year-end strategies for pension & opeb obligations and expense

The Journal of Corporate Accounting and Finance/Winter 1999 105

Year-End Strategies for Pension & OPEB Obligations and Expense

CCC 1044-8136/99/1002105-14© 1999 John Wiley & Sons, Inc.

Murray S. Akresh and Lawrence J. Sher

Year-End Strategies for Pension &OPEB Obligations and Expense

Murray S. Akresh, CPA, is a partnerin PricewaterhouseCoopers LLP’sGlobal Human Resource SolutionsTechnical Consulting Unit, NewYork. He was a co-author of researchstudies on pensions, retiree healthbenefits and stock options conductedby the firm for the InternationalAccounting Standards Committee,the Financial Executives Institute,the Institute of ManagementAccountants and the NationalAssociation of College and UniversityBusiness Officers. He is a frequentauthor and speaker on benefits-related accounting issues. LawrenceJ. Sher, FSA, EA, is a principal inPricewaterhouseCoopers LLP’sKwasha Human Resource Solutionspractice, Fort Lee, NJ and is the chiefactuary and director of the firm’sNational Actuarial Unit. He is thevice-chairman of the AmericanAcademy of Actuaries PensionPractice Council and a member ofthe Pension Committee of theActuarial Standards Board. He alsois a frequent author and speaker onactuarial and benefit-relatedissues.The authors thank KevinHassan and Jay Rosenberg ofPricewaterhouseCoopers LLP fortheir assistance with this article.

The potential impact of the 1998 decline in long–term interest rates along withthe July to September decline in the equity markets reminded us that employersshould focus on the assumptions, accounting methods, and other strategies beingused for pension and other postretirement benefits (OPEBs) that drive obligationsand expense under FAS’s 87 and 106. Employers will need to assess their discountrates and consider reducing them while also considering changes to other assumptionsfor salary increases, expected return on plan assets, and health care cost trends.Contribution and plan design strategies should be assessed as well. This articlehighlights the important implications of changing year-end assumptions and otherrelated issues, including the impact on funding and Pension Benefit GuaranteeCorporation (PBGC) premiums, and provides employers with an action plan.Even if interest rates rise and the equity markets rebound, the strategies discussedin this article should be considered as part of an effective management plan to dealwith pension and OPEB funding, obligations and expense. ©1999 John Wiley &Sons, Inc.

Under FASB Statement of Financial Accounting Standards (FAS) 87,Employers’ Accounting for Pensions, and FAS 106, Employers’ Accounting

for Postretirement Benefits other Than Pensions, employers must select a discountrate assumption generally based on rates of return on high-quality, fixed-income investments currently available whose cash flows match the timing andamount of expected benefit payments. A related FASB Special Report, A Guideto Implementation of Statement 87 on Employers’ Accounting for Pensions:Questions and Answers (also applicable under FAS 106), makes it clear thatdiscount rates should be reassessed each year and changed to reflect currentinterest rates. In addition, the Special Report indicates that employers shouldgenerally apply a consistent methodology from year to year in selecting theassumed discount rate.

SEC GUIDANCE ON SELECTING DISCOUNT RATESPrior to 1993, many employers changed the discount rate assumptions

infrequently or the change was smaller than technically required by a strict

106 The Journal of Corporate Accounting and Finance/Winter 1999


interpretation of FAS 87 and 106. In light of the significantly reduced interestrates in 1993, the SEC staff began to review the filings of registrants using highdiscount rates. As a result of this increased attention, the SEC staff, in publishedletters and speeches, issued further guidance which calls for the following:

• Discount rates should reflect the current level of interest rates at themeasurement date, following the methodology in paragraph 186 ofFAS 106 for pensions as well as other postretirement benefits. Paragraph186 states (in part) that:

The objective of selecting assumed discount rates is tomeasure the single amount that, if invested at themeasurement date in a portfolio of high-quality debtinstruments, would provide the necessary future cashflows to pay the accumulated benefits when due.

• “High quality” should be defined as debt securities that receive one ofthe two highest ratings given by a recognized rating agency (i.e., AA orbetter).

