Vast differences in how companies in different European countries measure life expectancy is leading to confusion over company pension liabilities and creating havoc for companies engaged in international merger activity.
Research by Cass Business School in conjunction with the Pensions Board of the UK Actuarial Profession, has revealed such huge variance in mortality assumptions that its authors have called for it to be made mandatory for companies to disclose how they measure mortality.
Banking and financial services group, UBS, recently calculated that the FTSE 100 companies have a combined pension deficit of more then £40 billion. But if this pension liability were to be calculated using German mortality tables, the deficit would become a £3 billion surplus – a difference of £43 billion.
Using Danish mortality assumptions this surplus increases to £30 billion but using French mortality assumptions the £40 billion deficit becomes a £63 billion deficit.
Research leader and Head of the Faculty of Actuarial Science and Statistics at Cass, Professor Richard Verrall, says this huge variance in mortality assumptions is creating havoc for UK companies engaged in international merger activity, with many companies taking on huge pension black holes they did not know about at the time of the merger.
"Many European companies are using inappropriate life expectancy measures which are driving down pension liabilities and artificially inflating share prices," Professor Verrall says.
"This means that a UK company wanting to buy a German company, for example, may assume its pensions liability to be quite acceptable and later get a nasty surprise which could seriously impact future business activity."
The German figures are particularly startling, Professor Verrall says, since they have one of the highest levels of company pension schemes of any European country.
"German companies have taken a 'cross your fingers and hope' approach to how long their employees will live. UK firms, on the other hand, are already taking rapidly increasing life expectancy figures into account."
For example, BAE Systems recently raised the life expectancy of the average pension by two years, adding £800 million to its liabilities.
All of the world's major accounting standard setters, including those in Europe, America and the International Accounting Standards Board, have announced that there is a need to reform pension accounting.
But as Cass' Dr David Tyrrall points out, none of them specifically require publication of the mortality assumptions - even though these can have just as big an impact on the figures.
"This omission came about because when the accountants were drawing up the standards they probably paid more attention to the financial issues they knew about when and overlooked the mortality issues they knew less about," he said.
Both Professor Verrall and Dr Tyrrall agree that this loophole needs to be closed.
"We are calling on the International Accountings Standards Board to make it mandatory for companies to disclose how they calculate mortality figures, so that we achieve international comparability among firms," Mr Tyrrall says.
The research found that one of the main causes of the variation in mortality assumptions is due to some countries incorporating an allowance for expected future improvements in mortality, while others use tables that relate to mortality observed over a period in the past, without allowing for the continuing rise of life expectancy.
Interestingly, the research found the French approach is to assume that men and women will live for the same period of time. All other countries assume that women will live longer then men. The French use this difference as a 'buffer' to account for future advances in overall life expectancy.
The research drew together the different government figures on life expectancy and compared these to the life expectancy estimates made by individual companies. In France, for example, it is assumed that company pension members will live 7.5 years longer then the general population.
Professor Verrall says this is partly explained by a difference in living standards.
"All European countries, except Denmark, assume the health of people on company pension schemes will be better then that of the general population and that they will therefore live longer."
As well as calling for clear and informative mortality assumptions to be included in the disclosure of pension expense in company accounts, the researchers are recommending that a single 'Cass index of mortality' be created.
This would be based on relative annuity values, to keep the disclosure as simple as possible while remaining sufficiently informative for analysts and auditors to be able to have confidence in the results, helping companies involved in merger activity to make informed choices on the size of pension debt.