WSJ: Pensions Unplugged
Pensions Unplugged
[FONT=times new roman,times,serif][FONT=times new roman,times,serif]By ARTHUR LEVITT, JR.
November 10, 2005; WSJ: p. A16[/FONT]
[/FONT]
As the wave of pension defaults that began with the steel companies and the airlines now threatens to engulf auto-parts makers and even car companies themselves, the pension crisis has grabbed headlines. Proposals to shore up the Pension Benefit Guaranty Corporation (PBGC) are making their way through Congress. Meanwhile, the problem -- in the private and the public sector -- will only get worse unless immediate action is taken to bring accuracy, transparency and accountability to pension accounting.
Over the past three decades, we have allowed a system of pension accounting to develop that is a shell game, misleading taxpayers and investors about the true fiscal health of their cities and companies -- and allowing management to make promises to workers that saddle future generations with huge costs. The result: According to a recent estimate by Credit Suisse First Boston, unfunded pension liabilities of companies in the S&P 500 could hit $218 billion by the end of this year. Others estimate that public pensions -- the benefits promised by state and local governments -- could be in the red upwards of $700 billion.
Claims on the PBGC have skyrocketed. If serious reform is not undertaken, the non-partisan Center on Federal Financial Institutions estimates that the PBGC could easily face a $100 billion hole, delivering to our overburdened treasury a crisis exceeding the massive savings-and-loan bailout of the late 1980s. It's imperative that we reform the regulatory incentives and accounting rules that encourage employers to make, and employees to accept, promises that can't be kept.
• First, we need to bring transparency and honesty back to pension accounting. Currently, there is far too much subjectivity and outright guesswork. The real economic liability for a company's pension plan and the actual value of assets that will be used to meet that obligation are often not reflected on the balance sheet. Instead, the rules allow companies to hide the obligations in footnotes that sometimes not even the most skilled analysts can understand, and to rely on projected numbers, too often unrealistic, of what they anticipate their pension plans' earnings and liabilities will be.
In all my years in and around Wall Street, I have never met anyone who could accurately forecast the market for a 30- or 40-year period. Yet that is precisely what we allow companies to do. The "smoothing" of assets and obligations masks underlying volatility and is producing financial statements that are deceptive. These projected numbers not only hide the true financial health of a company and can be used to artificially boost earnings (and in many cases executive compensation); they also save companies from making additional contributions to the PBGC that they might otherwise be obligated to make if their real financial status were revealed. The financial community recently rejected this sort of Potemkin accounting with regards to the expensing of stock options, and we should reject it as well with regards to pensions.
The Financial Accounting Standards Board (FASB) will reportedly soon address this issue -- and it cannot do so quickly enough. Pension plan assets and obligations are real assets and liabilities and should be reflected as such on the balance sheet. They should be valued accurately to give a realistic and transparent picture of what pension obligations are; what assets have been accumulated to meet them; and what the overall financial situation of a pension plan's sponsor is.
• Second, investors and pensioners deserve relevant and understandable information from pension plans about their fiscal health and operations, not impenetrable financial statement footnotes. It's time that we got away from jargon and addressed the average individual in a language that he can understand.
This should start with lifting the shroud of mystery around discount rates used to compute the present value of pension obligations (and thus the size of the liability or asset reported). For too long, companies have played with various variables to devise a rate that helps them to recalibrate employee retirement plan assets and liabilities in order to manage earnings. At the same time, many unions have been the willing victims, trading current wage increases for pension promises -- and ultimately getting neither. And instead of exercising sound professional judgment, too many accountants and actuaries, the ultimate gatekeepers, have been all too willing to go along for the ride, giving these estimates and assumptions their seal of approval while arguing that everyone else is "doing the same."
As a result, according to a Glass, Lewis and Co. study of the largest U.S. companies, the average company in this group could be understating future health care costs by 4% annually, adding billions to their bottom line that they don't actually have. The SEC and the Public Company Accounting Oversight Board should use their enforcement capabilities to stop the misleading of investors by companies who have fudged or abused accounting and disclosure rules -- and by the accountants and actuaries facilitating it. Actuaries must be held accountable to regulators in the same way as are accountants.