The SEC guidance has resulted in most companies looking to published AA-rated bond indexes to help them in selecting the discount rate. Some companies,however, use a specific bond matching approach. SEC staff guidance relating tobond matching calls for the following:

• Callable bonds should not be included in any bond matching (orincluded using the yield to the call date)—thereby reducing the yields.

• It is inappropriate to use the yield on a single bond of duration equal tothe benefit obligation duration in selecting a discount rate. Instead, theSEC staff appears to be saying that one should match cash flows to theaverage yield on AA-rated bonds.

• It is not appropriate to average in lower quality bonds with those of highquality (e.g., junk bonds with AAA-rated bonds)

• The objective of paragraph 186 of FAS 106 is to match cash flows toyields on zero coupon bonds. Because most bonds and indexes reflectcoupon bonds, it would be appropriate to make an adjustment (mostprobably upward) to take this into consideration.

The use of AA-rated bonds that are not callable will somewhat reduce theaverage yield to maturity, while the adjustments for longer duration and zerocoupon bonds will tend to increase the yield. Therefore, if a specific bondmatching is performed strictly following the SEC guidelines, it generally willresult in a discount rate that is close to the published AA-rated bond yields.

SELECTING THE YEAR-END DISCOUNT RATEGiven the relative maturity of FAS 87 and 106, we are not expecting any

additional FASB or SEC guidance on the selection of discount rates. However,if interest rates remain low, we expect the SEC staff to once again focus ondiscount rates as of year-end and challenge filings with high discount rates,

The SEC guidance hasresulted in mostcompanies looking topublished AA-rated bondindexes to help them inselecting the discount rate.



especially those companies with September 30 measurement dates. As shownin Exhibit 1, high-quality bond yields at October 31, 1998, were about 25 to 50basis points lower than the rates at the end of 1997 and significantly lower thanrates at the end of 1996. High-quality bond yields at September 30, 1998, wereabout 50 basis points lower than rates at the end of 1997. This decline shouldcause employers to adjust the discount rates being used under FAS 87/106.

The bond market indexes listed in Exhibit 1 should be helpful in selectingan appropriate discount rate. However, three of the indexes presented in the

Exhibit 1. Sample of Published Interest Ratesa

October 31, 1998 September 30, 1998 December 31, 1997 December 31, 1996

PBGC Single 3.75%b 4.00% 4.50% 4.75%EmployerTerminationImmediate AnnuityRate

U.S. Treasury: 5.145% 4.98% 5.93% 6.65%30-year bondsc

High-quality 6.36% 6.16% 6.70% 7.46%corporate bonds:10+ yearsd

High-quality 6.691% 6.524% 7.001% 7.563%corporate bonds:15+ yearse

Moody’s AA Bond 6.78% 6.52% 6.94% 7.47%Indexf

Salomon Bros. 6.87% 6.57% 6.78% 7.49%Duration CurveIndexg

(a) Latest available rates at date of publication(b) Rate obtained October 15, 1998 from PBGC(c) Wall Street Journal or Federal Reserve Statistical Release(d) Wall Street Journal – Merrill Lynch AAA/AA Bond Index(e) Bloomburg Business Service - Merrill Lynch AAA/AA Bond Index(f) Moody’s Telephone Service(g) Salomon Bros. has developed a special cash flow matching curve based on the SEC’s guidance on how to select the discount rate (issuedmonthly). The yield presented here is the discount rate that Salomon Bros. computed as of the date based on applying the curve to a typicalhypothetical plan.

Caution: Since this article was written in November 1998, Exhibit 1 contains bond yields as of October 31, 1998. Employers with aDecember 31 measurement date will need to obtain current bond yield information to properly assess year-end discount rates.



exhibit that employers find most helpful—because they include longer durationhigh-quality corporate bonds—are not widely published. Overall, these indexestend to provide a narrow range of discount rates acceptable under FAS 87/106and the SEC staff’s guidance.

While most employers have looked to high-quality corporate bond yields toset the discount rate, some may look to yields on 30-year U.S. Treasuries. Forthese companies, the impact of changes in these rates may have a more dramaticimpact on the obligation and expense because such Treasury rates have fallenmore than corresponding corporate rates.

