The New York Times - June 23, 2005
 

New Scrutiny on Auditing of Pensions
 

By MARY WILLIAMS WALSH
 

The body that writes the accounting rules for American business is now preparing an overhaul of how companies calculate the financial impact of their pension plans.

Corporations are likely to oppose revisions by the body, the Financial Accounting Standards Board, or FASB, because a new pension standard could lead to significant changes in how corporate earnings are reported. There could also be major changes in employee benefits and how pension funds invest workers' retirement money.

Under current accounting rules, companies are allowed to report that the investments in their pension funds have earned money, even in years when they did not, and to factor the illusory pension gains into their operating profits. They can also "smooth" pension values by spreading year-to-year changes over several years.

These accounting practices have come under criticism because they can mask the health of both the company and the pension plan.

"I'd like to make people believe I'm 6-foot-2 and had a full head of hair, but if you look at me, you'll see that I'm really 5-foot-9 and I'm bald," said Robert Herz, chairman of the standards board. "It's human nature to try to make yourself look as good as possible. Sometimes, it seems as though some people perceive accounting as a way of doing that."

David Zion, an analyst with Credit Suisse First Boston, has found that if hypothetical pension returns and other nonmarket pension values were stripped out of the earnings of America's 500 largest companies in 2001 and 2002, aggregate earnings would have fallen by 67 percent - more than $100 billion - in each of those two years.

In 2003, on the other hand, replacing the smoothed pension numbers with current market values would make aggregate earnings rise by about 3 percent.

The new push to overhaul pension accounting follows a report by the Securities and Exchange Commission last week on the quality of corporate accounting after  Enron. The report found that accounting had generally improved since Enron collapsed in 2001, but was still flawed in certain areas, including the pension-accounting standard.

"We view the S.E.C. report as a formal agenda request," Mr. Herz said.

For years, it has been something of an open secret that the current accounting rules for pensions distort the appearance of both pension plans and the companies that sponsor them. But Mr. Herz and other specialists said the problems of the current standard were more widely understood now than in the past.

This is, in part, because of the recent high-profile pension failures at companies like United Airlines, and the questions they have raised about how best to finance retirement.

Members of Congress are separately trying to solve problems with the federal rules for funding pensions, which are supposed to ensure that companies set aside enough money in advance to make good on all their promises. Those rules have failed to prevent disastrous pension collapses like the one at United.

Yesterday, a House Transportation and Infrastructure subcommittee on aviation held hearings on the pension problems of the major airlines, and the risk that a chain reaction of pension failures might sweep the industry, devastating employees and overwhelming the Pension Benefit  Guaranty Corporation, the federal agency that guarantees benefits.

The rules that govern how companies report pensions on the financial statements they file with the S.E.C. are different, but they raise some of the same controversies.

Both sets of numbers permit "smoothing," the widespread actuarial practice of spreading gains and losses over several years. And both make it extremely difficult for an employee, or an investor, to find out how well funded a pension plan is, or how much risk it exposes retirees and shareholders to.

At United, for example, actuarial projections that the pension fund would earn $740 million in 2000 helped to bolster corporate profits that year, even though in reality, the pension fund gained only $21 million.

The big hypothetical pension gains, and other smoothed pension numbers, made United look profitable that year. But if United had included actual pension values in its financial reports, rather than the smoothed numbers, it would have reported an operating loss instead of a profit that year, according to an analysis of its pension data by The  New York Times.

United filed for bankruptcy protection in 2002 and is now terminating its pension fund, which is $10 billion short of what it needs.

To be sure, the board has tried in the past to improve pension accounting, but it has not yet gone to the heart of the truth-in-accounting questions the current rule raises. Two years ago, the board developed some new requirements for the disclosure of pension data to be included in the footnotes of corporate financial statements. And this spring, the board began to consider changing the rules affecting certain types of pension plans known as cash-balance plans. That project has not yet been finished and may be wrapped into the one the S.E.C. now wants.

The proposed overhaul would be much broader, looking at all types of pension plans and how they affect both the balance sheet and the bottom line. Once the accounting board's staff completes its initial research, the seven members of the board will vote on whether to continue with a full-blown rewriting of the disputed accounting standard.

"I would hope that by early fall we could vote on it," Mr. Herz said.

Critics of the current accounting rule argue that it also gives companies a powerful incentive to invest their pension funds in riskier assets than the work force might want. This is because riskier investments can justify the higher assumed investment returns that are now incorporated into operating income, increasing reported profits.

The difficulties in the airline industry , and the possibility that they could spread, are now prompting some officials to call for more conservative pension investments. Some pension specialists think eliminating the accounting incentive could reduce the risk.

"It's not our job to dictate the investment behavior," Mr. Herz said. "Our job is to improve the accounting. But many people believe that a model that allows you to do smoothing, and allows you to include expected investment results in operating earnings, probably encourages certain types of behavior."

Companies, their actuaries and their lobbying groups have expressed strong opposition to these ideas in the past. They say the current pension-accounting practices are valid because a pension plan exists for the long run, and can therefore be expected to earn predictable average annual returns over the long run. These expected annual returns are more meaningful than the pension fund's real investment returns in any given year, many actuaries say, because the smoothing eliminates big year-to-year swings.

Some pension specialists fear that if companies are no longer allowed to smooth their pension values, they will end up with unacceptable volatility in their corporate financial reports.

"Some employers could say, 'I just don't want to do this anymore,' and just get out," said Ron Gebhardtsbauer, the senior pension fellow for the American Academy of Actuaries. "We want to be careful," so that companies do not just stop offering pensions altogether.

But Colleen Cunningham, president and chief executive of Financial Executives International, a group of corporate financial officers, controllers and treasurers, said many companies were getting out of the pension business in any case. She said more companies were reconciled to the idea of a new pension accounting standard.

The current rule is "extraordinarily complex, and rather opaque," she said. Many companies get the pension data from outside actuarial firms, "so sometimes even companies have a hard time understanding how the pension obligation and the fair value of the assets are determined."


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