Proposed Pension Rules May Threaten Defined Benefit Plans

The Financial Accounting Standards Board (FASB) announced late last year that it planned to make significant changes in the way companies report pension liabilities, the Associated Press reports. The first step will be to require companies to show on their balance sheets the total assets of their plans in comparison to what is owed to workers. The second step, which could take several years, would require companies to calculate their retirement costs and include them in their profit calculation, the New York Times says.

Current rules require companies to show pension liabilities in the Notes to the Financial Statements, but the information falls short of full disclosure. Firms can “post very positive numbers based on assumptions about investment returns, when the actual returns could hurt their results,” the Times says.

As analysts predict a surge in the number of companies abandoning defined benefit plans, Alcoa joined IBM and Verizon Communications Inc. last week in announcing that they would freeze their pension plans and end pension coverage for new hires. The freeze halts current participants’ benefit accruals. Under the arrangement Alcoa said it will make a contribution of 3 percent of an employee's annual salary and bonus to the employee’s retirement plan ( 401 (k) plan), whether or not the employee contributes to the 401(k) reports. Alcoa said it will also match the first 6 percent of salary that an employee contributes to the savings plan.

The freeze does not affect current retirees, but will usually change retirement economics for older workers who would typically have received benefits based on their last years’ salaries. Exactly who will take the biggest hit differs at different companies because pension plans vary widely, the Times says. The newspaper asked the Employee Benefit Research Institute, a nonpartisan group in Washington, to analyze data, and in general, the research institute found that “if a company freezes a rich pension plan, not only will older workers suffer bigger losses, but more people — and younger people — will be losers than when a company freezes a skimpier pension plan.”

“Not to blame the rules,” David Zion, an accounting analyst with Credit Suisse First Boston says, “but you change the rules and it provides a realization of the real economics.” Zion points to the early 1990’s “when FASB began requiring companies to put a value on retiree health care promises they had made. Within a few years, the number offering those benefits had dropped sharply,” he says in the Times report.

Pension plans are subject to the minimum funding requirements of the pension laws, the IRS says on their web site, and losses must be paid for through increased minimum funding requirements. The Deficit Reduction Contribution (DRC) has seriously affected employers with large underfunded plans, the IRS says, many of whom had had no funding requirement during the stock market boom and were now facing operating losses for other reasons. Congress enacted modest relief, in the Pension Funding Equity Act of 2004, (PFEA) that changed the interest rate on fund liabilities from 30-year Treasury securities to the higher investment grade bond rate and allowed an alternate DRC calculation for companies in the airline and steel industries.

The Pension Benefit Guaranty Corporation (PBGC) conducted a study summarized on their web site that analyzed forms 5500 and concluded that by the end of 2003, 9.4 percent of pension plans had been frozen. Only 2.5 percent of participants were affected, however, because most of the plans were small (with fewer than 100 participants). The Form 5500 data for 2003 showed that frozen plans were not as well funded as non-frozen plans.

The PBGC study indicates that the impact of frozen plans on their financial condition will be mixed. On the one hand, frozen plans are more likely to be terminated, and result in a decline in the number of participants paying premiums. On the other, frozen plans may become better funded as a result of a cap on benefits, and reduce the number of claims against the pension insurance program.

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