Based on past comment letters from the SEC dating as far back as 1993, thestaff may question registrants that select a discount rate that is more than 25basis points above the published AA-rated bond indexes (e.g., above about 6.25to 6.50 percent based on September 30th bond yields and 6.50 to 6.75 percentbased on October 31st bond yields) or that do not change the discount ratesufficiently from the rate used last year. Auditors may also challenge theselection of the discount rate. This will be especially true in situations that arevery material such as those in which a lower rate—along with a possiblycorresponding decrease in the asset value—will trigger a minimum liabilityunder FAS 87 and a charge to shareholders’ equity (see below).

For multinational companies, consideration should also be given to thediscount rates used to measure pension obligations outside the United States.Generally, interest rates worldwide tended to be lower in 1998 and employersmay need to reduce the discount rate for foreign as well as domestic plans. Forcountries (e.g., United Kingdom, Germany) that have automatic pensionindexation, the manner in which the company moves certain assumptions intandem with changes in the discount rate may or may not have a significantimpact on cost. For companies that move the salary scale and underlyinginflation assumptions in tandem with the change in discount rate, changes ineconomic assumptions will have relatively little impact on cost.

FINANCIAL REPORTING IMPLICATIONSThe discount rate selected at year-end is used to measure and disclose

obligations at year-end (including under FAS 87 any additional minimumliability, intangible asset, and reduction in stockholders’ equity). Reducing thediscount rate will generally increase obligations. The increase in the obligationis accounted for as an actuarial loss that will be used in determining 1999expense. For example, a one percentage point reduction in the discount rate willtypically cause a 10 to 15 percent increase in obligations, absent any otherchange in assumptions that may be appropriate to make at the same time (seediscussion below). Thus, reducing the discount rate will probably increase 1999expense, but will have no effect on 1998 expense. However, if the employerremeasured obligations and assets at an interim date during 1998—for example,a plan amendment or curtailment took place—a new (lower) discount ratewould need to be selected as of the remeasurement date, potentially increasing1998 expense for the remainder of the year.

A reduction in the assumed discount rate, along with reduced asset values,may also trigger the FAS 87 minimum liability requirements. Under FAS 87, anadditional liability is recognized when the unfunded accumulated benefitobligation (the excess of accumulated benefits over the fair value of plan assets)

A reduction in theassumed discount rate,along with reduced assetvalues, may also triggerthe FAS 87 minimumliability requirements.



exceeds the balance sheet liability for accrued pension costs. Under this approach,when an additional liability is recorded, an intangible asset is also recognized tothe extent that unamortized prior service cost and/or an unamortized transitionobligation exists. If the additional liability exceeds the total of these two items,the excess is recorded as a charge to stockholders’ equity, net of any applicabledeferred tax benefit under FAS 109, Accounting for Income Taxes. In 1998, thecharge to equity should be presented as part of other comprehensive incomepursuant to FAS 130, Other Comprehensive Income.

Some employers with underfunded pension plans affected by FAS 87minimum liability requirements may be able to eliminate the additional liabilityand the charge to stockholders’ equity through a contribution to the pensionplan (subject to appropriate funding limitations). However, sufficient assetswill need to be contributed before the measurement date (e.g., year-end) so thatthe fair value of plan assets exceeds the accumulated benefit obligation at thatdate. Some employers may be able to contribute the company’s own stock tothe pension plan, thereby conserving cash (subject to the transferabilityrequirement in FAS 87 and the Employee Retirement Income Security Act(ERISA) restriction that a pension plan may hold no more than 10 percent ofits assets in company stock).

Exhibit 2 illustrates the impact of the minimum liability on a hypotheticalemployer. This example illustrates the situation in which the impact of changingthe discount rate is severe.

For some employers, the change in discount rate and possibly reduced asset valuesmay also result in the employer being in default under covenants in debt agreements,as the increase in liabilities and the charge to stockholders’ equity will worsen theemployer’s debt/equity ratio. Employers in this situation may wish to begin discussionsearly with creditors regarding the impact of changing discount rates.

DEVELOPING STRATEGIES TO REDUCE OBLIGATIONS ANDEXPENSE

When faced with the prospect of increased FAS 87/106 obligations andexpense, many employers are seeking effective strategies that will reduceexpense and improve the bottom line. Typically, three areas should be evaluated:

• Actuarial assumptions,• Accounting methodologies, and• Plan design

Note: Later in connection with funding and PBGC issues, some of thesestrategies are discussed again in relation to those issues.