The FASB has recently required companies to give investors a projection of the benefit payments the plan is expected to make to pension plan participants in each of the next five years. It should build on this by requiring companies to disclose in their footnotes projected income from changes in asset values in the plan. To hold companies accountable for these projections, the FASB should require them to tell the public how those projections held up against reality. Such disclosure will help to create a system where off-base projections will be transparent and the gaming of the numbers will not have any real upside.
• Third, while the most recent headlines have focused on the impending crisis in corporate pension plans, there is perhaps an even larger problem with the public pensions of state and local governments. Not only are unfounded liabilities moving toward $1 trillion, but the accounting standards in this arena lag behind that of corporate America. Weakened disclosure rules fail to reflect accurately the assets and liabilities of public pension plans; alternative actuarial procedures are allowed that can be abused to lower reported costs; and the current rules fail to provide citizens and elected officials with a clear picture of what claims these programs will be making on future tax revenues. Contributing to these loose standards is a constituency of public pension officials and government finance officers who resist any moves to greater transparency.
Unrealistic pension assumptions already have gotten a number of public entities -- such as the city of San Diego and the states of Colorado and Illinois -- into economic difficulty, trouble that will spread if these impractical assumptions are not reined in. This past year, I have served as a member of the audit committee charged with investigating and remediating allegations of problems surrounding San Diego's pension funds and finances. I have seen firsthand how devastating apparent examples of bad pension accounting and mismanagement can be, and how vital correcting both are to the overall health of the capital markets and the retirements of tens of millions of workers and retirees.
Untangling the web of problems plaguing the automotive and airline industries, as well as those of municipalities and states, has not been easy. Putting their pension plan and finances on sound footing will require great sacrifice for all affected: investors, employees, management and citizens. To avoid the pain that Delphi and San Diego are undergoing, we must now place defined-benefit pension plans on solid ground. Doing so may be difficult for many cities and companies. But it will be very good for America.
Mr. Levitt is former chairman of the SEC.
Pensions Unplugged
[FONT=times new roman,times,serif][FONT=times new roman,times,serif]By ARTHUR LEVITT, JR.
November 10, 2005; WSJ: p. A16[/FONT]
[/FONT]
As the wave of pension defaults that began with the steel companies and the airlines now threatens to engulf auto-parts makers and even car companies themselves, the pension crisis has grabbed headlines. Proposals to shore up the Pension Benefit Guaranty Corporation (PBGC) are making their way through Congress. Meanwhile, the problem -- in the private and the public sector -- will only get worse unless immediate action is taken to bring accuracy, transparency and accountability to pension accounting.
Over the past three decades, we have allowed a system of pension accounting to develop that is a shell game, misleading taxpayers and investors about the true fiscal health of their cities and companies -- and allowing management to make promises to workers that saddle future generations with huge costs. The result: According to a recent estimate by Credit Suisse First Boston, unfunded pension liabilities of companies in the S&P 500 could hit $218 billion by the end of this year. Others estimate that public pensions -- the benefits promised by state and local governments -- could be in the red upwards of $700 billion.
Claims on the PBGC have skyrocketed. If serious reform is not undertaken, the non-partisan Center on Federal Financial Institutions estimates that the PBGC could easily face a $100 billion hole, delivering to our overburdened treasury a crisis exceeding the massive savings-and-loan bailout of the late 1980s. It's imperative that we reform the regulatory incentives and accounting rules that encourage employers to make, and employees to accept, promises that can't be kept.
• First, we need to bring transparency and honesty back to pension accounting. Currently, there is far too much subjectivity and outright guesswork. The real economic liability for a company's pension plan and the actual value of assets that will be used to meet that obligation are often not reflected on the balance sheet. Instead, the rules allow companies to hide the obligations in footnotes that sometimes not even the most skilled analysts can understand, and to rely on projected numbers, too often unrealistic, of what they anticipate their pension plans' earnings and liabilities will be.
