A proposed accounting approach for determining liabilities in cash balance
pensions would artificially drive up the liabilities for many of these plans
on corporate balance sheets, argues Watson Wyatt, the benefits consulting firm.
The Emerging Issues Task Force (EITF) of the Financial Accounting Standards
Board (FASB) appeared to reach consensus in favor of the new approach at a meeting
on May 15. To be enacted, this guidance would need to be ratified by the FASB,
which could occur as early as its meeting on May 28. While a written summary
of the task force's consensus guidance is not yet available, preliminary analysis
of the approach by Watson Wyatt has identified disturbing implications for many
sponsors of cash balance pension plans.
A cash balance plan is a defined benefit pension plan that is designed to look
more like a defined contribution plan, by expressing the benefit as an individual
account balance that increases each year with additional contributions and with
interest credited at a specified rate.
The new accounting approach would require many companies to value the accounting
liability for their cash balance plans using different, more conservative assumptions
than used by all other pension plans. This would apply to companies that credit
interest to individuals' cash balance accounts using a market-based rate (e.g.,
Treasury rates) rather than a fixed rate.
Currently all defined benefit plans calculate the size of the pension liability
using a discount rate based on the yields of high-quality long corporate bonds.
The proposed approach would require many cash balance plans to value their liability
using a discount rate based on government yields, which are lower. Some plans
would be forced to value the liability based on very short-term government bonds.
As a result, the new approach would artificially inflate the balance-sheet effect
of these cash balance plans.
"One of the key goals of pension accounting rules is to make it easier
to compare the true costs of pension plans between different companies,"
says Eric Lofgren, global director of benefits consulting at Watson Wyatt. "But
the EITF is on a course to introduce an approach that is seldom, if ever, used
currently, and that completely undermines the goal of comparability."
Lofgren explains that the proposed change results in materially different liabilities
for comparable cash balance plans based on the way interest credits with similar
values are described. If forced to use the lower discount rate in valuing liabilities,
some companies would be compelled to overstate their long-term plan liabilities
significantly. Certain companies would be forced to take a charge against shareholder
"By establishing a separate set of accounting rules applicable only to
cash balance plans, two plans that are expected to pay out very similar benefits
may be forced to recognize substantially different liabilities and costs
solely because one plan uses a different plan design to deliver the same benefits,"
"Ironically, cash balance plans that use shorter term interest credits,
perhaps based on 6-month yields, would have the largest relative disadvantage,
even though their design provided a lower benefit payout than plans that based
their benefits on longer term yields," added Lofgren.
FASB staff has suggested that the proposed accounting treatment is a clarification,
not a change, but Watson Wyatt cautions that it is a significant departure from
current practice. Watson Wyatt urges the EITF and FASB to seek and consider
formal input on this matter from the benefits community and plan sponsors before
enacting such a dramatic change.
In a separate action that Watson Wyatt supports, the EITF on May 15 also affirmed
defined benefit accounting treatment for cash balance plans and recommended
a specific attribution method (traditional unit credit) that most closely tracks
the value of benefits actually accrued. For some plans, this will not represent
a significant change. For others, the impact will be a decrease in certain accounting
liabilities and costs.