The following discusses strategies related to each of these three areas:

Assess FAS 87/106 AssumptionsWhen reducing assumed discount rates, it is also appropriate to consider

changes to other economic assumptions. FAS 87 and 106 both indicate that allassumptions should be consistent to the extent that each reflects expectationsof the same future economic conditions, such as future rates of inflation. As aresult—while it is generally appropriate to take a long-range view when selectingthe salary increase assumption—a change in assumed salary increases may be

Some employers withunderfunded pensionplans affected by FAS 87minimum liabilityrequirements may be ableto eliminate the additionalliability and the charge tostockholders’ equitythrough a contribution tothe pension plan (subjectto appropriate fundinglimitations).



Exhibit 2. Illustration of FAS 87 Minimum Liability—Impact of Changing Discount Rates

End of Year

1996 1997 1998 *

Discount Rate 7.50% 7.00% 6.25%Accumulated benefit $ (1,200) $ (1,400) $ (1,700)

obligation (ABO)Plan Assets at Fair Value 1,400 1,800 1,600

Overfunded (underfunded) 200 400 (100)ABO

Projected benefit obligation (PBO) $ (1,400) $ (1,600) $ (1,950)Plan Assets at Fair Value 1,400 1,800 1,600

Overfunded (underfunded) 0 200 (350)ABO

Items not yet recognized in earningsUnrecognized net transition

(assets) obligation (16) (12) (8)Unrecognized prior

service cost 6 5 4Unrecognized net

losses (gains) 60 (143) 404Prepaid (accrued) pension cost $50 $50 $50Required Minimum Liability $0 $0 $100

Adjustments Required to Reflect Minimum LiabilityPrepaid (accrued) pension cost $50 $50 $50Record minimum liability 0 0 100

Additional liability 0 0 150Record intangible asset 0 0 4

Charge to equity (pretax) 0 0 146Deferred tax benefit 0 0 58

Net charge to stockholders’equity $0 $0 $88

* In the example shown above, the poor asset performance along with a decrease in the discount rate from 7.00 to 6.25 percent in 1998causes the ABO to exceed the fair value of plan assets by $100. This triggers the FAS 87 minimum liability provisions. Because the balancesheet currently reflects a prepaid pension asset of $50, an additional liability of $150 is needed to bring the pension liability recorded onthe balance sheet to $100. This $150 additional liability is offset by an intangible asset of $4 (equal to the $4 prior service cost) resultingin a pretax charge to stockholders’ equity of $146.

The charge to stockholders’ equity will generally be tax-effected because it results in a temporary difference under FAS 109. Assumingthat a reserve against the deferred tax asset is not needed, the example reflects a deferred tax benefit of $58 (at an assumed tax rate of 40percent) and a net charge to equity of $88. In addition, there would be no impact on the company’s pension expense or net income for1998, but the changes in PBO would affect pension expense and, therefore, net income for the following year.



warranted at the same time discount rates are changed, possibly mitigating, tosome extent, the overall change in obligations and expense. In addition, someemployers may consider changing the expected return on plan assetsassumption—changing this assumption would have no effect on year-endobligations or minimum liability computations, but would impact 1999 expense.

Employers should also reassess their assumed per capita health care costsand their health care cost trend assumptions under FAS 106, either for 1998year-end disclosures or as part of a new actuarial valuation as of the beginningof 1999. It may be appropriate to lower near term trends, the ultimate trend rate,or the number of years until the ultimate trend rate is reached. In addition,employers should review the assumed per capita health care costs used formeasuring FAS 106 obligations. Many employers base 1999 per capita costs onactual health care claim costs that are one or two years old and then adjust forassumed inflation to get to average expected 1999 claims (e.g., using 1996 claimstrended forward at say 9 percent in 1997 and 8 percent in 1998). If actual costshave gone up less than assumed, per capita costs can be remeasured, resultingin a significant actuarial gain (e.g., if actual costs rose only 4 percent in 1997 and5 percent in 1998)—causing a reduction in the FAS 106 obligation and expense.

