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Strategies & Market Trends : Mish's Global Economic Trend Analysis -- Ignore unavailable to you. Want to Upgrade?

To: Jim McMannis who wrote (49053)	3/31/2006 1:17:34 PM
From: mishedlo	Respond to of 116555

Pension Update: Slip Slidin' Away? "We work our jobs, collect our pay, Believe we’re gliding down the highway, When in fact we’re slip slidin’ away." You know the nearer your destination, the more you’re slip slidin’ away." -Paul Simon pimco.com As we close the books on 2005, the early results indicate it was not a good year for pensions in the United States. Returns for both the S&P 500 and the Lehman Brothers Aggregate were anemic, trumped by returns on 20+ year Treasury bonds as the yield curve flattened during the year. This is never a good thing in (Un)Funded Status Land and the meager gains made in 2004 were more than erased in 2005. Fully funded defined benefit pensions are moving further out of grasp, and for a growing segment of the aging U.S. workforce, retirement income security may be fading as well. More on that later, but first a review of the health of defined benefit schemes. The combination of falling long bond yields and poor returns on broad market indices does not bode well for the funded status of pension plans when year-end 10K’s are released and the numbers totaled. The yield on the Moody’s AA long corporate bond index dropped approximately 25 basis points for the year indicating that discount rates for accounting liabilities will show similar declines. Most U.S. pension plans probably saw liabilities increase between 8-11% even before taking into account additional benefit accruals or benefits paid. With an 85% funded ratio, those plans would have needed asset returns of 9.5-13% to keep pace without making additional contributions. The 5.1% from our assumed mix of assets falls quite a bit short. The year-end funding ratio for 2004, at 88.4%, came in higher than our estimate last year of 85.8%, likely due to better asset returns than our simple model and higher contribution levels. Contributions, while increasing from the lows seen in 2000-2001, still look decidedly insufficient to keep up with the growth in liabilities from interest accruals and falling rates. The table below spells out an estimate of the roll forward from 2004. [click on link for lots of graphs - Mish] For those keeping score at home, accounting for retirement benefits was only the second most serious accounting concern relating to the understatement of corporate liabilities. The SEC estimated that there might be "approximately $1.25 trillion in non-cancelable future cash obligations committed under operating leases that are not recognized on issuer balance sheets." Given that subtle prodding by the SEC, it is little wonder that FASB voted unanimously to overhaul accounting standards FAS 87 (Pensions) and FAS 106 (Other-Post Employment Benefit Obligations (OPEB) aka: Retiree Healthcare) in November. The structure of the reform will take two phases: * Phase One: Show the net surplus/deficit (Assets - Projected Benefit Obligation (PBO)) of the plan at market on the balance sheet. Target date for implementation is December 31, 2006. * Phase Two: Everything else, in other words anything that would flow through the income statement. Timetable is uncertain, but probably three years or more until a recognition date (Dec. 31, 2008 or later). The two-step approach addresses SEC’s highest concerns, but leaves the dirtiest and most contentious work for later. For some sponsors, Phase One will dramatically alter the appearance of their balance sheet and reduce shareholder’s equity. According to a study by CSFB, if Phase One had been in effect at the end of 2004, eighteen companies would have seen shareholder’s equity reduced by 25% or more and seven would have seen it wiped out completely.4 While the one-time effects of the change are significant, reducing shareholder’s equity of the S&P 500 by some 7%, the impact of the change will be felt years into the future. Because asset values and PBO will be valued at market on the balance sheet annually (quarterly mark-to-market will probably come in Phase Two), sponsors of large pension plans who do not address asset-liability mismatches will see significant volatility in book value much as FAS 133 added volatility to the balance sheet of large derivative users. This may draw heightened attention from ratings agencies, bondholders, and those few equity investors who look beyond the income statement. Changes to how pensions are presented on the income statement will be far more contentious. Three of the major issues to be addressed in Phase Two: 1. Presentation of Net Periodic Pension Cost (NPPC) NPPC currently aggregates the cost of additional benefit provision (service cost), with financing costs (interest cost), income (return on assets), and amortized gains and losses. Revision of the standard may keep service cost as an operating expense while moving the other pieces to below the EBIT line. 2. Amortization of Gains and Losses It is unclear how this piece will be reflected on the income statement if the entire amount of gains and losses will be reflected on the balance sheet in Phase I. To preserve coherence between the two, some flow through the income statement is required. 3. Use of an Expected Return on Assets or Actual Realized Returns Accounting currently uses an expected rate of return rather than realized returns. This yields a considerable reduction in volatility, but there is some debate whether doing so gives an accurate picture of the company. It does enable a truer picture of core operating businesses, but not the total picture of the sponsor. A move away from expected returns would likely be the single greatest factor leading to major changes in sponsor asset allocation. .... ....