Transparency of Liabilities a Growing Trend

Since December 2010, companies like Honeywell, AT&T, Verizon Communications and UPS announced mark-to-market recognition in the corporate earnings statement of pension gains and losses, creating a more transparent representation of the economic cost of the pension plan in their income statements by marking to market their funded status immediately without smoothing. The U.S. Financial Accounting Standard Board (FASB) requires employers to recognize the full value of their funded status on balance sheets, with a deficit shown as a liability. The “new FAS 87” method increases the P&L cost immediately whereas “traditional FAS 87” increases P&L cost gradually through amortization.

These four corporations’ moves to mark-to-market accounting coincided with the International Financial Reporting Standards (IFRS), an initiative that simplifies the way pension income or loss is recognized by publicly traded companies outside the United States.

Because it is in most companies’ interests to have a consistent approach to accounting, it seems that mark-to-market accounting will reach a tipping point, said Bob Collie, chief research strategist for Americas Institutional, Russell Investments, in research about the $20 billion club—Russell’s name for the 19 U.S. listed corporations with worldwide defined benefit pension liabilities in excess of $20 billion. If other companies follow suit, analysts will come to expect mark-to-market figures, he said.

“I don’t think it would take much for the trend to continue,” Collie told PLANSPONSOR, adding that the change in international accounting standards could prompt the U.S. to converge with this method.

However, some companies are hesitant to adopt mark-to-market accounting because of volatility, Collie added.

One of the biggest advantages of mark-to-market accounting is transparency, said Karin Franceries, executive director of J.P. Morgan’s Asset Management Strategy Group. “The simplification of accounting makes the link between the pension fund and plan sponsor clearer,” she added.

The Impact of Accounting on Asset Allocation  

Accounting methods also have a direct impact on asset allocation. By using mark-to-market, it is easier to derive the impact of a company’s asset allocation because it is immediately translated in its pension cost, Franceries said.

Under the new FAS 87 accounting method, the expected return on assets is not reflected in the annual report. Without smoothing, the full impact of the deficit will show up on a company’s books immediately in the year it occurred. A higher deficit increase triggered by a riskier allocation would result directly in a greater loss, according to J.P. Morgan’s research paper, “The mark to market treadmill.”

Because reporting under the new FAS 87 method mirrors what is actually happening to a pension fund, it allows a CFO to focus on the economic reality of funded status.  Investment solutions that stabilize pension costs on the income statement under the new FAS 87 approach will be similar to those that stabilize liabilities on the balance sheet, the paper said.

J.P. Morgan’s paper provides a real-life case study showing what affect asset allocation would have on pension reporting.  The paper can be accessed here.  

Russell Investments’ research paper, “A busy pension year so far for the $20 billion club,” is available here.