FASB today voted to start overhauling its Statement 87 on pension accounting and Statement 106 on accounting for retiree health care and other non-pension post-retirement benefits.
"While the accounting and reporting issues do not appear to lend themselves to a simple fix, the board believes that immediate improvements are necessary and will look for areas that can be improved quickly," Robert Herz, chairman of the Financial Accounting Standards Board, said in a statement.
FASB plans to conduct the project in two phases. First, it expects to issue a standard before the end of 2006 "to improve transparency by requiring that the funded or unfunded status of defined benefit and other post-retirement benefit plans ... be recognized in the balance sheet," according to the statement. Second, it would address issues such as how to best recognize and report in earnings the elements that affect the cost of providing post-retirement benefits; how best to measure postretirement obligations, including the obligations under plans with lump-sum settlement options; and "whether post-retirement benefit trusts should be consolidated by the plan sponsor." No expected completion date was set for the second phase.
"In conducting the project, the FASB will seek the views of parties currently involved in other, independent reviews of the pension system including the Department of Labor and the Pension Benefit Guaranty Corp.," according to the statement. Also, FASB will work with the International Accounting Standards Board and other organizations "toward international convergence of accounting standards," the statement said.
The impact of the changes for companies that continue to maintain large pension plans "could be enormous," Michael A. Moran, vice president, and Abby Joseph Cohen, U.S. investment strategist, Goldman Sachs, said in a report issued following the FASB meeting. The FASB "project will attempt to introduce more of a 'mark-to-market' approach to pension accounting" and "would introduce substantially more volatility to reported ... financial results for these companies."
"These proposed changes would likely further hasten the decline of the DB pension plan" as companies seek "to escape the potential increased volatility to financial results from their plans under rule changes," their report noted.
Pension plans might shift asset allocations to high-quality fixed income from equities to avoid volatility, and plan sponsors "could minimize the volatility in funding gaps by engaging in asset-liability matching strategies."
"However, a price would be paid. High-quality fixed income has a lower expected return than equity instruments. The plan sponsor would bear more of the costs of the plan in the long term since the capital markets would be contributing less. Therefore, some plan sponsors may elect to maintain current asset allocations but overlay an interest rate swap to better hedge the interest rate exposure inherent in the plan."
Plan sponsors might contribute more cash to pension plans to improve funded status in response to FASB changes to enable them to take on more investment risk, which they could afford at a higher funding level, the report noted.