Retirement Townhall Adds to Debate on Pension Accounting

Posted on March 25, 2011 by Susan Mangiero

In "New reporting trend may ultimately put pain in rearview mirror" (Retirement Townhall, March 23, 2011), Milliman Inc. executive Bart Pushaw cites "Big Baths and Pension Accounting" by Susan Mangiero (March 9, 2011) and "Rewriting Pension History" by Michael Rapoport (Wall Street Journal, March 9, 2011) in his discussion about pension plan reporting reform. Specifically, Pushaw talks about the convergence of U.S. Generally Accepted Accounting Principles ("GAAP") with international standards and the likelihood that plan sponsors' earnings "would be automatically increased, and expenses decreased, for future years" because of accelerated "hits" when performance is poor. He adds that a move towards more realistic representation of the funding status of a particular defined benefit plan will encourage the use of liability driven investing ("LDI") as a way to "avoid the significant mark-to-market hits that are expected in the future."

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Big Baths and Pension Accounting

Posted on March 9, 2011 by Susan Mangiero

According to "Rewriting Pension History" by Michael Rapoport (Wall Street Journal, March 9, 2011, several large multinational corporations are changing the way they report retirement plan numbers. The goal is to stop smoothing losses and gains and instead have current year earnings reflect the full extent of what is owed (or available as a surplus).

Cynics might describe this strategy as a "big bath" approach. Report pain all at once and therefore be able to report higher earnings the following year. On a more benign note, companies may simply want to provide more transparency to their investors, especially at a time when lots of questions are being asked about the costs associated with providing retirement benefits to current and past employees.

Assuming good intentions, recognizing the pension deficit (surplus) in the year in which it occurred may still not provide accurate information about the true economic costs associated with servicing a traditional pension plan. There are many reasons why a comparison of the non-smoothed pension gain or loss for two or more companies could differ, sometimes dramatically. Consider the following.

  • Reported numbers that are based on accrual accounting do not necessarily reflect the actual cash flowing out (in) the door. Investors will still have to assess whether the sponsor can readily access cash to meet its pension obligations and at what cost.
  • Assumptions about factors such as wage hikes, cost of living adjustments, mortality, return on assets and risk exposure given a particular asset allocation mix can and do vary across companies. Unless a prospective or existing investor can assess whether underlying assumptions make sense, it is difficult to know if reported numbers are too low or too high, relative to economic reality.
  •  A year-by-year analysis of reported earnings is going to be hard to render without making some adjustments to past financial statements. Hopefully companies that use current accounting methodology for their 2010 books will provide sufficient information for investors to be able to compare "apples to apples."
  • Actuarial numbers used for compliance with the Pension Protection Act of 2006 could still vary, perhaps materially, from reported current year numbers, causing confusion for investors and creditors as to which number is "right."
  • For those companies that are infusing their defined benefit plans with massive amounts of cash, it would be helpful to understand how enterprise value is impacted as a result since that cash cannot be used for product development, dividend payments and so on.
  • For those executives who receive earnings-linked compensation, there are questions about how their respective bonuses will be computed in the year of the big bath versus the following years. The concern for investors is that executive compensation might be too "generous" later on due to this year's accounting decision versus a growth in operating earnings.

As described in "The Plan That Didn't Bark" by Susan Mangiero (CFA Magazine, March/April 2008), quantity is not the same thing as quality. Investors may be provided new and arguably more information about pensions and still be in the dark about the true encumbrance associated with an underfunded plan.

The same "clear as mud" dilemma that confronts investors of ERISA plan sponsors likewise applies to public pension and health care plans. According to Dr. Michael Kraten, an accounting professor with Providence College and president of Enterprise Management Corporation, "There are no requirements in the MD&A sections of the annual reports of the health plans to disclose and/or discuss detailed 'churn rates' of the subscriber base, 'turnover rates' of the provider base or the quality of care 'outcomes data' of the network itself."

More than a few individuals have called for a separate financial report for each retirement and health care benefit plan sponsored by a particular company or government. There are distinct advantages of that approach as long as uniform reporting standards are used and the accounting numbers are as close as possible to economic losses (gains). On the flip side, treating the benefit plans as separate and distinct makes it difficult, perhaps impossible, for a firm to manage risks across the enterprise.

That's a significant discussion for another day...