For defined benefit plans that are cash balance plans, reducing the assumedinterest credit rate may mitigate changes in the discount rate. While cash balanceplans are generally interest rate insensitive because the discount rate and the interestcredit rate (usually tied to Treasury rates) tend to move in tandem, recent movementsin 30-year Treasury yields did not move in tandem with AA-bond yields. Employersshould monitor both yields to assess this important assumption.

It may also be appropriate to adjust the turnover or early retirementassumptions that may mitigate increases in obligations and expense. In timesof economic downturns, changes in employment status tend to occur. Inparticular, cost-cutting measures may be implemented. (There is additionaldiscussion of this topic in the Funding and PBGC issues section below.)

Accounting Methodology ChangesIn order to compute expense under FAS 87/106, an employer must choose

among acceptable alternative approaches with respect to the computation of themarket-related value of plan assets, the manner of recognizing gains and losses,and the measurement date. These approaches are viewed as accountingmethods – once an approach is adopted, it should be applied consistently fromyear-to-year. If an employer wishes to change an accounting method, it willneed to apply the rules in APB Opinion No. 20, Accounting Changes, whichrequires (in part):

• The new method must be viewed by management and the employer’sauditor as being preferable to the old method—generally from aconceptual accounting viewpoint.

• The cumulative effect of adopting the new method should be calculated,based on applying the new method from the initial adoption date of FAS87/106 to the beginning of the year in which the change is made. This“cumulative catch-up adjustment” should be recorded in the currentyear’s income statement, along with the current year’s effect of applyingthe new method.

For defined benefit plansthat are cash balanceplans, reducing theassumed interest creditrate may mitigatechanges in the discountrate.



In many cases, companies may conclude that the effect of a change inaccounting method is immaterial. In Staff Accounting Bulletin Topic 5-F(SAB), the SEC staff provides guidelines with respect to accounting changes notretroactively applied due to immateriality. The SAB states that the cumulativeeffect of such changes should be included in the determination of income (loss)for the period in which the change is made but not as a cumulative effect of achange in accounting principle pursuant to APB Opinion No. 20. Therefore, foran immaterial accounting change, the cumulative catch-up adjustment shouldstill be computed, but it is reported in operating income, not as a separate“below the line” item on the income statement.

With the above accounting rules in mind, the following available accountingmethodology changes may be considered:

Market-related valueMost companies employ a market-related value (MRV) methodology for

purposes of calculating FAS 87/106 expense, whereby asset related gains and lossesare spread over a period of up to five years. The MRV is multiplied by the assumedearnings rate to compute the expected earnings on plan assets. Because of thesignificant appreciation in the equity markets in recent years, most companiestoday have MRVs that are 75 to 85 percent of the fair value of plan assets. As a result,pension expense may be considerably higher than if the fair value of plan assets wasused to compute expense. Therefore, to reduce expense, employers may be lookingat ways to adopt an MRV method that is closer to fair value. Generally, approachesthat move the MRV closer to fair value are deemed to be preferable under APB 20,so long as the new approach is acceptable under FAS 87. However, such approachesmay introduce greater pension expense volatility.1

Change in Manner of Amortizing Gains and LossesAt a minimum, amortization of unrecognized net gain or loss (excluding

asset gains and losses not yet reflected in market-related value) is included as acomponent of net pension cost for a year if, as of the beginning of the year, theunrecognized net gain or loss exceeds 10 percent of the greater of (a) theprojected benefit obligation (FAS 87) or the accumulated postretirementbenefit obligation (FAS 106), and (b) the market-related value of plan assets.The minimum amortization is generally over the average remaining serviceperiods of active employees expected to receive benefits. Any systematicamortization faster than the minimum amortization is also permitted.

If there are significant deferred gains, companies will review theiramortization methodology to determine what can be done to accelerate gainrecognition. Faster gain and loss recognition is generally deemed to be morepreferable. However, such approaches may introduce greater pension expensevolatility.

Change the Measurement DateFAS 87 and 106 allow the use of a measurement date that is up to three

months prior to year-end. Changing the measurement date from a date priorto year-end to a date that is closer to year-end is generally considered preferable,so employers seeking to use an earlier measurement date may find that theirauditors disagree with the change.

