pension fund perspective: accounting for pension funding
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CFA Institute
Pension Fund Perspective: Accounting for Pension FundingAuthor(s): Patrick J. ReganSource: Financial Analysts Journal, Vol. 35, No. 6 (Nov. - Dec., 1979), pp. 6-7Published by: CFA InstituteStable URL: http://www.jstor.org/stable/4478281 .
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by Patrick J. Regan, BEA Associates, Inc.
Accounting For Pension Funding This year marks the fifth anniversary of the passage of the Employee Retire- ment Income Security Act, and the ac- counting profession is finally addres- sing the issue of how employers should account for pension costs and unfunded liabilities. For more than four years now, the Financial Accounting Stan- dards Board's (FASB's) Pension Task Force has been working on the first half of the project-accounting and report- ing by defined benefit pension plans. It disseminated an exposure draft in April 1977 and a revised exposure draft in July of 1979 and should issue a final statement before the end of the year.
The second half of the project in- volves accounting by employers for pensions, and the major controversy centers on the computation of pension costs and unfunded liabilities and whether or not the latter should appear on the employer's balance sheet. The FASB staff and the Pension Task Force met to discuss the subject in September, in preparation for an issue paper. The Board expects to issue a discussion memorandum by mid-1980; this will be followed by a public hearing some time between October and the end of the year, issuance of an exposure draft be- tween April and mid-1981 and adoption of a final standard in late 1981 or early 1982. In the intervening two years, companies will continue to follow Ac- counting Principles Board (APB) Opin- ion No. 8 in reporting and disclosing their pension costs and unfunded liabilities, despite the fact that Opinion No. 8, which was adopted in 1966, has an income statement orientation, whereas ERISA is more balance-sheet oriented.
APB Opinion No. 8 solved a major problem of the 1950s and the 1960s- the fact that funding policies were en- tirely discretionary, with many com- panies varying their contributions ac- cording to their level of profits. If its profits were low, a company could re- duce or even eliminate its pension con- tributions. The Accounting Principles
Board felt that contributions should not be totally discretionary. They estab- lished certain minimum and maximum requirements, dependent on the actua- rial methods used by the firm.
Opinion No. 8 requires disclosure of the pension expense, the unfunded vested benefits and the impact on in- come of changes in the actuarial as- sumptions or funding methods. While such changes also affect the present value of the pension liability, this figure was of so little interest in 1966 that Opinion No. 8 did not require disclo- sure of unfunded past service costs or the impact of actuarial changes on un- funded vested benefits.
Over the last 13 years, the emphasis has shifted from pension costs to un- funded liabilities. Inflation has been a key factor in this shift: Because most plans are of the "final pay" variety, permitting benefits to escalate with sal- ary increases, unfunded liabilities have grown substantially. Poor investment performance and demographic trends have compounded the problem. The lat- ter will continue adverse, as the popula- tion ages and fewer active members work to support the inactive. For exam- ple, persons over 65 made up 5.4 per cent of the U.S. population in 1930, 9.2 per cent in 1960 and 10. 8 per cent in 1977. Furtherrnore, the figure is ex- pected to grow to over 22 per cent in the next 50 years.
The major factor responsible for the shift in interest from pension costs to liabilities has been ERISA itself. ERISA makes the plan sponsor legally responsible for the contributions and unfunded obligations of a defined bene- fit plan. Prior to ERISA there was some justification for accountants viewing unfunded pension obligations as "con- tingent" liabilities; the sponsor could always terminate the plan and walk away. Under ERISA, the sponsor would be liable to the Pension Benefit Guaranty Corporation (PBGC) for the lesser of the unfunded guaranteed bene- fits (which approximate the unfunded
vested benefits) or 30 per cent -of its own net worth.
The FASB had no doubt been waiting to see if the PBGC would develop the contingent employer liability insurance program outlined in ERISA. Now that the PBGC has come out against such a program, and has even gone so far as to recommend that the 30 per cent of net worth ceiling be lifted, it is clear that ERISA has transformed pension liabilities into corporate liabilities.
Amending Opinion No. 8
How can APB Opinion No. 8 be amended to reflect the new realities of pension funding? To begin with, com- panies should be required to include in their disclosure of retirement costs a breakdown of their contributions to company-sponsored pension plans, multi-employer pension plans, profit- sharing plans and plans covering foreign employees. The unfunded lia- bility relates to the company's own pen- sion plan. Under ERISA, the company can also be held responsible for its share of the unfunded liability of a multi- employer plan to which it has contri- buted; the existence of such contribu- tions should be disclosed in the notes to the financial statements. There are no unfunded liabilities in profit-sharing plans, and the funding of foreign pen- sion plans differs considerably from that of domestic plans; a breakdown of contributions to these types of plan is essential for analysts who want to relate annual pension costs to unfunded liabilities.
Actuaries and corporate planners focus on pension costs as a percentage of covered payroll. A complete disclo- sure of this figure, including the number of active and inactive members covered by the pension plan, as well as the appropriate payroll figure and the total benefits paid during the year, would be desirable. With such data, an analyst can determine the maturity of a plan by calculating the active-to- inactive ratio and the contributions-to-
6 O FINANCIAL ANALYSTS JOURNAL / NOVEMBER-DECEMBER 1979
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benefits ratio. He can also examine the growth of contributions relative to payroll in order to predict better the impact of new labor contracts.
The FASB will probably correct most of the deficiencies of APB Opinion No. 8 by adopting new disclosure require- ments for pension assets and liabilities (as discussed in the Accounting for Fi- nancial Analysis column in the last issue of this journall). Sponsors would have to state pension assets at market value, disclose the actuarial value of vested benefits and explain any changes in assets (including unrealized gains and losses, investment income, con- tributions, benefit payments and ex- penses) and benefit values (including changes in actuarial assumptions and plan amendments). With this kind of input, the analyst could calculate assets and liabilities per employee, judge which plans were well funded and de- termine the sensitivity of contributions and unfunded liabilities to changes in the investment portfolio.
Perhaps the most heated debate fac- ing the FASB will be over whether the sponsor's balance sheet should reflect the unfunded pension liability. This should in truth be a non-issue for analysts, who can always reconstruct the balance sheet for themselves, given the appropriate data.
Readers with suggestions on how the pension costs and liabilities of plan sponsors should be handled can write to Mr. Terry Mortimer, Pension Task Force Chairman, Financial Accounting Standards Board, High Ridge Park, Stamford, Connecticut 06905. A
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FINANCIAL ANALYSTS JOURNAL / NOVEMBER-DECEMBER 1979 0 7
(1) William C. Norby, "New Exposure Drafts on Defined Benefit Pension Plans," Financial Analysts Journal, September/October 1979.
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