Pension Asset Ceiling
February 28, 2025
What is the Pension Asset Ceiling?
The ‘pension asset ceiling adjustment’ sometimes appears in the footnotes to accounts, as an adjustment to the balance sheet value of a pension asset or liability. However, it’s one of those quirky areas of accounting which isn’t well understood…why does a pension asset need a ceiling? And why is it sometimes also applied to pension liabilities?
The aim of the pension asset ceiling is to make sure that a company’s balance sheet properly reflects how the value of any defined benefit deficit or surplus is affected by a pensions scheme’s rules and funding requirements. These rules and regulations can mean that the ‘normal’ calculation of a pension liability or asset – the difference between the fair value of the scheme assets and the present value of the projected benefit obligation (PBO) – is in adequate. This is particularly the case when the scheme rules state that any surplus in the scheme belongs to the scheme members[1], rather than the company.
To explain why this is, let’s look at the two possible effects that an asset ceiling can have on the balance sheet: (i) reducing a pension asset and (ii) increasing the size of a pension liability.
Key Learning Points
- The Pension asset ceiling is used when calculating the difference between the fair value of a pension scheme and the present value of the projected benefit obligation (PBO)
- Ceilings are used when any surplus in a pension scheme is deemed to belong to the scheme members
- If there is a surplus in a pension scheme, it must be disclosed when it belongs to the scheme members, usually in the footnotes of the Financial Statements
- This disclosure is undertaken as the assets are not owned by the company itself
Why is there a Pension Asset Ceiling?
The aim of the pension asset ceiling is to make sure that a company’s balance sheet properly reflects how the value of any defined benefit deficit or surplus is affected by a pensions scheme’s rules and funding requirements. These rules and regulations can mean that the ‘normal’ calculation of a pension liability or asset – the difference between the fair value of the scheme assets and the present value of the projected benefit obligation (PBO) – is inadequate.
This is particularly the case when the scheme rules state that any surplus in the scheme belongs to the scheme members[1], rather than the company.
To explain why this is, let’s look at the two possible effects that an asset ceiling can have on the balance sheet:
- Reducing a pension asset
- Increasing the size of a pension liability
1. Reducing a Pension Asset
The fair value of the scheme assets and the present value of the PBO are volatile numbers. Therefore, at certain points in time, it is possible that the value of the scheme assets will exceed the value of the PBO. If the scheme rules state that the surplus in the pension scheme belongs to the scheme members, rather than the company, then an asset ceiling adjustment is required to prevent the company recognizing a pension asset on the balance sheet; this ‘asset’ doesn’t benefit the company in any way so it isn’t their asset to recognize.
Example 1: Pension Asset Ceiling When Assets Exceed the Value of the PBO
For example, if a pension scheme has assets of 120, the value of the PBO is 100 and the scheme rules state that any surplus belongs to the scheme members then the pension disclosures in the notes would show:
| FV of scheme assets | 120.0 |
| PV of pension benefit obligation | (100.0) |
| Scheme surplus | 20.0 |
| Asset ceiling adjustment | (20.0) |
| Pension asset on balance sheet | 0.0 |
In this example, the asset ceiling prevents the company from recording a pension asset in the balance sheet, as the surplus doesn’t ‘belong’ to the company.
2. Increasing the Size of a Pension Liability
Pension regulation in most countries (including the UK and US) requires periodic assessment of pension scheme funding (typically every 3 years). If the scheme is underfunded, the company is required to commit to additional funding payments over a number of years to eliminate the deficit. This is often referred to as a recovery plan.
However, in the years between the funding assessments, changes in the value of the scheme assets or the value of the PBO may result in the committed recovery payments exceeding the size of the pension deficit. If the scheme rules prevent the company from avoiding these payments AND any surplus in the pension scheme belongs to the scheme members, rather than the company, then the asset ceiling would increase the size of the pension liability to reflect the PV of the remaining recovery payments, as these are now considered onerous payments.
Example 2: Pension Asset Ceiling During a Recovery Plan
Let’s assume a company has scheme assets of 80 and a PBO of 140 at its funding valuation (i.e. a funding deficit of 60). It has agreed to make recovery payments of 20 per year for the next 3 years. The scheme rules state that recovery payments cannot be avoided once committed and any scheme surplus belongs to the scheme members.
A year later, the pension deficit falls to 30 because the company has made its first recovery payment scheme and also because the assets have increased in value. However, the company is still committed to making the remaining recovery payments of 40. The pension disclosures in the notes would show:
| FV of scheme assets | 110.0 |
| PV of pension benefit obligation | (140.0) |
| Scheme deficit | (30.0) |
| Asset ceiling adjustment | (10.0) |
| Pension asset on balance sheet | (40.0) |
So, in this example, the asset ceiling ensures that the balance sheet liability reflects the value of the future pension payments, if this is higher than the value of the scheme deficit.
Why Does the Asset Ceiling Affect Some Companies but Not Others?
There are two reasons for this: firstly, remember that the asset ceiling will only have an effect when the scheme is already in surplus, or the current recovery plan would result in a surplus. This situation is surprisingly common, with many pension assets benefiting from buoyant equity markets, whilst the companies are still locked into punitive recovery plans agreed during the QE program.
Secondly, it’s important to note that the asset ceiling applies only where a surplus ‘belongs’ to the scheme members. If the scheme rules allow the company to benefit from the surplus, then the asset ceiling would not be relevant – hence why the asset ceiling will affect some companies but not others.
There are two reasons for this. Firstly, remember that the asset ceiling will only have an effect when the scheme is already in surplus, or the current recovery plan would result in a surplus. This situation is surprisingly common at the moment, with many pension assets benefiting from buoyant equity markets, whilst the companies are still locked into punitive recovery plans agreed during the QE program.
Secondly, it’s important to note that the asset ceiling applies only where a surplus ‘belongs’ to the scheme members. If the scheme rules allow the company to benefit from the surplus, then the asset ceiling would not be relevant – hence why the asset ceiling will affect some companies but not others.
[1] We have simplified the terminology here – the accounting standard actually refers to whether or not the company can obtain any ‘economic benefits in the form of refunds from the plan or reductions in future contributions to the plan’.
Conclusion
Pension asset ceilings are disclosed so that a company’s balances sheet properly reflects how the value of any defined benefit deficit or surplus is affected by a pensions scheme’s rules and funding requirements. They are used when the difference between the fair value of the scheme assets and the present value of the projected benefit obligation (PBO) is inadequate. Details should always be disclosed in the footnotes to the financial statements when it’s relevant.