The New York Times
January 20, 2005
Talk of Changing Pension Math Raises Concern on Benefit Cuts
By MARY WILLIAMS WALSH
AT&T, the once-mighty phone giant, has a pension plan with obligations of about $10 billion, according to its annual report for 2003. Yet the company paints a somewhat rosier picture for employees: an extrapolation from workers' individual statements indicates that the plan owes them roughly $10.6 billion, or 6 percent more.
There is nothing improper or unusual in AT&T's approach. Like many other companies, it uses two methods to calculate the value of its pensions: one to tell employees how much they have earned, the other to tell investors how large the company's pension liability is.
But that may soon change. The seeming discrepancy in accounting, which has been an accepted business practice for two decades, has begun to bother accounting rule makers, who say the practice allows companies to understate to investors the extent of their pension liabilities.
The panel that sets accounting standards is now preparing a proposal that would require many big American companies to give a more accurate financial picture of their pension plans. As a result, a number of them will have to increase the pension liabilities on their books, in essence telling investors that they owe their employees more than they have disclosed in the past.
"Depending on the company," said Gerard O'Callaghan, project manager for the pension review by the Financial Accounting Standards Board, "it could be nothing; it could be $10 million; it could be $100 million; it could be a billion; it could be more." The board is a nongovernment body that establishes rules for American companies.
While the amounts paid to retiring workers would not change immediately, some companies would have to increase their reported pension liabilities as much as 30 percent. To bring things back into balance, some may contribute more money to their pension funds - a boon to participants, but a jolt to shareholders, who may have thought that the money would be used for business operations. Other companies may delete attractive features from their plans, to bring the cost back down.
There is precedent for such a cutback. When a change in accounting rules forced companies in 1990 to report the value of the health insurance they had promised to retirees, companies began to reduce the coverage.
Indeed, the accounting board's proposal comes as the pension system itself is under pressure. Many companies, citing the burden of providing retirement benefits, have cut back, converted or closed their plans. At the same time, the Bush administration is proposing changes in both the way companies set aside money to pay for future benefits, and the way they pay to support the federal system of insuring traditional pensions. Business groups have warned that if companies are pushed too hard, they may stop offering pensions altogether.
The looming changes in accounting rules are expected to be strongly opposed by companies. The staff of the Financial Accounting Standards Board hopes to present the draft of a proposal by the end of March.
"That's where a lot of people are going to be giving us a lot of pushback," Mr. O'Callaghan said.
The accounting board is grappling with something of an open secret in American business: the current accounting rules for pensions allow companies to underestimate, if not conceal, their liabilities legally.
The board's efforts to improve reporting mirror recent administration proposals to overhaul the rules that companies follow in funding their pension plans. Both sets of rules are now widely thought to obscure the economic reality of a pension plan, sometimes allowing insolvency to grow, undetected by all but the best-informed insiders.
United Airlines, for example, was able to state that its pension funds were fully funded even after sharp declines in the stock market wiped out much of their value. It thus went for several years without making any contributions. Now, however, the company is arguing in bankruptcy court that it can no longer fund the plans and that the government must take them over.
The particular issues that the accounting board is looking at represent only "a sliver" of the overall problem of pension accounting, Mr. O'Callaghan said.
Other experts agreed. "They're trying to repair a broken heating system in a house that's falling down," said Jeremy Gold, a consulting actuary to the Financial Accounting Standards Board and an economist who has criticized current pension accounting rules. "They're headed in the right direction. They're sending some signals about what a rewrite of the pension rules is going to look like."
Even so, the board may have a fight on its hands. If it approves its staff's proposal, public comment will then be solicited. The board has set a year-end target to put the rule into effect, but issues raised in the comment period could take months to sort out, pushing that deadline back.
"Nothing gets done here fast," Mr. O'Callaghan said, recalling that it took more than 10 years to complete a rule on accounting for stock options. In that case, Congress weighed in, threatening to reduce the board's funds. The board, based in Norwalk, Conn., also gets contributions from business and accounting firms.
Its current project was initially supposed to change the way companies calculate the value of a kind of pension plan known as a cash-balance plan. But more recently, the board said it also wanted companies with conventional defined-benefit plans to adopt the new approach if they allowed retirees to take their entire benefit in a lump sum.
Thousands of companies, employing millions of people, have one or the other of these two types of pension plans. Lucent Technologies, I.B.M., Avon Products, AT&T, Colgate-Palmolive, Hewlett-Packard, Toshiba America, Wells Fargo, Qwest Communications, Bank of America, Cummins and Delta Air Lines are among the hundreds of companies with cash-balance pension plans.
