Mark-to-market accounting helps companies shift pension plan losses

AT&T Inc., Honeywell International Inc., Verizon Communications Inc. and other companies moving to mark-to-market valuation of their pension plans will avoid reporting billions of dollars in losses, largely from the 2008-2009 financial market crisis.

The companies revised past financial statements retroactively under the accounting change to recognize the losses as if they occurred in the prior years: For Verizon, its losses total $22 billion; AT&T, $17 billion; and Honeywell, $5.5 billion.

The change from the typical accounting method of amortizing, or smoothing, pension plan losses and gains over several years enabled the companies to dodge reporting past losses in current and future financial statements, and being a drag on corporate income.

The new method aligns the pension plans with fair value or market-based accounting principles, to recognize gains and losses in the year they occur. It is a simpler method, promoted by the Financial Accounting Standards Board and the International Accounting Standards Board, in a move toward convergence of global accounting standards.

In a way, it anticipates adoption of an IASB proposal, released last year, requiring immediate recognition of pension plan gains and losses and ending the current approach of amortizing valuation changes over a number of years. The IASB approach would place the market-based adjustment into a category called other comprehensive income. In comparison, FASB requires pension plan valuation changes reported directly into the income statement, whether they are amortized over several years or marked to market in the year they occur.

The new accounting will reflect pension plans' actual returns on assets, changes in discount rates on liabilities and other actuarial assumptions, whether gains or losses, instead of the annual smoothing approach.

Whether or not the drive for the change was motivated to avoid amortizing the losses in future financial statements, that elimination is the outcome for the companies making the change, said Steve Alpert, principal and consulting actuary at Mercer LLC, not referring to the three corporations.

“We no longer have some amortization of prior losses because those losses have been recognized” in revised prior years, said Richard G. Lindner, AT&T's senior executive vice president and chief financial officer, in a transcript of a Jan. 13 teleconference. As part of the accounting charge, AT&T revised its 2008 financial statement to show $25.4 billion in benefits costs for pension plans and other retirement costs instead of the $500 million it reported at the time, according to the Jan. 13 presentation.

The $24.9 billion difference represents the 2008 impact of a “large loss in (pension) asset value,” according to a report that was part of the presentation.

“So the losses are assigned to the past (statements), which nobody cares about,” Mercer's Mr. Alpert said.

Doing so “basically says we are going to fix up our past income statements ... and how they would have affected earnings in the past,” Mr. Alpert said. “By making the accounting change, the accumulated losses won't affect earnings in the future. So a company believes it has a more rational basis for projecting earnings in the future.”

In the Jan. 13 teleconference Mr. Lindner said: “In the past, we have amortized actuarial gains and losses over many years. Now these gain and losses, which are driven by changes in the value of benefit plan assets and liabilities due to changing market conditions and assumptions, will be reflected on our income statement annually in the fourth quarter.”

AT&T wanted to improve accounting clarity so “everyone can understand where the gains and losses that get recognized in our income statement at the end of each year are tied to real economic events,” Mr. Lindner said. “If we have a large financial loss, like we had in 2008, you see it in our results that year instead of it being reflected over many years in the future.”

Dallas-based AT&T has $46 billion in pension assets.

At Honeywell, David J. Anderson, chief financial officer and senior vice president, said in a teleconference: “(W)e think this approach will provide better clarity ... regarding Honeywell's underlying operating performance.”

Honeywell, based in Morristown, N.J., has $12.8 billion in assets in its U.S. pension plans and $3.9 billion in its non-U.S. pension plans.

Under its new mark-to-market accounting, Honeywell plans to recognize some $5.5 billion of those deferred losses, splitting them up among its 2010 financial statements and for prior years by restating their financial statements, Mr. Anderson said in the transcript of the Nov. 16 teleconference. As a result, “we'll be recasting our reported financials to reflect the impact of the recognition of those losses in the years in which they incur (or) were incurred, and we'll no longer be amortizing deferred losses going forward,” he said.

Most of the Honeywell pension losses will be reported in prior years, including $3.29 billion in 2008. Making that change, for instance, reduced 2008 corporate net income by $1.98 billion, according to a Honeywell report.