Most companies employ amarket-related value(MRV) methodology forpurposes of calculatingFAS 87/106 expense,whereby asset relatedgains and losses arespread over a period of upto five years.



Plan Design ChangesAs part of an assessment of overall human resources and financial objectives,

management may wish to consider making changes (or accelerating alreadycontemplated changes) to the design of its pension and/or OPEB plans. On thepension side, while ERISA does not permit a reduction in pension benefitsearned to date, it may be possible to reduce future accruals and related FAS 87expense. For example, a change in the design of the plan from a final average payplan to a cash balance plan could both reduce the level of annual expense andexpense volatility due to interest rate swings.

With respect to OPEBs, it is often possible to reduce FAS 106 expense byadopting “negative” plan amendments, reducing the level of promised benefits.Such amendments may include capping the benefit promise, changing eligibilityprovisions, or increasing the share of the cost borne by retirees. Employersshould assess related human resource, retiree relations, and communicationsissues before implementing any changes to plans.

Under FAS 87/106, plan amendments are accounted for as of the approvaldate. Generally, this is the date when the highest level of management necessaryto make the change approves the amendment to the plan—not the effective dateof the change. Thus, a negative plan amendment approved mid-1999 willreduce expense for the remainder of 1999, even if it is effective at the beginningof the year 2000. Note that certain design changes may also result in a plancurtailment to be accounted for under FAS 88/106.

Plan Funding and PBGC-Related ActivitiesImplications of Changing Economic Conditions

Minimum required contributions for 1999 may be much larger than thosedetermined for 1998 due to changes in the economic climate noted above. Thefollowing conditions may develop:

• Amortization of experience loss—The investment experience for 1998may not produce the sizable gains that were typical of previous years.Thus, adverse experience due to unfavorable turnover or retirementpatterns, payment of lump sums at low interest rates, and salaryincreases may produce a net experience loss for the first time in severalyears. The amortization of this experience loss normally over a periodof five years will begin in 1999.

• Requirement to pay additional funding charge—Current IRS rulesrequire that the contribution made for the year must be at least enoughto improve the funded position of the plan with respect to the plan’s“current liability” (i.e., essentially the present value of accrued benefitsmeasured using a prescribed mortality table and an interest rate withina prescribed range). A plan is exempt from the additional fundingrequirement if its assets are at least 90 percent of the current liability atthe beginning of the 1999 plan year, or at least 80 percent for 1999, andwas at least 90 percent in both 1997 and 1998 or both 1996 and 1997.

The combination of the lower yields on 30-year Treasuries and thescheduled decrease in the upper limit on the prescribed interest ratefrom 106 to 105 percent of the weighted average Treasury yield willreduce that upper limit by about 60 basis points from 1998 to 1999. This

Under FAS 87/106, planamendments areaccounted for as of theapproval date.



reduction will increase the current liability used in the test for exemptionby about 5 to 10 percent. Such increase may not be offset by acomparable change in valuation assets. If the conditions for theexemption are not met, the minimum required contribution may beincreased so that it would reduce the unfunded current liability by asufficient amount.

• Higher full funding limitations—The Internal Revenue Code doesnot require an employer to make a contribution to its plan when itwould be expected to have the plan’s assets exceed its accruedactuarial liability at the end of the year (be “overfunded”). If anemployer has had assets well in excess of its liabilities for the pastseveral years, it may have enjoyed a contribution holiday thatwould eventually expire as the accrual of additional benefits by planparticipants uses up the excess assets. The experience during 1998may significantly reduce or eliminate this overfunded position. Inaddition, a plan is not considered to be fully funded at the end of theyear if its expected valuation assets are not at least 90 percent of itsexpected current liability. With the decrease in the current liabilityinterest rate, this “90 percent override” may come into play, therebyincreasing the required contribution to the plan.

Other implications of the changing economic conditions include thefollowing:

• Higher PBGC premiums—Employers may have larger variable ratepremiums to pay to the PBGC for 1999 because of the lower requiredinterest rates and lower assets in effect at the end of 1998. Someemployers may have been able to avoid these payments by makingcontributions to the plan during the preceding year at least equal to thefull funding limitation. With the potential increase in the full fundinglimitation for 1999 noted above, that exemption may be lost in the year2000.

