
2007 78 55 The increase in discount rate has nullified the increase in salary and pension
increase rates resulting in a gain. Assets have also increased.
2008 (113) (6) The main reason for loss is the plan assets of which equity had a major
composition which reduced dramatically due to the crisis. The loss due to
increase in longevity has been offset by the discount rate increase.
2009 (425) 328 Full blown crisis leads to fair value of assets diminishing majorly. Especially
equities and properties. Higher discount rate nullifies >70% of the loss.
2010 245 (316) Assets reclassified in Corporate bonds and gilts improve the return. However the
changes in assumptions, particularly the discount rate, lead to an actuarial loss.

An analyst should compare the discount rate across the industry as this is crucial in the
analysis. An average discount rate assumption should be utilized and the resulting loss or gain be used
in valuation of the obligation in his own analysis. As the crisis caught everyone by surprise the loss in
Asset schemes (2008, 2009) is understandable. They should have probably been invested more in
bonds. They have recovered well in 2010. However their use of currency management assets prior to
the crisis is questionable.

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Appendix:

References:
1. http://ar2010.tescoplc.com/~/media/Files/T/Tesco-Annual-Report-
2009/Attachments/pdf/tesco-annualreport.pdf
2. http://www.morrisons.co.uk/Global/Images/Corporate/Annual
%20Report/Morrisons_AnRep10.pdf
3. http://www.morrisons.co.uk/corporate/2008/annualreport/pdf/Rep_7_Consolidated_financials
.pdf
4. http://www.jsainsbury.co.uk/ar10/downloads/pdf/Sainsburys_AR10_note_30_retirement_ben
efit_obligations.pdf
5. CFA notes.

Important tables: (for Q.2.)

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SINGH Aashish Analysis of Pension Funds 102186