MAP-21 skirts IASB
Under the seemingly innocuous Moving Ahead for Progress in the 21st Century Act (or MAP-21 for short), new accounting rules have been approved in the US that will affect their private pension funds. But will it be for better or for worse?
Adoption is voluntary but companies taking advantage of the new rules will certainly drift farther away from the international standards of the International Accounting Standards Board (IASB), which come into effect from January 2013 in the UK and elsewhere.
In the worst scenario, the most vulnerable pension plans would become weaker because of lower contributions, after a year when their funding status has deteriorated, as a new study by Standard & Poor's shows.
At the end of 2011 the companies in the S&P 500 index collectively reported pension obligations of $1.68trn (€1.36trn) and assets of just $1.32trn. The $355bn deficit was the largest ever - $100bn more than the previous year and surpassing the record $308.4bn level set in 2008. Only 18 of the 338 S&P 500 firms with defined benefit pension plans were fully funded.
Over recent years, pension investments have not performed as well as the expected returns implied in their assumptions; on the other hand, historic low interest rates, used to discount future obligations and estimate current costs, have pushed up liabilities. For the fourth year in a row, and the eighth year in the past 10, S&P 500 companies have underfunded their pensions, the S&P report said.
This is why associations and lobbyists representing corporate plan sponsors have called for relief - among them Charles Millard, managing director of pension relations at Citigroup and former director of the Pension Benefit Guaranty Corporation (PBGC), in an op-ed in the Wall Street Journal in June. The relief proposed is to replace the discount rate based on a two-year average of AA corporate bond rates - as the Pension Protection Act (PPA) of 2006 requires - with a higher rate. Liabilities then reduce, the funding status goes up and companies do not have to contribute as much.
Accordingly, Millard's wishes, as well as those of the American Benefits Council and the ERISA Industry Committee, have been fulfilled by the bipartisan MAP-21 that was signed by president Barack Obama on 6 July 2012. The new provisions allow plan sponsors to use a 25-year historic average of corporate bond rates to determine a rate within a 10% range, or corridor, of the two-year rate. The alternative discount rate would be smoothed and higher - an average 6.7% versus the current 5.3% - which could reduce liabilities by 10-20%, according to estimates by Donald Fuerst, senior pension fellow at the American Academy of Actuaries. Plan sponsors in the S&P 1500 index could save as much as $50bn in 2012 and $100bn to 2014, according to consulting firm Mercer.
The actuaries recommended keeping the current method for determining funding targets and participant disclosures - instead, directly providing for a reduction in contributions.
Some are sceptical: "The new ‘corridor' leaves more space to accounting manipulation and helps hiding the financial truth," says Ronald Ryan, CEO of Ryan ALM. "It's the opposite of what IASB has decided - using mark-to-market financial reporting also for pension funds. The latter is the right way and the American Financial Accounting Standards Board will follow, sooner or later."
If their funding status appears healthier, companies can contribute less and their bottom line will look healthier. Because pension contributions are tax exempt, this also means paying more tax. The US Congress' joint committee on taxation estimates that the government could get an additional $17bn in tax in the next 10 years.
"In the short term, companies may love it, but while pension contributions are still part of their balance sheet, taxes are money that leaves the company and that may hurt in the long term, damaging the pension funding ratio and certainly not improving funds' solvency," concludes Ryan.
General Electric - which has a $21.6bn pension deficit, the largest among the S&P 500 companies - has already announced that it will cut its pension contributions thanks to the new law. But other big corporations such as IBM, Honeywell, AT&T, Intel, UPS and Verizon have instead, during the past 18 months, adopted the mark-to-market approach and are not likely to go back. It is more transparent and less complicated, said a spokesperson for UPS.