Pension Priorities: Why the Accounting Belongs on FASB’s Agenda

Last summer, the FASB issued an invitation to comment on their agenda plans. Now that the really “big ticket” projects have been completed - the ones like revenue recognition, leasing, and credit losses - the Board is casting about for where to direct their attention next. I put my views forward in this letter.

One potential project I think deserves a place on their agenda: the accounting for pension benefits. (And its cousin, the accounting for other postretirement benefits, which has some peculiar quirks of its own, to be saved for another day.)

The accounting for pension benefits has been around for almost thirty years. That doesn’t automatically make it a candidate for repairs. The problem is that when it was initially constructed, there were a lot of smoothing mechanisms built in at the behest of companies who were afraid of showing too much reality when reporting earnings. There are many parts of the existing standard that could be simplified: elimination of delayed gain/loss recognition on plan assets and obligations, elimination of the delayed recognition of prior service costs, and elimination of the “market-related value of plan assets” in applying the expected return on assets.  Even the elimination of the concept of an “expected return on assets” might be an improvement - maybe firms could report their pension plans actual returns.

Notice the commonality of all suggestions above: elimination. These moves could eliminate a lot of the work involved in pension reporting, while making earnings more volatile and realistic. The FASB has been on a simplification tear in the past three years, and this would seem to be a simplification that should be right up their alley.

Why isn’t this an easy target? First of all, anything that increases earnings volatility isn’t something most companies will champion - they’re more likely to resist efforts to change such accounting.

There’s another perception, however, one that becomes a mitigating reason for not doing something about the state of pension accounting. It’s the perception that the defined benefit plans being accounted for are going away.

It’s not just a perception. It’s true: firms don’t sign up for them any more - it’s a risk to be avoided, especially when you can simply contribute to defined contribution plans and let the employees shoulder the investment risk. It’s common to hear of defined benefit plans being “frozen” and accruing no new benefits to covered employees.

The fact that defined benefit plans are not being created, and the fact that many of them won’t grow because of being frozen, doesn’t mean they will go away anytime soon. They’ll be around at least until the workers in them are no longer around, and it would be safe to guess we’re talking about decades, not years. Call them dying, but call them dying slowly.

And call them pervasive. If you buy into the “do nothing and they’ll fade away” argument, you’re in for a surprise: there are more companies in the S&P 500 with defined benefit plans than there were five or ten years ago. Using S&P’s Research Insight database, we looked for companies having a projected benefit pension obligation at the end of each year since 2005, an indicator they have a defined benefit. Look at the table below and you might be surprised: two-thirds of the S&P 500 have defined benefit plans at the end of 2015, up from 60% (299 firms) at the end of 2005.

How to explain the increases in defined benefit plans in the S&P 500? It doesn’t seem likely that S&P is intentionally adding companies that possess defined benefit plans.

To a significant degree, there is a spin-off phenomenon at work here. Below, a list of the companies with a PBO showing up in the count by each year; they appear in the first year that the PBO is publicly disclosed. The ones shaded green are the product of some sort of corporate spin-off action. Out of the 38 companies increasing the PBO count over the last ten years, 16 of them related to spin-offs.

Note: Abbvie is an R.G. Associates, Inc. holding.  R.G. Associates, Inc., its clients, and/or its principals and employees thereof may make purchases or sales thereof while this commentary is posted.

The point: companies may not be coining new plans, but packaging parts of companies into new ones – along with their workforces and the pension plans that cover them – old pension plans are being redistributed in the investable universe. They may not be getting any bigger, but they are more omnipresent.

The S&P 500 is loaded with large-cap companies, many in industries that have been around for ages possessing labor forces heavily represented by unions - and that’s where the pensions are presumed to be. The characterization makes sense for some spinoffs perhaps, but a scan of the companies added (table above) shows that the new PBO sightings aren’t dominated by old-line industrial firms.

It’s not just a phenomenon of large-cap firms, either. Expanding the search of the Research Insight database to the Russell 3000 shows the same trend: more firms showing a PBO over the last five and ten years. (Note: there were 887 such “PBO firms” at the end of 2005.) There’s less representation of firms with defined benefit plans in the entire Russell 3000, which is to be expected. With many small firms in this universe, one would expect fewer defined benefit plans in any circumstances: they’re not typically used by smaller firms. Consistent with the S&P 500, however, representation of firms with defined benefit plans in the entire population of the Russell 3000 has climbed over the last ten years.

Bottom line: defined benefit plans have been hardy survivors for a long time and may have been unfairly counted out as being somehow “immaterial” to setting the accounting reform agenda. Letting the data speak for itself shows that there’s more pervasiveness to their presence than the prevailing common wisdom. FASB could simplify much of the accounting - maybe even quickly - if they were to prioritize it. And they could even claim a “simplification” win to boot.

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