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Accounting Rulemakers to Mull Broad Changes to Pensions

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Accounting Rulemakers To Mull Broad Changes To Pensions
April 19, 2004 3:54 p.m.

NEW YORK -- Companies could be required to mark their pension plans to market under a project being considered this week by accounting rulemakers in the U.S. and Europe.

Though not certain to be adopted, the effort has already become a hot-button issue for actuaries, pension advisers and chief financial executives, who say it would make financial statements far more volatile.

At a meeting in London on Thursday and Friday, the Financial Accounting Standards Board of Norwalk, Conn., and the International Accounting Standards Board, based in London, will consider whether to add the pension project to an agenda of joint projects. They are also studying whether to collaborate on issues outside of the pension realm.
If adopted, the project could result in the most profound changes in decades in the way companies account for traditional retirement plans. Though its scope remains unsure, its opponents are alarmed by the prospect that rulemakers could go so far as to require marking to market.

"Opening up pensions is likely to be at least as controversial as the project to expense employee stock options," said Pat McConnell, an accounting analyst at Bear Stearns Cos. (BSC)

Since the 1980s, employers have used a method known as "smoothing" to amortize pension gains and losses over a period of several years. The approach lets them tinker with their financial statements to level the hills and valleys their plans may experience. As a result, investors have little sense of how a corporate pension plan - which can be worth billions of dollars - is faring in markets, and how it may be affecting cash flow.

Marking pension plans to market would require companies to display those hills and valleys in their income statements.

"A client has $10 million in pension expense," said Scott Sustman, a partner in the Houston office of Ernst & Young LLP's Human Capital Practice. "Let's say that for the $10 million, they recognized a million dollars worth of actuarial losses. They can amortize that expense over 15 years under current rules. By removing the amortization, it could more than double expense in a given year."

Sustman is monitoring the possible joint project, and beginning to alert clients to the potential implications of adopting new standards.

Though companies haven't launched a concerted campaign against marking to market, a number say they don't like it. For example, General Motors Corp. (GM), which sponsors the largest private pension plan in the U.S., argues that it's not appropriate to take the approach, given that pensions are long-term investments that don't live or die on market fluctuations in the short term.

"We do not believe that marking to market pension assets would be appropriate, because it would introduce volatility into the income statement and provide less clarity to investors," said Jerry Dubrowski, a spokesman for GM.

A wide-ranging report published recently by the Committee on Investment of Employee Benefit Assets, an employer group, said the possible shift to a mark-to-market approach is one of several factors that could push companies to phase out traditional retirement plans. And Barry S. McInerney, who heads the U.S. practice of Mercer Investment Consulting, a unit of Marsh & McLennan Cos. (MMC), wrote in a recent paper that the change could prompt a stampede by pension plans out of equities and into bonds.

"I think the implications are that defined benefit plans could go by the wayside," said Colleen A. Sayther, president and CEO of the Financial Executives International, a group of chief financial officers, treasurers and comptrollers. "There's a risk of that, mainly because we would be called upon to talk about our earnings with all the volatility associated with our pension plans in there."

Analysts say that if the project doesn't get the green light this month, it could be years - or never - before rulemakers consider a comprehensive review of pension accounting again.

Jim Leisenring, a Norwalk-based IASB liaison to FASB, said the timing of the decision will likely unfold over the next few months.

"It's not going to get on the agenda in April, but that doesn't mean it won't go on in June," Leisenring said. "This is the first step in attempting to unify the agendas."

In fact, the U.K. has already switched to a mark-to-market approach, and IASB has a limited, short-term pension project on its agenda that could bring it close to the new U.K. accounting, which takes gains and losses out of the traditional income statement and puts them into another category known as "other comprehensive income."
Observers agree that if the rulemakers take on the project, it will likely become a hugely political issue, with companies fighting hard to block it. Employers are already coping with substantial changes to their traditional retirement plans, including big shortfalls that arose in 2002 and 2003, during the worst funding environment of the past decade.

"I think they would like to go farther, but do it jointly with the FASB," said McConnell, of Bear Stearns. "It's going to be a battle of wills. I think FASB has mixed emotions about opening up this project, still having bruises from the employee stock option project."

Refer to the article above
1. In your view, what are the major problems areas regarding pensions that rule makers must address?
2. The reporting of pension expense must take into account actuarial and other estimates. How are the uses of such estimates and possible impact on earnings volatility similar or different from others found in company reports, for example regarding depreciation and bad debt estimation?
3. It may be argued that most of the relevant pension-related information is found in footnote disclosures and not in the valuations of the financial statements themselves. What advice would you give to a client regarding the ability to better understand the risks and overall importance of pension requirements for a given

4. The FEI president asserts that proposed changes may signal the end of defined benefit plans. What does this mean in general, and what might it mean to your future retirement planning?

The FEI president asserts that proposed changes may signal the end of defined benefit plans. What does this mean in general, and what might it mean to your future retirement planning?

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Solution Summary

This solution reviews the article, "Accounting Rulemakers To Mull Broad Changes To Pensions".

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The objective of the case is to focus on the impeding deliberations on changes to be made to pension rules that would make pension investments more transparent and the managers of the funds more accountable. This case is written before the government has made changes in law. This case also explores the implications of these changes from the perspectives of actuaries, pension advisers and chief financial executives and almost pleads that the changes would have baneful implications. What is significant is that the case does not give the employees perspective on the issue.

The case makes several assumptions; firstly, it presupposes that a unified approach with countries like the U.K. is positive even though it would imply marking to the market. Second, it assumes that marking to the market will expose the hills and valleys in the income statements and somehow this is better than the smoothing that ...

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