Subprime Crisis Casts Shadow on Pensions

Should accounting standards reflect current events, or should they be written for the ages?

The Financial Accounting Standards Board has embarked on a project that might plunk employers down squarely into such events as the subprime mess in an unexpected way: by requiring them to report in their balance-sheet footnotes how much of their pension assets are tied up in hedge funds, derivatives, and other “alternative investments.”

On Wednesday the board went to work on the second phase of its plan to revamp corporate pension and benefit accounting. The result of the first phase was revolutionary enough for some. In September 2006, FASB began requiring publicly traded companies to state the underfunded or overfunded status of their pension and benefit plans on their financials at the end of fiscal years ending after December 15, 2006.

The project’s new phase, however, could change the rules a whole lot more. Most seriously under consideration, for example, is the notion of eliminating companies’ ability to “smooth” the volatility of pension asset returns over years. But FASB will also mull such things as whether companies should continue to recognize an aggregate net cost for their retiree benefits instead of breaking the cost down into such components as service, interest, amortization, and gains and losses; whether companies taking part in multiemployer pension plans should begin recording plan experience on their financials; and whether — and how much — to detail their plan investments beyond the stocks, bonds, and real estate they commonly report in their balance-sheet footnotes.

To judge by what went on at the FASB meeting, adding disclosures of such alternative investments is a favorite for the most-contentious issue on the new pension agenda right now. Maybe that has something to do with the subprime crisis and a sense at the board that pension investments in hedge funds might expose issuers to it in a less-than-transparent way.

The board’s disagreements also reflect a split among the users of financial statements, with “some constituents believing there are too many [disclosures] and others believing there are additional disclosures that would be worthwhile,” Peter Proestakes, staff manager of the FASB pensions and other postretirement benefits project, told CFO.com.

In 2003, to be sure, the board issued 132(R), a statement requiring pension-plan sponsors to disclose “the percentage of the fair value of total plan assets held” in stocks, bonds, and real estate, and “all other assets” as of the measurement date used for each balance sheet. The standard also requires plan sponsors to serve up a narrative description of the plan that includes allocation for each asset, as well as risk-management strategies and risk tolerance. Proestakes notes that while many companies are already reporting their plans’ equity, debt, and property investments, few have revealed much about the “all other” category.

Now the board will try to define what that cloudy category comprises. But the issue triggered a more-fundamental argument: how much should FASB standards reflect current events and how much should they be written for the ages?

On the one hand, the changing investment attitudes of pension-plan managers may need to be reflected in the financials to provide an up-to-date-picture to investors. “The problem is that a lot of institutional investors, including pension funds, have been going to alternative investments — hedge funds, private equity, structured notes,” said FASB chairman Bob Herz at the meeting. “Users might want to know that they’re invested in volatile instruments.”

But digging up the information about their alternative investments might be too tough a task for employers to tackle. That’s because the hedge funds — which have been big participants via securitization in the surge in subprime real estate lending — are mostly privately held and thus don’t have to report publicly on their investments. Some FASB members believe that reporting corporate hedge-fund investing should be handled in a separate board project, while others think money managers have as much access to the details of hedge funds as they need. The FASB staff will continue working on proposing a solution to the issue, says Proestakes.

The staff will also be grappling with the more-familiar matter of whether plan sponsors should continue to be able to smooth the effect of pensions on earnings over time. Under the practice, employers can report an expected return on plan assets and delay the recognition of actual gains and losses. Proestakes calls the practice “one of the most highly criticized” in pension financial reporting. He says he expects the board to have a preliminary views document — the precursor to an exposure draft of an actual board standard — on most of the issues involved in the second phase of the project, with a matching preliminary views document not too long after that.

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