New Accounting Rules Require New Investment Strategies

Panel members at PLANSPONSOR's DB Summit in Washington, D.C. last month were in agreement that new pension accounting rules hatched by the Financial Accounting Standards Board (FASB) and Governmental Accounting Standards Board (GASB) will prompt plan sponsors to utilize new investment strategies.

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The first phase of the FASB/GASB project requires companies to measure pension assets and liabilities on their balance sheets. Robert McBride, Vice President and Senior Consulting Actuary at Diversified Investments, said this means a move to alternative investments and a shift from equities to bonds.

Michael Peskin, Managing Director, Morgan Stanley Asset Liability Management Group, added that a shift to derivatives will be driven by the desire for separation of alpha and beta (what hedge funds do), and selling equities and buying alternative investment vehicles reduces risk while maintaining expected returns.  As for the shift to bonds, Peskin said the market can ultimately handle the bond rush as these investment offerings are usually driven by demand. The government responds to demand by offering more treasury notes.

As part of the panel “The Bottom Line: The Impact and Implications of the FASB/GASB Pension Project “, Peskin also noted the accounting rules mean plan sponsors will have to now address the fiduciary interest of participants when selecting investments for funded assets of their DB offerings and should ask, “Is choosing this investment in the company’s best interest or the participants’?”

McBride said the new accounting rules also mean sponsors will need to take a new look at plan design. According to McBride, since FAS 158 requires changes to a company’s balance sheet and not its income statement, plan sponsors will move to a DB system where benefit measurement is more smooth over time.

He points out PBO (Projected Benefit Obligation) – now required to be reported rather than ABO (Accumulated Benefit Obligation) – includes the measurement of future possible pay increases. This has resulted in many sponsors changing their DB plan from using final average pay in benefits calculations to using career average pay.

The Chicken or the Egg

Plan sponsors have expressed concern that both pension reform and pension accounting changes, proposed by the Financial Accounting Standards Board (FASB) will be the death knell of the defined benefit system, panel member Aliya Wong, Director of Pension Policy at the US Chamber of Commerce, told the DB Summit audience. However, panel members suggested FASB rules were driven by changes in the DB system, rather than the other way round.

Peskin explained that what happened was the funding status dropped 5,000 basis points among S&P 500 corporations making them ask, "Do we know what we're doing?" Also, "Investors started to feel hosed," he said. Then, the FASB reacted.

The accounting rule changes are not causing the latest rash of DB plan freezing, according to Peskin. Rather, companies freeze DB plans because, in a very low interest rate environment, the cost of providing a DB offering is higher. Further, participants are not valuing the DB benefit because most do not believe they will retire from the company they currently work for, Peskin added. He does not expect the FASB/GASB project to change the pension landscape negatively in the future either. Peskin said he believes by the time the proposed accounting rules go into effect the market will have already adjusted and sponsors will have already addressed plan funding issues.

Wong pointed out, though, pension accounting rules are not helping with corporate management's misconception about the benefits in continuing to offer DB plans. "It's hard to see the good of DB when you're worried about the bottom line and pension accounting is having a negative effect on the bottom line," Wong said. She encourages human resource professionals to focus on the advantage of attracting and retaining skilled workers when talking to management about DB plans.