• Financial reporting to the PBGC—If the plan sponsor’s corporategroup has an aggregate unfunded vested liability (determined usingPBGC mandated assumptions) of $50 million at the end of a fiscal year,the group will be required to submit company financial informationand plan actuarial information to the PBGC (generally by April 15 forcalendar fiscal year companies).

• Reporting to plan participants—If the plan must pay a variable ratepremium for 1999 and does not satisfy the exemption for theadditional funding requirement noted above for either 1998 or1999, the plan administrator must issue a notice to plan participantscontaining information regarding the plan’s funded status and thelimits on benefits that are guaranteed by the PBGC if the plan wereterminated.

Possible ActionsThere may be courses of action to take now in order to mitigate these

funding and PBGC-related effects.

Employers may havelarger variable ratepremiums to pay to thePBGC for 1999 because ofthe lower requiredinterest rates and lowerassets in effect at the endof 1998.



• Make additional contributions for the 1998 plan year—Recognition ofadditional contributions for 1998 will increase the plan assets recognizedfor the test for exemption for the additional funding charge and thecalculation of PBGC premiums. It may also reduce the full fundinglimitation for purposes of determining whether the full fundingexemption for PBGC variable rate premium purposes for the year 2000applies. The additional 1998 contributions could represent advancedeposit of amounts that otherwise would be made with respect to 1999.

Care should be taken in determining the best time for actual depositof the contribution. As noted earlier, only contributions made prior tothe end of the fiscal year may be used to determine whether anyadditional minimum liability is necessary for FAS 87 purposes. Generallyin this situation, such contributions would be subject to the deductiblelimits for 1998. However, contributions made during the 1999 taxableyear and prior to filing the 1998 return could be deducted in either the1998 or 1999 taxable years. Contributions deposited up to 81/2 monthsafter the end of the 1998 plan year could be designated as 1998 paymentsin minimum funding calculations independent of the treatment affordedsuch contributions for tax deduction purposes. If these amounts arecontributed prior to the due date for quarterly installments and are inexcess of the amount otherwise necessary to meet 1998 minimumfunding levels, they could also be used to satisfy the quarterly contributionrequirement for 1999.

• Change funding actuarial methods or assumptions for 1998 or 1999—Changes in methods and assumptions for the 1998 plan year may havethe effect of lowering the full funding limitation so that the companycan qualify for the exemption from PBGC variable rate premiums for1999. For example, a change in asset valuation method may result in asubstantial reduction in the full funding limit. Unless a change infunding method meets the requirements for automatic approval underRevenue Procedure 95-51, a request for IRS approval of the change inmethod generally must be filed before the end of the plan year in whichsuch change becomes effective. An undesirable effect of such change inmethod may be to substantially increase the amount of experience lossto be amortized in the year following the change, if the method willaccelerate recognition of future years’ investment performance orremove the cushion of historical investment gains that have yet to berecognized under the current method.

It may also be appropriate to review all actuarial assumptions forreasonableness. For example, there may be some conservatism builtinto the assumption set that may no longer be deemed appropriate.Thus, it may be possible to reduce liabilities measured for funding/PBGC purposes as a result of a change in assumptions. Any review ofassumptions should take into account the following:

- Lower rates of inflation and high real rates of return on assets havepersisted for several years, perhaps indicating a fundamental shiftin economic conditions that should be reflected in actuarialassumptions developed by using an expected average long-term

Unless a change infunding method meets therequirements forautomatic approval underRevenue Procedure 95-51,a request for IRS approvalof the change in methodgenerally must be filedbefore the end of the planyear in which suchchange becomes effective.



inflation rate. For example, the spread between the assumed rateof investment return and assumed future rates of salary increasesmay be widened to recognize these trends. There may have beenrecent changes to the covered workforce as a result of resizing, earlyretirement windows, etc. that could alter one’s view as to theanticipated demographic experience for the future.

- The Society of Actuaries published new group annuity mortalitytables in 1995, together with a discussion of the issues to considerin using the tables, and a study of retirement and turnover experiencefor large corporate pension plans. Actuaries must also comply withStandard of Practice No. 27 relating to the selection of economicassumptions.

