FASB, Employers Clash on Pension Metric

Corporations don't like to estimate future employee salary hikes.
David KatzJune 28, 2006

Financial Accounting Standards Board members and the Securities and Exchange Commission’s top accountant sparred with employers and actuaries on Wednesday about whether estimated future pension obligations should be reflected on the balance sheet.

In two roundtable discussions on FASB’s plan to revamp corporate accounting for defined-benefit plans, the recording of pension liabilities was easily the diciest issue. The board proposes that companies should gauge their liabilities by using a projected benefit obligation (PBO) metric that would require them to project salary increases and other costs far into the future.

In the first of two phases of FASB’s proposed overhaul, the board wants plan sponsors to record on their balance sheets the amount their defined-benefit retirement plans are underfunded or overfunded. That funded status would be the difference between the fair value of a plan’s assets and its benefit obligations.

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For pensions, the board wants to ask companies to use their PBOs to gauge those obligations. Many opponents, on the other hand, would prefer that company use an accumulated benefit obligation (ABO). The key difference: ABOs don’t require estimates of future liabilities.

While granting the ABO metric’s flaws—it doesn’t include lump-sum payments to retirees or expenses related to stock-options embedded in cash-balance plans—employers taking part in the roundtable clearly preferred it to PBOs. “In certain circumstances, ABO is too low,” granted Bruce Monte, director of retirement plans for PepsiCo. “But PBO is wrong because of future commitments that have not been earned.”

In many pension plans, outlays for retirees are based on their final average pay. Opponents of FASB’s metric contended that it’s inaccurate to estimate future salary increases because raises aren’t guaranteed. “PBO includes future salary increases that don’t meet the concept of a liability,” said Hugh McCoy, a representative of the Edison Electric Institute, an association of shareholder owned electric companies. The measurement is meant for use in calculating future funding requirements rather than in pension accounting, he argued.

Other participants argued that adding the requirement could move companies to freeze pension plans at current benefit levels. The use of PBO “creates an acting bias in terms of freezing plans,” asserted John Steele, an actuary with Watson Wyatt.

The issue has sparked a schism between actuaries and credit rating agencies, at least one speaker observed. “All actuaries feel PBO is inappropriate; nobody in credit agencies thinks ABO is a good idea,” said William Sohn, chair of the pension committee of the American Academy of Actuaries. Once the board decided to use PBO as the standard measure for liabilities, it would never reopen the issue, the actuary fears.

On the other hand, Scott Taub, the SEC’s chief accountant, contended that it would be against FASB’s mission to refuse to discuss the issue. “That better not be the case because then the board would be guilty of deceiving its constituents,” he said. “If there’s no discussion, that is something we will be watching out for,” he said.

For his part, Taub broadly favored the use of estimates in accounting. The SEC is “concerned by people’s unwillingness to use estimates,” he said. “We’re certainly not looking for each number to be 100 percent exact when you book numbers in your financial statements.”

Arguing against the use of PBOs, Sohn claimed to have the support of most major financial economists, quoting a paper by the prominent Zvi Bodie that asserted that PBO is “not an appropriate measure of the benefits that that the employer has significantly guaranteed.”

In a spirited reply, FASB member Katherine Schipper shot back that many economists do favor the use of PBO. “I see your Bodie and Merton and raise you other ones,” she retorted, referring to economist Robert Merton.