FASB Seeks the Full Monty on Pension Plan Assets

A new rule will force companies to bare it all when it comes to alternative investments held in post-retirement benefit plans.

Accounting rulemakers want companies to fully disclose the kinds of alternative investments they hold in pension and other post-retirement plans. And a revision of the Financial Accounting Standards Board’s FAS 132, Employers’ Disclosure about Pension and Other Post-retirement Benefits, is their instrument for getting companies to bare the additional information.

The proposal, which will be released for a 45-day comment period by March 7, reportedly will require companies to disaggregate the current broad asset categories — equity securities, debt securities, real estate, and other — into subcategories and then further sort them by risk using the fair value hierarchy laid out in FAS 157, Fair Value Measurement. The idea is to give investors more details about the risk associated with the plan assets, and any uncertainty that risk may have on the company’s future cash flows.

Monitoring plan assets of large companies is as important to investors as tracking company operations, noted FASB board members on Wednesday, in reference to the effect that underfunded pension obligations can have on a company’s cash flow. To that end, FASB staffers are crafting language, along with a grid that can be used by companies to better identify the investments in pension plan portfolios.

It is likely that the grid will be fashioned after the one developed for FAS 157, Fair Value Measurement.
It features columns running across the top labeled with the three FAS 157 hierarchy levels, and rows running down the side, listing assets in the plan.

The fair value hierarchy is based on risk-related criteria. Level 1 assets and liabilities are those that can be measured using quoted prices in active markets. Level 2 entities can be measured by using other observable inputs, such as current market transactions. And Level 3 entities are measured using unobservable outputs, such as data and assumptions used in modeling.

FASB board members, satisfied with the principle of disaggregating plan assets, are reluctant to use the rule to prescribe additional categories and subcategories. They said only that FAS 132(R) should be based on risks and expected long-term rates of return associated with each asset category. However, the board did agree to have the FASB staff include examples in the draft proposal, including categories such as, government bonds, corporate bonds, mortgage-backed securities, derivatives, and real estate.

The rule will also require companies to break down alternative investments into additional categories or subcategories if the plan is exposed to a significant concentration of risk. For example, the grid would have to be expanded to include extra rows if the plan is heavily invested in a single company, industry, country, or type of security — such as a collateral debt obligation. Some FASB members argued that certain investment strategies should be revealed, such as whether an investment was held by a hedge fund.

It is unclear what level of minutia will satisfy the revised rule’s disclosure principle. Indeed, that question may go unanswered until the FAS 132(R) is road-tested next year. Board members debated two particularly thorny examples without coming to a conclusion. In one example, they discussed a corporate plan that is heavily invested in a single stock, and wondered whether the disclosure also should reveal that the investment is broken into direct stock, as well as shares held in a mutual fund and a hedge fund. Similarly, they speculated about whether a real estate investment should be separated into different investment buckets — such as direct ownership of property, a real-estate hedge fund, and a real estate investment trust.

The FASB staff will also be working on FAS 132(R) provisions related to valuation techniques used to determine the fair value of the plan assets. It is likely that FASB will require companies to provide investors with information about changes in valuation techniques and in fair value of Level 3 assets — particularly with respect to modified inputs or assumptions used in models.

FASB members hope to issue the new rule by Dec. 15 and make it effective at the same time. Taking into consideration the “aggressive” schedule, the board is leaning toward making the rule prospective, rather than forcing companies to retroactively apply the mandate to past periods. However, it is not clear whether the proposal draft will retain a forward-looking approach.

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