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May 21, 2003
Proposal for Cash-Balance Plan Accounting Criticized

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.

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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 equity.

"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," says Lofgren.

"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.

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