Human Capital & Careers

Pension Funding Gap Seen Widening in 2003

With widespread retirement-plan shortfalls looming, FASB contemplates possibility of accounting rule changes.
Stephen TaubDecember 3, 2002

So much for the two-month stock market rally.

The corporate pension crisis is expected to get much worse in the next year or so as the nearly three-year bear market has forced many companies to make contributions to their defined-benefit plans to cover shortfalls and comply with federal laws that protect workers’ pensions.

In 2002, about 30 percent of the plans will require contributions, according to a Watson Wyatt analysis of the financial statements of some of the country’s biggest companies. This figure, though, could more than double to 65 percent in 2003 if current conditions don’t improve.

This compares with just 15 percent of employers that made pension plan contributions in 2000 and 25 percent in 2001.

In fact, Watson Wyatt said only about 40 percent of pension plans had assets in excess of plan liabilities as of January 1, 2002, down from about 85 percent in 2000. If current economic conditions persist, only about 20 percent of plans will have enough funds to fully cover liabilities in 2003, it added.

“Pension funding laws were originally developed to allow employers to budget pension contributions over time with flexibility, so they could fund more in good times and less in bad times,” says Kevin Wagner, a retirement practice director with Watson Wyatt. “But with numerous changes to funding rules over the past 15 years, today’s laws have precisely the opposite effect.”

The benefits-consulting firm points out that current law requires an annual comparison of the market value of a plan’s assets with its current benefit liability.

Here’s the interesting part: if the ratio falls below 0.9, the plan may be subject to additional minimum funding requirements above and beyond “normal” funding requirements. However, if the ratio exceeds 1.0, plan contributions may not be deductible. What a difference 0.1 makes.

As a result of this narrow range, contributions tend to be volatile from year to year. In fact, because of the market’s collapse, many plans went from a situation where they were not eligible for a deduction to one of major underfunding.

“The bottom line is that if employers aren’t given more flexibility in terms of when they can or can’t make pension plan contributions, they won’t sponsor these plans,” notes Wagner in his statement. “Without orderly funding, employers have difficulty managing other important costs, including pay budgets and technology investments. And ultimately, this hurts employees the most.”

To smooth the pension funding process, Watson Wyatt proposes, an employer’s current liability should be based on interest rates in effect as of the date of the plan’s valuation rather than on the current liability based on a four-year weighted average of 30-year Treasury bonds. “This measurement represents a much more accurate measure of the plans’ funded status at the valuation date,” said Wagner.

FASB Mulls Pension Rule Changes

The corporate pension crisis has caught the attention of the nation’s accounting-rule maker.

The Financial Accounting Standards Board (FASB) plans to discuss during upcoming meetings whether to change the way companies must account for pension income and expenses, chairman Robert Herz told Reuters in an interview.

According to Reuters, FASB is reaching out to analysts and fund managers to help determine whether it should add a project on pension accounting to its agenda.

Herz told the wire service that The Financial Accounting Standards Advisory Council (FASAC), which plays a critical role in whether FASB proceeds on major accounting issues, will discuss the pension accounting issue at its meeting this week.

He also said a new advisory council that FASB is forming will discuss the issue later on. This group will be comprised of Wall Street analysts, hedge fund managers, and others who scrutinize financial statements.

However, don’t count on changes anytime soon. Herz conceded in the interview that FASB is not likely to add such a project to its agenda until at least next year.

Clearly if it were only up to Herz, FASB would make major changes. “I’m not too fond of pension accounting,” he told Reuters. “It is complex, it’s somewhat opaque.”

Herz said the key issue would be whether FASB permits companies to calculate pension costs with a “smoothing approach,” in which companies spread pension costs over several years. The reason: current pension accounting permits the use of a long-term rate of return from assets rather than relying on actual returns, and allows companies to amortize gains and losses on investments.