Delphi and U.S. Steel are among many companies that have conventional pension plans, allowing departing workers to take lump sums. So do American Airlines and Delta with the pension plans for their pilots.
A cash-balance plan is a hybrid design, combining features of a conventional defined-benefit pension plan with those of a 401(k) plan. The company sets aside money to pay the benefits in a pooled trust fund, as it would for a traditional pension plan. But it provides each worker with regular statements, reporting the amount of benefits as an individual account balance, like a 401(k) balance. There are, in fact, no individual accounts, but expressing the benefits this way is said to make employees understand and value them more.
Each year, an employee's balance increases, as the sponsoring company credits the account with interest at some specified rate. Often, the rate is linked to a conservative market rate, like that for Treasury bills. At AT&T, for example, the cash-balance plan has recently been offering employees interest credits at 4 percent a year.
The discrepancy in accounting arises when the company calculates the total value of these obligations for its annual report. It must again factor in an interest rate, because pension values vary inversely with interest rates, much as bond prices do.
But in this calculation, the crediting rate is not used. The current accounting standard for pensions lets companies use a high-quality bond rate instead. AT&T used 6 percent, according to its annual report for 2003.
It is the difference between these rates that troubles the accounting rule makers. Because of the inverse relationship, using 6 percent produces a smaller pension value for the annual report than the one reported to workers in their statements.
Actuaries say that correcting the reported value in AT&T's case would mean increasing it by about 24 percent, citing a rule of thumb that every percentage-point change in the interest rate causes about a 12 percent change in the value of the benefits.
AT&T reported that its workers had earned about $10 billion of benefits at the end of 2003, but only about $2.5 billion of that was owed to active workers. Conforming to the accounting board's approach might require increasing the amount owed to active workers by 24 percent, or $614 million. That would increase AT&T's total pension debt to its work force to about $10.6 billion.
AT&T declined to comment for this article.
These adjustments would vary at different companies, depending on the interest rates used and the ages of the work force.
The accounting board's work on cash-balance plans showed that companies also use two interest rates when calculating lump-sum distributions, with the result that they have also been reporting smaller pension obligations to investors than the amounts workers are really allowed to take.
About half of all workers at big companies are currently allowed to take lump sums, according to Mark G. Beilke, director of employee benefits research at Milliman USA. The practice is much more common among plans for salaried white-collar workers than those for union or hourly workers, he said.
Among the companies affected because they offer cash-balance plans or pay lump sums, some, like Toshiba and Wells Fargo, have written letters to the accounting board expressing opposition to the accounting change.
"The board's tentative conclusions could result in large charges to earnings for many companies," wrote Richard D. Levy, the controller of Wells Fargo, in a letter sent in May 2004. "These companies could conceivably implement changes to their pension plans to minimize the impact of the accounting changes on their financial results. These plan changes may ultimately result in reductions of pension benefits for employees."
Other companies like Avon, American Airlines, Hewlett-Packard and Delphi said that they did not want to comment because they were not yet sure what the new method would be. Some, including I.B.M., Qwest and Colgate-Palmolive, did not respond to requests for comment.
A Lucent Technologies spokeswoman said the company's cash-balance plan accounted for a small part of the pension benefits it owes retirees, so the accounting change would have a minimal effect on its financial reports. Bank of America cited a lawsuit by its employees in connection with its cash-balance plan and declined to comment on possible accounting changes.
Many actuaries find the accounting board's new approach disturbing, because it challenges core concepts of the actuarial approach to pensions. Years ago, cash-balance plans were marketed to companies on the very feature the accounting board now considers incorrect: the interest-rate differential that made them look cheaper than they turn out to be.
"There is substantial leverage in this assumption," said a 1985 promotional brochure on cash-balance plans by Kwasha Lipton, an actuarial firm that has become a part of Mellon Financial.
"A '5 percent of pay' plan might require a contribution of only 4 percent of pay, after a realistic investment differential is taken into account."
Mr. Gold, the pension-accounting critic, who worked at Kwasha Lipton before it began to promote cash-balance plans, said: "Kwasha Lipton's actuaries didn't think that was misleading. When Kwasha Lipton was writing this, that's what all actuaries believed. We were taught this. We were tested on it. The right answer was to say that you could give $5 at the cost of $4."
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