WASHINGTON - The Securities and Exchange Commission could require some companies to restate their financial results using assumptions that more accurately reflect their pension fund obligations.
SEC officials in recent months have become increasingly concerned that many companies overstated their pension assets using artificially high return assumptions. Now, they also are worried that companies are understating their pension liabilities, using inappropriately high interest rates to calculate the present value of their obligations.
If the impact is material, "we could ask companies to re-present their information on a historic basis," said Carol Stacey, chief accountant in the SEC's division of corporation finance. Ms. Stacey's warning is consistent with a similar warning the SEC issued a decade ago, when interest rates also had declined sharply.
The Committee on Investment of Employee Benefit Assets is studying the issue but is not ready to comment on the possibility of any SEC action, said Judy Schub, managing director of pension and investment policy at the Bethesda, Md., trade association.
The right rate
Richard Q. Wendt, a principal and senior consultant in the Philadelphia office of Towers Perrin, said companies should be able to demonstrate to regulators that they have picked the appropriate rate to discount their pension liabilities. For 2002, Towers Perrin used an interest rate of 6.63% to discount the liabilities of a hypothetical benchmark plan the consulting firm has been tracking since 1990.
The accounting rule for pensions requires companies to discount their obligations using an interest rate that matches the duration or risk levels of their liabilities and reflects current interest rates. SEC guidance clarifies that companies should use a "portfolio of high-quality zero-coupon bonds whose maturity dates and amounts would be the same as the timing and the amount of the future benefit payments."
Most companies calculate the value of their pension liabilities using the interest rate on the Aa Moody's corporate bond index - 6.72% on average in 2002, according to a new analysis of 39 large corporations by Towers Perrin, Valhalla, N.Y.
Pension liabilities have a duration of 10 to 15 years. The interest rate on 10-year Treasury strips (or zero-coupon bonds) was 4.34% as of Dec. 31, while the interest rate on 15-year Treasury strips was 5.1%. If the Treasury instrument was used instead of the Moody's index, companies would be understating their pension liabilities by as much as 32.4%, noted Ron Ryan, president of Ryan Labs, a New York fixed-income money management firm.
The interest rate on the Salomon Brothers Pension Liability index was 6.05% with a duration of 15.65 years on Dec. 31.
Recalls are likely
Michael Peskin, principal in the global pensions group of Morgan Stanley, New York, said the Moody's Aa index is artificially higher in large part because 11 of the 16 bonds that make up the index can be recalled by the companies that issued them. And with interest rates so low, recalls are likely. That would put pressure on interest rates in the index to fall as recalled bonds are replaced with newer bonds at lower prevailing interest rates, he noted.
"There is something wrong with using an index that has bonds in it that are callable," he said.
Mr. Ryan said the Moody's index also is a poor choice because it does not represent bonds of financial service companies, which comprise nearly half of the corporate bond index, and interest rates are not realistic because companies cannot invest in securities at that interest rate.
Others suggest there is a built-in bias in the Moody's system that overrates corporate bonds.
Some investment consultants justify using the Moody's Aa index because it was mentioned in a Sept. 22, 1993, letter from Walter P. Schuetze, SEC chief accountant at the time, to Timothy S. Lucas, former chairman of the Financial Accounting Standards Board's emerging issues task force.
Mr. Schuetze said in the letter that the SEC expected companies to measure pension obligations using current interest rates on high-quality debt. "Fixed-income debt securities that receive one of the two highest ratings given by a recognized rating agency be considered high quality," he said. So, for example, a fixed-income security that receives a rating of Aa or higher from Moody's would be considered high quality.
No blanket permission
The SEC's Ms. Stacey said the letter did not give companies blanket permission to use the Moody's index. "Companies need to select a discount rate that is based on some high-quality bonds that are similar in terms of timing and amount to their pension obligation," she said. The SEC intends to question companies that used interest rates on indexes out of sync with their pension obligations, Ms. Stacey said.
The solution, according to Mr. Ryan, is companies should be required to disclose the true market value of their liabilities. But the accounting rule should be changed to give companies several years to make that move so their financial statements and credit ratings are not devastated.
"In the end, they have to mark to market (both) assets and liabilities for us to understand the economic truth," Mr. Ryan said.