FTSE 350 companies may be collectively overstating or understating their pension liabilities by as much as £40 billion.
According to data analysed by the global consulting, outsourcing and investment services provider Mercer, at 31st March, the long-term price inflation assumptions of the FTSE 350 varied by 0.8% from 2.6% to 3.4% a year.
The discrepancies are caused by the current uncertainty in the price inflation assumption underlying the calculation of pension scheme liabilities.
The effect of the price inflation assumption, alongside uncertainty in other assumptions, illustrates the difficulties in determining whether share price valuations effectively reflect the impact of pension liabilities.
Warren Singer, principal at Mercer, said: “Either extreme could be right but most companies’ inflation assumptions are currently somewhere in the middle. However, there is no economist consensus on the changing nature of UK inflation over the next 5 years, let alone for the decades over which pension benefits are paid, so the difficulty is obvious.”
Mercer’s analysis suggests that, while this level of volatility will be due partly to the market trying to settle on a price for long-term inflation expectations, it is likely to be exacerbated by other market influences that have little to do with inflation.
Mercer believes the difference between the market price for long-term inflation and the underlying inflation expectations will depend on the time period being considered and will vary from month to month.
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