Feature / Finance explained

THE DEPARTMENT OF Health last month issued clarification on the application of the new discount rate for valuing pensions liabilities and injury benefits.

While core pensions are paid out by the NHS Pension Scheme, employers are liable for some payments – for example, enhancements to pensions where staff have retired early as part of redundancy arrangements to improve the efficiency of services.

In accounting terms, NHS bodies include the full future costs of such payments in the statement of comprehensive income (SOCI) – or operating cost statement – in the year in which the redundancy or early retirement happened.

However, it does not simply sum all the known future payments. Instead it applies a discount rate to future payments to reflect the falling value of money (a payment in five years’ time is worth less than a payment of the same amount now because of the impact of inflation). For example, using a discount rate of 2%, £100 paid out in a year’s time would have a current value of £98.04 (£100/1.02).

As the organisation has yet to pay out the cash relating to future payments, it would also include a provision in the statement of financial position. Each year this provision is recalculated with the provision increasing as the organisation gets closer to the actual payment of the amount. The difference between the newly calculated provision and the discounted amount included in the first year’s SOCI is added as further expenditure in the new year’s SOCI, known as unwinding the discount rate.

However, more substantial changes occur when the discount rate itself changes – as is the case this year. The Department had already confirmed that, in line with the Treasury’s Finance reporting manual, the pensions discount rate was increasing from 1.8% to 2.9% as of 31 March 2011.

Any amounts previously included in the SOCI will have been overstated compared with the new discount rate (discounted value of £100 paid in one year using 1.8% rate = £98.23, using 2.9% rate = £97.18). The recalculated provision will now be smaller, requiring the difference to be
credited to the SOCI.

Some confusion had arisen as an earlier alert about the change in discount rate had linked to the Treasury’s guidance for departments on valuing pension liabilities. Departments take the decrease in pension liability straight to reserves, rather than through income and expenditure accounts. Although the Department of Health provided the link only to evidence the change in discount rate, some organisations were unsure whether they were supposed to follow the Departmental procedure.

While the Department had originally said that the ‘straight to reserves’ approach was not applicable to NHS bodies, its further clarification has underlined this.