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New Pension Investment Disclosure Rules a Reality

Posted on July 17, 2008 by Susan Mangiero

Unhappy auditors and plan sponsors may be roaring in response to the outcome of yesterday's FASB board meeting. In case you missed it, Norwalk-based accounting rulemakers opine in favor of enhanced asset risk disclosures. Despite industry arguments to the counter, FASB concludes that benefits outweigh costs, citing credit-related large losses as a factor in their decision to enhance plan transparency.

As stated in our July 15, 2008 post ("FASB Meets to Unlock Pension Investment Risk Information"), critics offer that FAS 132(R) compliance entails time-consuming data collection and analysis, across asset categories and fund managers and, in some cases, for multiple corporate entities. According to CFO.com reporter Marie Leone, FASB chairman Bob Herz (himself a former pension fiduciary) favors layers of information. A plan that allocates four out of every ten dollars to equities would be asked to disclose industry and sector concentrations as follows:

  • 40% in equities
  • 25% of that 40% in pharma
  • 50% of that 25% in high-growth pharma stocks.

Leone adds that FASB board members unanimously dismissed the need for a materiality guidance rule, also concluding that "drilling down to the underlying assets that make up mutual funds, trusts, and fund of funds was not necessary" as long as qualitative text is provided to financial statement users. Click to read "One Step Forward on Pension Disclosures" by Marie Leone (CFO.com, July 16, 2008).

Click to access the FASB audio file for "Disclosures about plan assets" (July 16, 2008 FASB board meeting). Noteworthy is the discussion about what constitutes an "optimal" level of granularity, while acknowledging that some fund managers are VERY reluctant to say too much about how they invest.

Call me circumspect but one wonders whether point in time qualitative information would be better replaced with a description (even if somewhat broad) of risk management and valuation policies and procedures for (a) the plan sponsor and (b) external money managers, respectively.

Process is extremely important. An investment may not return much over a given period(s). However, if financial statement users know that a plan sponsor (and/or asset managers, in the case of outsourcing the investment function) is regularly measuring and managing risk, there may be less angst on the part of nervous beneficiaries and shareholders.

What an interested party does not know (and can't control or influence as a result) is a sure way to lose sleep.

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FASB Meets to Unlock Pension Investment Risk Information

Posted on July 15, 2008 by Susan Mangiero

The Financial Accounting Standards Board ("FASB") meets on July 16, 2008 to discuss how much investment-related information pension plans should disclose to the public. Following the "exposure" of Statement 132(R) on March 18, 2008, industry participants weigh in about the feasibility of compliance. In its 17-page summary of comment letters, FASB notes disagreement among respondents with respect to the need for asset categorization. Some suggest the use of Form 5500 as a guide to the proper delineation of asset investment risks. (As mentioned elsewhere in this blog, we take issue with the Form 5500 as a meaningful guide for economic risk assessment purposes.) 

Surprising to this blogger, only one other organization (Eli Lilly) besides Pension Governance, LLC comment on the need to better understand a reporting entity's process. In our May 2, 2008 letter, we suggest  that accounting rules "require plan sponsors to describe how it decided on a particular concentration, who monitors the concentrations, what triggers a breach, and what happens when a concentration is exceeded."

Regarding fair value, several companies aver that such disclosures would "provide little information to users because annual postretirement benefit cost is based on the expected return on plan assets rather than the actual return." In stark contrast, note that the U.S. Department of Labor is holding hearings today about "hard to value" assets held by ERISA plans.

More than a few respondents claim that the costs of gathering, and then analyzing, requisite information will outweigh the benefits, especially for those companies with geographically dispersed benefit plans. Others cite problems related to assets held by "multiple trustees in pooled asset accounts" whereby the "look through" process cannot be done by a "trustee with partial information, and the employer may not have the skills or proper information to do so."

A key question remains - If something like FAS 132(R) is not adopted, what do critics propose in its place? At a time when more and more plans allocate monies to complex securities and/or funds with less than full transparency, is it sufficient for fiduciaries to simply say "trust me" and assume that disclosure of investment risk is unwarranted? That may be a lot to ask of plan participants who are already nervous about their financial futures.

Editor's Notes: Click to read "Postretirement Benefit Plan Asset Disclosures - Comment Letter Summary" (FASB). Click to access comment letters submitted by various organizations (including Pension Governance, LLC) about "Employers' Disclosures about Postretirement Benefit Plan Assets."

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