Honeywell, in its modified market-basis accounting, plans to recognize annually any pension plan gains or losses in excess of a so-called corridor of 10% of the greater of the market-related value of plan assets or the plans' projected benefit obligation. Honeywell will defer recognizing gains or losses that fall within the corridor.

AT&T and Verizon in adopting the new approach got rid of that corridor, typically used as part of the amortized method of accounting.

At companies with defined benefit plans, Mercer's Mr. Alpert noted that in general, the huge pension plan losses in 2007 and 2008 will be amortized as an expense for possibly five or 10 years, reducing corporate income. But companies adopting the new accounting will avoid carrying the losses.

“The move isn't right for everyone, because of the volatility it brings to (corporate) earnings” by recognizing actual market movements in the year they occur rather minimizing volatility by smoothing them over a number of years, Mr. Alpert said.

For Honeywell, Mr. Anderson said “the adoption of (mark-to-market) accounting now, while (interest rates) rates (for discounting pension liabilities) are stable and likely to rise over the next 24 months, mitigates the potential for pension expense downside volatility.”

“Honeywell is taking steps to enhance the visibility and limit the volatility of pension expense going forward by reducing our assumed rate of return, evaluating our asset mix, and looking for more of a matching portfolio as we approach fully funded status over the next several years,” he said.

“Convergence is in the air,” Mr. Alpert said. “Sometimes an idea gets going and gets it own head of steam and everybody starts doing it.”

Mr. Alpert doesn't have an opinion on whether the new accounting change is better than the current method. “In theory, an investor could do all these adjustments on his own” because the detail is in the financial statement footnote anyway, he said. “The change in accounting doesn't change the fundamental operations of companies or pension plans, but only how it gets presented.”

“(M)ark-to-market is where the accounting world is headed and it's where international standards are today,” said Honeywell's Mr. Anderson in the teleconference transcript. “(W)hat adds credence and momentum to that (accounting) change is the recent IASB proposal, which is getting a lot of attention.”

Francis J. Shammo, Verizon executive vice president and CFO, said the new approach “actually is a preferable accounting method and one that aligns with the fair value accounting concepts and current (International Financial Reporting Standards) proposal,” according to a Jan. 21 teleconference with investors. Verizon, based in New York, has $25.2 billion in pension assets.

Verizon has been considering the new accounting for some time and “accelerated our action” and adopted this change now after AT&T, Honeywell and “some other large-cap companies” recently announced their adopting of the market-based approach, Mr. Shammo said.

The accounting change won't affect pension plan funding requirements, Mr. Alpert and the corporate executives agreed.

The new accounting approach enhances transparency and the ability to forecast benefit costs, Mr. Lindner said. “Very simply, our expected asset returns will equal the market value of assets times our assumed return on assets,” he said. “Our interest costs will equal the benefit plan liability times the assumed discount rate. Service costs will equal benefits earned based on force levels and the level of benefits provided. Taken together, we believe this approach will provide better clarity” for investors on AT&T's operating performance and benefit obligations.

For 2010, using the new accounting, AT&T plans to take a $2.5 billion charge to its income statement because of pension plan losses in the year, mostly from a $6.8 billion loss from reducing the discount rate it uses to value pension liabilities, a loss offset in part by the gain of more than $2.9 billion in pension plan assets, which returned more than more than 13% for the year, said AT&T spokeswoman McCall Butler.

Its former accounting would have amortized the loss over several years.

AT&T lowered its discount rate to 5.8% from 6.5%; Honeywell, to 5.25% from 5.75%.; and Verizon, 5.75% from 6.25%.

Because of the move to market-based accounting, the companies also lowered their expected return on assets assumption for 2011. AT&T lowered its assumption to 8.25% from 8.5% because of an asset allocation change, John Stephens, AT&T vice president and controller said in the teleconference, according to the transcript.

Honeywell cut its return assumption to 8% from 9% because of lowered expected market return, according to a company report.

Verizon lowered its return assumption to 8% from 8.5%. In 2010, Honeywell's actual pension plan investment return was “in the low teens,” Mr. Anderson said. Verizon's actual return was 14%, Robert J. Barish, senior vice president and controller, said in the Verizon presentation.