Accounting lessons go beyond mark-to-market

Since late last year, there has been an increased interest in actively moving to a mark-to-market pension accounting methodology. This sudden shift in pension strategy was first announced by Honeywell International Inc. and marked an important step in the evolution of modern pension risk management.

Through a major change in its pension accounting, Honeywell announced on Nov. 16 that it will eliminate all amortizations of gains and losses related to pension plan asset performance, discount rate changes and other actuarial assumptions. Instead of the typical five- to 15-year amortization of these amounts, Honeywell will immediately recognize these variations at the end of each year, as long as the amounts fall outside a commonly used 10% corridor for changes in valuation results. In doing so, the company also revised prior year results and took into account recent losses immediately in a similar manner to how they will in future years.

Since that time, AT&T and Verizon also moved to a mark-to-market approach quite similar to Honeywell's. They took the idea one step further by eliminating the 10% corridor completely and therefore moving even closer to full market value. (The 10% corridor allows accumulated gains or losses that fall below 10% of the total plan liability to be carved out of any plan expense amortization calculations, therefore eliminating the impact of small variations from expected values. It is one of the most common ways to defer the impact of asset returns or discount rate movements that differ from the plan's expectations.)

No. Plenty of corporations will appropriately decide to retain their current methods; they will calculate expense and balance sheet provisions as they do today by amortizing pension plan gains and losses. Honeywell's large unrecognized loss, coupled with its relatively short amortization period, made it a great candidate for this change. Further, carrying a $15 billion pension plan liability was quite significant to its financial statements and deserved the attention it was given. Companies with different trends or those in the midst of some significant pension design or investment changes may not be ready to move to the mark-to-market approach.

Whether or not the specific accounting change is right, all companies should recognize the importance of the broader risk management strategies introduced in these announcements. As part of the accounting announcement, Honeywell also shared details about its future pension investment strategies and related funding requirements helping place the accounting change in context. This clear connection gave a complete picture of its pension plan and showed investors how management was going to handle this large obligation.

So regardless of a decision on mark-to-market accounting, all plan sponsors can take away three very important lessons from the recent announcements:

• A comprehensive and well-communicated approach to pension risk management will be appreciated by investors. Honeywell's announcement was a rare moment that allowed us to measure the impact of a pension disclosure directly in share price — often pension announcements are included in broader financial announcements, making it nearly impossible to separate out their impact. On Nov. 16, the S&P 500 saw its biggest one-day drop in about three months, going down more than 1.5% on concerns over European debt and global monetary policies. All sectors were down at least 1%. However, Honeywell was up almost 2%, one of the clear market leaders of the day.

• Pension risk management is not always first accomplished by freezing your pension plan. Too often the first strategy considered to manage pension risks is to close or freeze the plan. Pension risk strategies go way beyond this very important human resources decision and must include investment decisions, funding strategies and even accounting methodologies. Honeywell's plan remains an open and accruing plan where employees are still earning benefits as an important part of their total rewards structure. While the strategies may be different, focusing on pension risk management is critical for all plans, open or frozen.

• Self-governance works. Instead of waiting for long-discussed and often delayed accounting changes and potential moves to a mark-to-market requirement, a few focused companies started making the move themselves. Whether it is the new earnings methodology used by International Business Machines Corp. and General Electric Co. or the pension accounting change made by Honeywell, AT&T and Verizon, each of these companies improved the disclosure of their significant pension results to add transparency and clarity of their reporting. All plan sponsors, public sector and corporate, should try to meet a similar goal and help investors and the public understand their plans better.

There is much more to come down the pension risk-management journey, with many more milestones along the way. Let's remember to note of some of the key steps along the way and acknowledge the leaders in the field that clear the path for better plan management.

Ari Jacobs is national retirement solutions leader of Aon Hewitt LLC and based in Norwalk, Conn.