This page has been archived and commenting is disabled.
Pension Accounting Change to Hit Profits?
Bob Tita of the Dow Jones Newswire reports in the WSJ, Pension Accounting Change Could Make Company Profits Less Predictable:
Efforts
to make pension accounting more transparent could cause corporate
profits to become more volatile if gains and losses from pension assets
are mingled with results from companies' business operations.
The agency for international accounting standards is expected to take
up a proposal next year that would require companies with
defined-benefit pensions to report annual changes in the value of their
pension assets as part in their income statements. Under current
procedures, returns on pension investments and gains and losses in
pension-plan assets are accounted for in small increments over several
years to keep them from skewing companies' earnings.
The
change would provide a more immediate snapshot of companies'
pension-plan performance. But U.S. companies, aside from Honeywell
International Inc. (HON), have so far been reluctant to voluntarily
change their pension accounting. Observers warn that investors could be
subjected to bouncier stock prices if earnings become significantly
less reliable with the addition of unpredictable gains and losses from
pensions.
"If we've learned nothing else over the
last three years, it's that the market isn't always rational," said
Alan Glickstein, senior consultant for Towers Watson, an employee
benefits consultancy. "It's not necessarily a good thing if [the
accounting change] just increases earnings volatility."
If
the International Accounting Standards Board--the nongovernmental
agency for accounting rules used by companies outside the U.S.--adopts
the change for pension accounting, observers predict the Financial
Accounting Standards Board will follow suit for the sake of consistency
and amend the Generally Accepted Accounting Principles used by U.S.
companies.
"To the degree that a company wants to make
sure that their financials are reflective of their operations, it
would make sense to go through a change like this. It would add
transparency to the numbers," said Daniel Holland, an analyst for
research firm Morningstar Inc.
More
than 340 companies in the Standard & Poor's 500 Index have
defined-benefit pensions that guarantee employees pension incomes when
they retire. To meet these obligations, the companies have set aside a
combined $1.22 trillion that is invested in stocks, bonds and other
types of investments.
Smoothing out annual gains and
losses from defined-benefit pensions has come under increasing scrutiny
as regulators dismantle other accounting practices used for decades to
wall off pension costs and liabilities from companies' balance sheets
and their profit statements.
"The pension volatility has
always been there. It's just not measured today. The accounting doesn't
require that it be highlighted," said David Larsen, managing director
for corporate finance consulting at Duff & Phelps Corp., a
financial services and investment banking advisory firm.
Honeywell is the largest U.S. company to begin using market-to-market
accounting for its pension. The move is intended to put the brakes on
escalating costs for Honeywell's pension. Falling interest rates on
bonds used to determine companies' future pension obligations have
driven up annual pension costs for all companies with defined-benefit
plans. But Honeywell's expenses have been exacerbated by a decision it
made in the late 1990s to use a six-year schedule for amortizing pension
gains and losses on pension assets and a three-year schedule for
smoothing out returns from pension investments. Most companies amortize
gains and losses over 10 years or 12 years and account for investment
returns over five years.
Honeywell's
shorter time frame helped the company lower its pension expenses when
asset values soared. But when pension-fund performance tanked in 2008,
Honeywell's pension headwinds were magnified in its earnings.
Without the option of switching back to a longer amortization
schedule, Honeywell will stop deferring gains and losses. The aerospace
and building-systems manufacturer will recognize $5.5 billion in prior
asset losses in its 2010 income statement. Going forward, Honeywell
will report gains and losses in their entirety during the year they
occur.
The change will increase the company's pension costs
for this year to $1.61 billion, compared with $791 million under the
six-year schedule. But its pension expenses are expected to plunge to
$200 million in 2011.
"It takes all that old stuff and puts
it behind them," said Howard Silverblatt, an analyst with Standard
& Poor's investment services unit.
Once
the slate is wiped clean, Honeywell aims to limit its pension expenses
to about $200 million a year. Moreover, the company will attempt hold
down pension-related volatility in its earnings by making pension asset
values and returns more predictable than in the past.
"I can see investors having this fear that every fourth quarter
there's going to be this wild swing," Chairman and Chief Executive David
Cote said during a Nov. 16 conference call with analysts. "More likely
than not, that is not going to happen."In the coming
years, Honeywell plans to shift more of its pension funds from equities
to fixed-income investments. That will lower annual returns to 6.5%
from 9%, but will lessen Honeywell's exposure to sudden swings in stock
values and returns that would contribute to earnings volatility.
If
mark-to-market pension accounting becomes the standard, other
companies will likely change their investment mix as well, creating a
profound shift in the allocation of pension funds the next decade.
"I would expect it to take a while, but pension assets would shift to less volatile securities," Morningstar's Holland said.
Is
there a "profound" shift in asset allocation going on? I'm not
convinced. If corporate plans adopt mark-to-market pension accounting
rules, they will reduce pension costs and likely shift assets into less
volatile securities, winding up their existing defined-benefit plans
while scrapping them for new employees (moving them into
defined-contribution plans).
But I've already discussed that
while private pension plans are reducing risk, most public plans are
increasing risk, continuing to invest the bulk of their assets in
equities and alternatives. Public plans are much larger and shifts in
their asset mix carry a lot more weight. In other words, we can
speculate all we want, but it remains to be seen whether a "profound"
shift in asset mix will take place over the next decade, even among
corporate plans.
Of course, if Charles Nenner is right (see Yahoo
Tech Ticker interview below), and a Japan-style slump hits the US
economy, then corporate plans adopting Honeywell's approach might come
out ahead. I don't agree with Mr. Nenner (correlation does not imply
causation!!!), but if he's right, bonds will continue to outperform over
the next decade.
- advertisements -



Man , this is all too confusing.
Japan seems fine with all this deflation which in fact is fine for the bloke on the street. but japan has a falling population whereas the rest of the world's population is going up.
more pressure on food, oil etc - inflation no? QE2,3,4 he aint gonna stop.
So long cash or commodities?
No guns and ammo answers please.
convert all pension funds into SOLAR PANELS!!! there!! Heaven for Leo!!!
I cannot understand valuing loans at full value but pension funds at market ... any inconsistencies here
thanks for posting. clever bloke.
I wouldn't doubt public and private stay in equities or junk bonds (PIIGS debt bonds) or whatever.
It doesn't matter if they come up short; they simply say "sorry" twenty to forty years late or get bailed out by the taxpayer.
History repeating...
Leo,
Solars = Bloodbath
Yup, computers are on overdrive for Chinese solars. Keep them on your radar, especially the ones testing their 200-day m.a.:
Whats the dive really about ??? The credit issues in china or demand in europe.. ?
Which of all the crap falling has the strongest balance sheet / record.?