Reform Would Mandate Greater Disclosure On Pensions

Companies clutching the remains of pension plans and other benefits paid to retirees may consider loosening their grip and making cuts as momentum for pension reform continues to grow.

Gamzon

IBM last week joined the fold of companies freezing pension plans and steering employees toward defined contribution plans, where costs are more predictable. IBM said it will freeze its pension at the end of 2007 and is redesigning its 401(k) plan by increasing its own match contribution and encouraging more employees to sign on.

Other companies amending their pension plans include Northwest Airlines, Delta, Hewlett Packard, Sears, Motorola and Verizon and more. Still others, most notably United Airlines, have defaulted on pensions and saddled the government's Pension Benefit Guaranty Corp. with the obligations.

“We believe these are prudent and balanced steps at a time of uncertainty and conflicting legislative and regulatory directions about defined benefit retirement plans in the United States,” IBM senior vice president Randy MacDonald said in a statement.

Efforts in Washington to clarify that uncertain regulatory climate, as well as pressure from investors, will likely lead to further cuts in or elimination of defined-benefit pension plans and retiree health benefits, experts say. “Everything will be on the table now,” says Sheldon Gamzon, a principal in the retirement practice of PricewaterhouseCoopers HR Services—even, he adds, for companies that have worked to protect pension plans and retiree health benefits. “Companies will have to see what they need to do to bring their liabilities down and minimize the impact on the balance sheet.”

Just before breaking for the holidays, the House of Representatives approved the Pension Protection Act, a comprehensive pension reform measure similar to one approved earlier by the Senate. The legislation would require companies to fund pension plans more fully and disclose the plans’ status to beneficiaries more plainly. The two chambers are now working to reconcile their measures and send a package to the White House.

At about the same time, Standard & Poor’s reported that the S&P 500’s liability for post-employment benefits (typically health insurance for retirees, and known as OPEB) totals $292 billion, nearly twice the underfunded pension liability of $150 billion. Those benefits are not regulated or guaranteed to retirees in the same manner as pensions, making them a likely target for cutbacks if companies eventually are required to report them as a strike against earnings, Gamzon said.

The Pension Protection Act approved by the House seeks two major changes, Gamzon said. First is an overhaul of funding rules and methodologies to get pensions closer to full funding and to reduce the smoothing of interest rates that has long protected balance sheets from excess volatility. The legislation also requires companies to beef up payments to their plans over a five-year period and increase contributions to the Pension Benefit Guaranty Corp., to prop up the government’s troubled pension insurance system.

The second change, Gamzon said, is an expansion of disclosure requirements aimed at ensuring rank-and-file employees better understand the status of their pension benefits. The Financial Accounting Standards Board, meanwhile, already is pursuing a change in accounting rules to bring pension liabilities out of financial statement footnotes and display them more prominently on balance sheets.

Wirthshafter

“As soon as these measures go into place, companies are going to have to start looking very closely at what they provide and make some cuts,” predicts John Wirtshafter, an employee benefits attorney with McDonald Hopkins. The increased cost and volatility associated with defined-benefit plans is likely to further the push toward changing or eliminating such benefits, he says. “A lot of companies can’t live with that kind of volatility on their balance sheets. Wall Street is very fickle about those things.”

Company-By-Company Changes

Noll

The likely changes in pension accounting are sure to drive a change in corporate behavior, “and that’s a consequence we wish we didn’t see,” says Dan Noll, AICPA. “In financial reporting we try to report neutrally, without bias, what’s happening.”

In addition to cutting benefits, companies are likely to respond by going back to lenders and asking to rework debt covenants. “It takes a lot of energy and effort to do that, but we’ll see companies start to do that,” Noll says.

Ultimately, Gazmon says, changes will occur company-by-company as each mulls the expenses it faces. “In the past, when the interest rates change or the rules change over time, there’s a concern for the unintentional liability and how it will impact debt covenants, and companies usually are able to deal with it,” he says. If ultimately even OPEB liability becomes a charge to earnings, “we have some auto makers who would be insolvent… When it gets to that magnitude, debt covenants are a serious concern.”

Wirtshafter said concerns about OPEB liability are somewhat overdone. “It’s not fair to say it’s worse than pension funding because there isn’t a very advantageous way to fund them,” he said. “Most companies pay as they go, so there’s going to be a lot of unfunded liability.”

Gamzon too, was circumspect about OPEB liability concerns. “The numbers are kind of silly,” he said. “There’s no legal requirement to find them and no tax incentive to do so.”

Noll cites growing concern about whether the magnitude of change will affect investor behavior. “The information is already told in the totality of the financial statements,” he notes. “We really don’t know how investors will react.”