Mark-to-market accounting could threaten pension funds

GREENWICH, Conn. — Requiring pension funds to adopt "mark-to-market" accounting could have potentially dangerous and costly results for the equity markets, companies and their employees, according to a new Greenwich Associates report.

Two-thirds of executives at the largest pension funds in the United States said they are closely following the regulatory debate over whether to institute mark-to-market requirements.

Mark to market refers to the pricing of securities in an investment portfolio; securities that are marked to market are listed using their current value. Traditionally, companies have been able to use a smoothing mechanism when they list the securities in their pension fund portfolios in their annual reports, so major losses or gains are reported over a three-year period, not as they occur.

Although the Financial Accounting Standards Board is not currently working on a mark-to-market rule for pension funds, there has been some mention of it by officials from various regulatory organizations, in response to the corporate financial accounting scandals and the desire for greater transparency in financial statements.

When asked how they would respond to mandatory mark-to-market standards, 11% of executives at pension funds with more than $1 billion in assets said they would close their defined benefit plans to new employees, and 9% said they would convert their defined benefit plans to cash balance plans, according to John Webster, a Greenwich consultant.

"That's one-fifth of U.S. employers who would close access to defined benefit pension plans for new employees," said Mr. Webster in an interview.

He pointed out that when the mark-to-market rule was put into effect in 2003 in the United Kingdom, more than 40% of very large plans — those with more than £250 million ($454 million) in assets — closed their defined benefit plans to new employees.

"It's not an idle threat," said Mr. Webster. "If regulators force their (corporations') hands into something by adding a rule that would increase the short-term volatility (of their pension assets) and make the plans more costly to run, many companies will end their (defined benefit) pension plans."

Moreover, if mark-to-market rules were adopted in the United States, nearly 15% of pension plans with more than $1 billion in assets would decrease their liabilities by adopting a strategy of immunization; 14% would increase their exposure to absolute-return strategies; and 10% would reduce their investments in equities. Pension fund executives in the survey indicated these shifts would result in a reduction in equity exposure by 18%, with the very largest funds saying they would reduce it by considerably more.

"That would mean the withdrawal of tens of billions of dollars from the stock market," which could cause a massive investment crisis, Mr. Webster said in the interview.

The mark-to-market questions were part of a broader Greenwich report: "U.S. Investment Management," February 2004.

Peter Proestakes, project manager at the Financial Accounting Standards Board, Stamford, Conn., said: "There is no current proposal on the table to change the accounting rules for pension funds." He said that in April, FASB representatives will meet with their counterparts at the International Accounting Standards Board, and that meeting will include a discussion of "what is the next step for pension accounting." Representatives of the two organizations will decide if they should work together to form one international rule, which would include a mark-to-market provision.

Mr. Proestakes also pointed out that while current pension fund accounting rules permit the smoothing of results in the basic financial statements, mark-to-market results must be given in the footnotes to the financial statements, which does give the true fair value and market losses of pension funds.