NEW YORK - Now that corporate America’s pension promises will be thrust into the spotlight by new regulations, investors should watch for accounting tricks companies may use to reduce their benefit obligations.
New rules from U.S. Financial Accounting Standards Board will force companies to report the status of their pensions and other postretirement employee benefits — as an asset or, for most, a liability if they are underfunded — on their balance sheets rather than have them buried in a footnote to the financial statements.
That means huge liabilities could suddenly drop like a bomb onto balance sheets, putting any deficits squarely in the public view and possibly throwing some lending agreements into question because it may lead to sharp drops in corporate net worth.
Figuring out if any maneuvering is going on won’t be an easy task. Investors will have to closely watch companies’ assumptions for such things as health care and wage inflation that are used to determine the costs of defined benefit plans, which promise retirees a monthly check and often medical coverage.
For years, companies have gotten off easy by agreeing to such benefits without having to immediately set aside ample assets to cover them. Standard & Poor’s estimates that the companies in its benchmark index offering such benefits held assets worth only $1.409 trillion in 2005 to cover $1.870 trillion in pension and other retireebenefit obligations, resulting in a record deficit of $461 billion.
‘‘In the past, analysts, auditors and investors looked at numbers differently if they were in the footnotes vs. the financial statements,’’ said Lynn Turner, a former chief accountant with the Securities and Exchange Commission who is now managing director at the independent research firm Glass, Lewis & Co. ‘‘But when you move something onto the balance sheet, suddenly people want to study it more.’’
Which is why so many in corporate America protested the FASB’s moves. The U.S. accounting rulemaker also intends to eventually revamp how pension funding levels flow into earnings.
Besides just the balance sheet effect of the new rule changes, this could also jeopardize lending agreements should credit ratings be lowered due to the additional liabilities.
Once the rule changes seemed likely, companies fought hard to get the FASB to allow them to measure benefit obligations based on what employees had already earned as opposed to what they could make in the years ahead.
The difference between the two is huge. In 2005, the pension deficit based on the accumulated benefit obligation was about $10 billion for 100 large U.S. public companies with pensions, while it was $96 billion when the projected obligation is used, according to a study by actuarial consultants Milliman Inc.
The FASB didn’t relent, so bigger numbers are likely to show up on balance sheets for public companies with fiscal years starting after Dec. 15. For some companies, that might give them more incentive to end their pension programs — a trend seen in corporate America in recent years as pension costs have soared.
Other companies might instead try to trim the size of such obligations. That could be done by capping what they are willing to shell out for such things as retiree health care or shifting some of the financial burden to their workers.
But they could also reduce such obligations by low-balling some of the assumptions used to calculate the amounts owed, notes Jack Ciesielski, author of the popular industry newsletter The Analyst’s Accounting Observer.
For instance, in determining the projected benefit obligation, companies use a rate of expected future salary increases for employees entitled to the pension benefits. By tinkering even just a little with that — which can be largely based on management’s view of wage growth — a company could significantly lower the liability.
Investors can see that information in the pension footnote found in the annual report, where companies give the rate of compensation increase for the last few years. It should raise a red flag if that rate differs from the trend seen in the past or from what competitors show.
Companies also have discretion over health care cost trend rates, which they have been underestimating for years. The median estimated long-term rate of health care inflation was 5 percent every year since 2001 for the 245 companies in the S&P 500 that disclosed such information. But those costs have been rising about 10 percent a year, Ciesielski said.
While missing such targets help lower benefit obligations at one point in time, companies could ultimately have to pay for such mistakes.
For instance, UPS Inc. forecast a health care cost trend rate of 8.5 percent for 2005 and expects to hit a steady rate of 5 percent by 2009. Should the Atlanta-based company be wrong with such predictions, every one-percent gain in its assumed health care cost trend rates could cost it $88 million in post-retirement benefit obligations, according to securities filings.
Shifting such benefit obligations to the balance sheet is better accounting — in terms of practice. But that doesn’t mean all companies are really accounting better.