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5500 Preparer's Manual for 2012 Plan Years
The premier resource in the field of Form 5500 preparation, 5500 Preparer's Manual will help you handle the required annual Form 5500 filings for both pension benefits and welfare benefit plans.
"Despite their massive size and economic importance, defined benefit pension plans have been largely hidden from view behind a nearly impenetrable thicket of often incomprehensible accounting standards, funding rules, and actuarial conventions," according to outgoing PBGC executive director Bradley D. Belt. Belt assessed the current state of the defined benefit system at a March 13, 2006 meeting of the National Association for Business Economics held at the University of Texas School of Law.
In his remarks, whimsically entitled "Through the Looking Glass: Adventures in Pension Land," Belt observed that "when we gaze upon the pension landscape, we are struck with the peculiar sensation that much of what we were taught -about economics, about corporate finance, about accounting - no longer applies." He went on to state, "With apologies to Lewis Carroll, we feel as though we have followed Alice down the White Rabbit's hole into a looking-glass world that is disconnected from economic reality - one where you can add risk without adding cost, where a dollar of stocks is worth more than a dollar of bonds, and where the value of assets five years ago affects your pension contributions today."
Belt noted the "remarkable" proposition that employee compensation, which one generally considers to be a cost center for corporations, can be a rich source of profits. "As you know," he said, "private-sector plan sponsors are required by law to set aside a certain level of assets to meet their pension obligations. But under the pension accounting rules - Financial Accounting Statement 87 - companies can book to income not the actual return on those pension assets but the expected return. Holding everything else constant, a company with $50 billion in pension assets and a 10% assumed rate of return can claim a 'pension profit' of $5 billion, even if in reality the assets decline by 10% that year. For some companies in recent years, the pension plan has been a primary source of profits - phantom profits in the view of many, but with the power to boost share prices and executive compensation just the same. ...Imagine if this approach applied to other areas of corporate finance. That 10% drop in sales you experienced becomes a 10% gain, because that's what you 'assumed' would happen based on past experience. That 50% increase in the price of raw materials never happened, because it wasn't in your projections."
According to Belt, "When pension-land was dominated by actuaries and benefits professionals, it was relatively easy to get away with loose thinking about how to value pension assets and liabilities. Consider two promises to pay: one collateralized with stocks and the other collateralized with bonds. The actuarial view says the 'cheaper' promise is the one backed by stocks, because stocks have higher expected returns. The financial economics view, which has been making steady inroads in the pension space, considers that approach nonsensical - a dollar of stocks is worth exactly the same as a dollar of bonds. The economic cost of a benefit promise is the same whether it is backed up by stocks, bonds, or no assets at all."
Belt noted that the actuarial view, which also informs FAS 87, encourages companies to meet their obligations by borrowing from employees, investing in riskier assets, and hoping the assets beat the borrowing rate. "And," he said, "it holds a surface appeal: If you borrow at a 6% corporate bond rate and earn 8% on a basket of riskier assets, your cash contributions to the pension plan can be reduced accordingly. Of course, what pension plans experienced in the early part of this decade was the opposite. Companies borrowed at 6%, earned negative 8%, and reacted with shock when the margin call of higher required contributions came due." That, he said, "explains why the asset allocations of pension plans are remarkably similar despite vast differences in the liability profile. For example, some people think that a 'young' pension plan with five active workers for every retiree can afford to invest along the traditional lines of 60% equity, 35% fixed income, and 5% cash. But what we observe in pension-land is that 'mature' plans with five retirees for every active employee invest exactly the same way. The cash flows and inflation sensitivity of these two pension plans could not be more different. What is the same is the desire to chase returns in heretofore almost blissful ignorance of the liabilities."
Belt went on to state, "Let me be clear: the pension alchemy we see practiced every day is permitted, even encouraged, by financial accounting standards, ERISA funding rules, and actuarial conventions. But it is disconnected from the economic reality in which you must operate, and it obfuscates what every worker, retiree, investor, and creditor has a right to see." Those who take a different view, he said, will argue that we need not worry about these stakeholders of the pension system. "In this rose-colored view of the world, pension plans are seen only as long-term obligations, with pension gains and losses amortized over time. Corporate income statements will catch up with economic reality eventually. Yes, that may happen. At some point pension reporting and economic reality might even agree with each other, but only by coincidence, and never for long."
The interaction of pension finance, pension policy, and the decisions made by pension managers and the PBGC affects real people in the real world, said Belt. "It affects workers and retirees of American corporations, who can lose billions of dollars in promised benefits when plans terminate because of legal limits on the PBGC guarantee. It affects corporations saddled with massive unfunded legacy burdens from an earlier era. It affects healthy companies with well-funded pension plans, which are growing weary of paying the pension bills of bankrupt steel and airline companies through ever-higher PBGC premiums. It affects investors who cannot penetrate the pension veil to perceive a company's true value and end up paying more than they should. It affects taxpayers who may one day be called upon to bail out the PBGC when corporate America says enough is enough."
Belt concluded by saying, "There is reason for hope. Whereas the broad implications of the pension system were heretofore not well understood, I believe we are poised to see improvements both on the funding front and the accounting front." He noted that the House and Senate versions of pension reform legislation share some important common elements with the proposal the Bush Administration unveiled in January 2005 (see CCH Pension Plan Guide Report No. 1563, January 18, 2005). However, Belt said that the bills, "need to be strengthened and improved to better protect the benefits earned by workers and retirees."
Changes are needed now - otherwise the costs will be higher and the decisions that much harder down the road, Belt said. The promise to provide deferred compensation to workers is a straightforward proposition that should be accounted for and funded in a clear and financially sound manner. "It is time to pierce the veil and allow the stakeholders of the pension system to understand these liabilities using the same rules that govern other corporate obligations. Even Alice didn't remain in Wonderland forever. Eventually she woke up."
For more information on this and related topics, consult the CCH Pension Plan Guide.
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