Saturday, May 13, 2006

Defined Benefit Plans-Industry Update

There has been substantial activity over the past quarter related to pension accounting and funding reform. In early March, conferees met to reconcile the Senate and House versions of pension reform legislation. The industry had been anticipating a final bill by April 15 which coincides with the first due date for quarterly plan contributions. At issue is the benchmark rate used to determine contributions. For some plans, that rate would revert to the 30 year Treasury rate instead of the more favorable high grade corporate bond rates. The conferees now concede that the bill will take longer then expected.

The Financial Accounting Standards Board recently released its exposure draft on the reporting of benefit liabilities for public comment. The new disclosure standard, SFAS 132 (Revised), Employers’ Disclosures About Pensions and Other Postretirement Benefits, replaces a previous statement of the same title and number issued in 1998. SFAS 132R, the “new” SFAS 132, retains essentially all of the disclosure requirements of the original but includes new disclosures. The major thrust of the standard is disclosure oriented rather than measurement or recognition oriented. It would require sponsors to make the difference between the fair value of plan assets and the benefit obligation to retirees a balance sheet item, thereby increasing pension plan transparency. Towers Perrin estimated that the Fortune 100 companies would have been required to recognize $331 billion of additional liability according to these rules at year end 2004. Additionally, the draft requires that funds' values be assessed on the same dates as other assets or liabilities.

Phase 2 of the FASB pension accounting project will address all aspects of accounting for pensions and other post retirement benefits. This phase could have a more onerous impact on a company’s earnings, thereby further accelerating plan freeze and termination activity. For now, the impacts relate primarily to balance sheet related debt covenants and possibly employee/shareholder communication for public firms. For Example, the Wall Street Journal estimated that these changes could add $68 billion in unrecorded liabilities to GM’s balance sheet generating shareholder equity of negative $43 billion.[i] If the European experience with this accounting trend is any guide, liability driven investing strategies may begin to creep into the consciousness of defined benefit plan sponsors over the next few years.

If you are considering freezing your defined benefit plan, the Employee Benefit Research Institute performed a study that may be of interest to you. The study, entitled Defined Benefit Plan Freezes: Who’s Affected, How Much and Replacing Lost Accruals was undertaken to determine the level of future contributions necessary to immunize participants from the loss of their future defined benefit accruals. Though there was significant variability in the output based on plan terms, participants circumstances and earnings assumptions, the median annual contribution required to indemnify a participant in a frozen defined benefit plan was estimated to be in the 7% - 8% range (assuming 8% investment earnings).

[i] WSJ, 4/5/06, For GM Pension Accounting Shift Could Dwarf Gain on GMAC Deal

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