In all my years in and around Wall Street, I have never met anyone who could accurately forecast the market for a 30- or 40-year period. Yet that is precisely what we allow companies to do. The "smoothing" of assets and obligations masks underlying volatility and is producing financial statements that are deceptive. These projected numbers not only hide the true financial health of a company and can be used to artificially boost earnings (and in many cases executive compensation); they also save companies from making additional contributions to the PBGC that they might otherwise be obligated to make if their real financial status were revealed. The financial community recently rejected this sort of Potemkin accounting with regards to the expensing of stock options, and we should reject it as well with regards to pensions.
The Financial Accounting Standards Board (FASB) will reportedly soon address this issue -- and it cannot do so quickly enough. Pension plan assets and obligations are real assets and liabilities and should be reflected as such on the balance sheet. They should be valued accurately to give a realistic and transparent picture of what pension obligations are; what assets have been accumulated to meet them; and what the overall financial situation of a pension plan's sponsor is.
• Second, investors and pensioners deserve relevant and understandable information from pension plans about their fiscal health and operations, not impenetrable financial statement footnotes. It's time that we got away from jargon and addressed the average individual in a language that he can understand.
This should start with lifting the shroud of mystery around discount rates used to compute the present value of pension obligations (and thus the size of the liability or asset reported). For too long, companies have played with various variables to devise a rate that helps them to recalibrate employee retirement plan assets and liabilities in order to manage earnings. At the same time, many unions have been the willing victims, trading current wage increases for pension promises -- and ultimately getting neither. And instead of exercising sound professional judgment, too many accountants and actuaries, the ultimate gatekeepers, have been all too willing to go along for the ride, giving these estimates and assumptions their seal of approval while arguing that everyone else is "doing the same."
As a result, according to a Glass, Lewis and Co. study of the largest U.S. companies, the average company in this group could be understating future health care costs by 4% annually, adding billions to their bottom line that they don't actually have. The SEC and the Public Company Accounting Oversight Board should use their enforcement capabilities to stop the misleading of investors by companies who have fudged or abused accounting and disclosure rules -- and by the accountants and actuaries facilitating it. Actuaries must be held accountable to regulators in the same way as are accountants.
The FASB has recently required companies to give investors a projection of the benefit payments the plan is expected to make to pension plan participants in each of the next five years. It should build on this by requiring companies to disclose in their footnotes projected income from changes in asset values in the plan. To hold companies accountable for these projections, the FASB should require them to tell the public how those projections held up against reality. Such disclosure will help to create a system where off-base projections will be transparent and the gaming of the numbers will not have any real upside.
• Third, while the most recent headlines have focused on the impending crisis in corporate pension plans, there is perhaps an even larger problem with the public pensions of state and local governments. Not only are unfounded liabilities moving toward $1 trillion, but the accounting standards in this arena lag behind that of corporate America. Weakened disclosure rules fail to reflect accurately the assets and liabilities of public pension plans; alternative actuarial procedures are allowed that can be abused to lower reported costs; and the current rules fail to provide citizens and elected officials with a clear picture of what claims these programs will be making on future tax revenues. Contributing to these loose standards is a constituency of public pension officials and government finance officers who resist any moves to greater transparency.
Unrealistic pension assumptions already have gotten a number of public entities -- such as the city of San Diego and the states of Colorado and Illinois -- into economic difficulty, trouble that will spread if these impractical assumptions are not reined in. This past year, I have served as a member of the audit committee charged with investigating and remediating allegations of problems surrounding San Diego's pension funds and finances. I have seen firsthand how devastating apparent examples of bad pension accounting and mismanagement can be, and how vital correcting both are to the overall health of the capital markets and the retirements of tens of millions of workers and retirees.
Untangling the web of problems plaguing the automotive and airline industries, as well as those of municipalities and states, has not been easy. Putting their pension plan and finances on sound footing will require great sacrifice for all affected: investors, employees, management and citizens. To avoid the pain that Delphi and San Diego are undergoing, we must now place defined-benefit pension plans on solid ground. Doing so may be difficult for many cities and companies. But it will be very good for America.
Mr. Levitt is former chairman of the SEC.