- IRS approval for changes in assumptions that significantly reducecurrent liability is required where the plan sponsor maintains (ona controlled group basis) pension plans having unfunded vestedliability as of the end of the preceding plan year in excess of $50million.

• Use the PBGC alternative calculation method for variable ratepremiums—The PBGC permits use of two methods for determiningthe variable rate premium. The first, known as the general rule, requiresa valuation to determine unfunded vested benefits to be made usingdata, including asset values, as of the last day of the preceding year (orthe first day of the premium payment year). The second procedure, thealternative calculation method, estimates the unfunded vested benefitsas of the end of the preceding year using the results of the valuationperformed for the preceding year and projecting them to the end of thatyear on an estimated basis.

If plan experience during 1998 is poor, using the alternativecalculation method to determine unfunded vested liability may lowerPBGC variable rate premiums for 1999. Under this method, theactuary uses the results of the 1998 valuation as the basis for determiningthe unfunded vested liability used to pay 1999 premiums. However, beaware that the PBGC regulations indicate that an actuary must adjustsuch results to reflect the effects of any significant events that occurredsince the last valuation date.

• Changes in plan structure—As discussed earlier, an employer mayconsider a change to the provisions of its pension plan that is anticipatedto reduce total costs. The employer may want to accelerate the effectivedate of the change to provide relief to the annual funding requirement.Generally, if the changes are not adopted before the beginning of theplan year, the expected reductions in cost may only be recognized on apro-rata basis during 1999. Because any such plan amendment isprohibited from reducing the level of accrued benefits for any employee,there should not be any material impact on current liability and PBGCpremium payment determinations for 1999, regardless of effective dateof the plan change.

An employer that has a significantly overfunded pension plancould reduce overall short-term funding requirements and PBGCpremiums by merging that overfunded plan with one which is unfunded

Generally, if the changesare not adopted before thebeginning of the planyear, the expectedreductions in cost mayonly be recognized on apro-rata basis during1999.



so that the combination after the merger would still have assets in excessof liabilities, thereby eliminating the minimum contributionrequirement and variable rate premium obligation of the unfundedplan.

MANAGEMENT ACTION PLANIn light of the requirements of FAS 87/106 and the SEC staff concerns,

employers should assess the discount rates to be used for measurements underFAS 87/106—as well as other important assumptions, design and methodologychanges and related disclosures—both for year-end disclosure and thedetermination of 1999 expense. In addition, funding and PBGC-relatedchanges should be considered. Modeling of alternative assumptions andapproaches will be helpful in management’s evaluation of an appropriatecourse of action.

We believe that the action plan presented in Exhibit 3, tailored to eachcompany’s specific facts and circumstances, will provide an effective means ofdealing with this significant issue. ♦

Exhibit 3. Action Plan For Employers

Step One—Modeling• Select alternative discount rate assumptions for both domestic and foreign

plans• Consider other assumption changes that may be appropriate in light of

declining interest rates and health care costs (e.g., salary increase assumption,expected return on plan assets, health care cost trend rates and turnoverassumption) and assess sensitivity to alternative assumptions

• Evaluate effect of current economic conditions on funding and PBGCpremiums

• Estimate obligations and expense under FAS 87/106 using revisedassumptions

Step Two—Analysis and Disclosure• Evaluate possible reduction in stockholders’ equity due to FAS 87 minimum

liability and its impact on debt/equity ratios or other covenants in debtagreements

- If potential default may occur, consider discussing issue with creditors- Consider additional funding before measurement date to eliminate

minimum liability (i.e., so that fair value of plan assets would exceedaccumulated benefit obligation)

• Consider impact on budgets and forecasts due to projected increase inexpense for coming year(s)

• Consider other strategies to reduce expense, including alternativeaccounting methodologies and plan design changes

• Consider appropriate funding and PBGC-related changes



NOTE1. Additional discussion of MRV issues and related accounting changes are included in “Pensionand OPEB Accounting: Time for a New Look at Market-Related Values” which was published inthe Winter 1997 issue of the Journal of Corporate Accounting and Finance.

year-end strategies for pension & opeb obligations and expense

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