Deferred Pension Expenses Looming: Towers Perrin

July 14, 2003 (PLANSPONSOR.com) - Smaller than expected pension returns and growing pension obligations (exacerbated by record low interest rates) are combining to create another growing problem for pension plans, according to a new study.

The Towers Perrin study found that among a group of 300 major corporations that sponsor pension plans, these deferred costs nearly tripled last year, growing to an average of about $1.4 billion at each company, according to the report, which is scheduled to be published today.  

“The emergence of deferred costs creates a critical new financial management issue – one that pension plan sponsors have previously not had to address,” according to Reuters, citing comments from the report.

Of additional concern to plan sponsors is how pending changes currently under consideration in pension accounting might accelerate the negative impact of these expenses.

Flipsides

The accounting dynamic represents the flipside of what pension funds experienced during better times.   As recently as the end of 2000, some companies were deferring significant pension income rather than expense.   The Towers Perrin study notes that the 300 companies studied reported average deferred income of $770 million in 1999, at a time when the strong market conditions helped bolster pension finances.

These “deferred costs” are unfunded benefit obligations that haven’t yet appeared on the corporate income statement. Companies are allowed to amortize them over a long horizon.   Company income statements last year didn’t reflect how large the costs have grown overall, according to the report. Indeed, the average cost for the surveyed companies was $23.9 million, compared to pension income of $14.4 million for the prior year.

Still, as things stand presently, pension costs in the companies Towers Perrin studied accounted for just 2.0% of operating earnings in 2002, compared with -1.4% a year earlier.

P&L Impact

“When the numbers are relatively small, there’s less reason to question whether what’s going through the P&L (profit and loss statement) is reasonable,” Steven J. Kerstein, managing director of global retirement at Towers Perrin and an author of the study, said, according to Dow Jones.   The report quotes Kerstein’s caution that even restoring the funds to a fully funded status won’t resolve the deferred cost dilemma.   “If you fund but don’t record additional pension expense, the deferred cost will remain unchanged. Deferred cost only goes away when it goes through the profit and loss statement,” according to Kerstein.

The significance is that eventually, if this deferred cost does not reverse naturally, the cost is “going to work itself into the pension expense calculation, affecting earnings over time,” Kerstein said on Friday, according to the Reuters report.

Towers Perrin based its research on non-public data, as well 10k filings to the Securities and Exchange Commission this spring.

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