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Pension Accounting - How we got here
Old 05-05-2009, 05:27 PM   #1
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Pension Accounting - How we got here

Pension Privateers | Mother Jones

This article is almost 100% spot on for everything I have seen.
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Old 05-05-2009, 08:16 PM   #2
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Good article, I thought I was up on the fancy accounting tricks for pension plans, but this surprised me.

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In erisa, Congress allowed companies to treat their own estimates of how much their pension investments would earn as if they had actually earned that much, even when the true returns were much smaller. Thus, a company can estimate that it will earn 8 percent, actually make 3 percent, yet still value its pension plan as if it had made the higher amount. In theory, this process, known as "smoothing," is supposed to account for fluctuations in asset valuations over time. In practice, it means that pension plans can become filled with phantom assets. At one point in 2004, the New York Times reported, the entire net worth of General Motors was accounted for by these imaginary investment gains in its pension plans. (The fanciful accounting practice has since been limited somewhat.)
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Old 05-05-2009, 09:25 PM   #3
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My family is very close to this issue. My father who has helped design pensions for most of his life, is leading a class action against his former employer over his pension. Its a global 50 company, so it may make the news.
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Old 05-05-2009, 09:59 PM   #4
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This article is largely full of crap, though. The problem is not enough protection for employee pensions, not the ways that executives protect theirs.

I will say that there is nothing wrong with top hat plans. I know I've helped design them before, and as the article says they aren't as tax efficient as employee pensions are, but they are more tax efficient than paying out more money to the executive. They also provide an adequate substitute to paying the executive more, and they are traditionally used as "golden handcuffs" tying the executive to that corporation if they want the benefit.

Tax shelters have no causal relationship to executive benefits/compensation. Tax shelters will continue to be used as its in the best interests of everyone involved with the corporation--employees, executives, stockholders, and customers. No single group solely benefits from a corporation paying less in taxes. They don't shortchange the employee benefits because it provides more for them. They shortchange them because of any of the following reasons: hard times, desire to show good numbers, having trouble competing, and ultimately because employees don't understand their pensions and therefore they think they can get away with it.

I haven't ever seen anything like the what is described in the bonus, bonus section. I will say that I've never been apart of one for the truly big boys, but a partner of ours has. The reason why I don't think that stuff is common is because top hats traditionally take in the same amount every year regardless of pay, etc.

While moving from guaranteed benefit to cash balance did hurt some older people(and I'm not happy that they haven't gotten compensated), it will be better for future retirees. My father got hit by that one, too, but that isn't going to be what the class action is about.

Personally I think it is a good thing that many companies are blocking new hirees from joining there pension system. 401K and personal control is much better.

Pensions shouldn't exist for average employees. Instead they should get very generous 401K, HSA matches and higher compensation. Executives should decide for themselves whether or not they want to trust their company to pay their top hat or not.

Also its funny one of those pensions in that article was written by one of our partners.
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Old 05-06-2009, 01:45 PM   #5
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In erisa, Congress allowed companies to treat their own estimates of how much their pension investments would earn as if they had actually earned that much, even when the true returns were much smaller. Thus, a company can estimate that it will earn 8 percent, actually make 3 percent, yet still value its pension plan as if it had made the higher amount. In theory, this process, known as "smoothing," is supposed to account for fluctuations in asset valuations over time. In practice, it means that pension plans can become filled with phantom assets. At one point in 2004, the New York Times reported, the entire net worth of General Motors was accounted for by these imaginary investment gains in its pension plans. (The fanciful accounting practice has since been limited somewhat.)

This is not an "accounting trick". This process is part of GAAP. A company is required to recognize an additional pension expense if their expected return fall to far behind actual return though.
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Old 05-06-2009, 04:29 PM   #6
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This is not an "accounting trick". This process is part of GAAP. A company is required to recognize an additional pension expense if their expected return fall to far behind actual return though.
Could you point me to the GAAP ruling that requires an adjustment in the company's estimate of expected return due to underperformance of invested assets? I have the GAAP book on my desk and I do not see anything about adjusting the expected return other than a requirement to use a reasonable expected return and to disclose the change in benefit obligations for a one percentage point in the expected return.

FAS-35 states only that the assumption is that the pension plan is a going concern and will continue to exist indefinetly. Actuarial and rates of returns "should reflect the plan's most likely expectations and be consistent with returns for the type of assets held by the plan." There is nothing I have ever seen that requires a lowering of expected returns for a plan due to several years of underperformance.

This is what the article addressed until 2006 you were able to value the assets at the phantom rate of return now you are limited by the Pension protection act of 2006 to no more than 10% of your pension assets being "phantom expected returns" This is not a GAAP ruling.
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Old 05-06-2009, 05:43 PM   #7
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[quote]Could you point me to the GAAP ruling that requires an adjustment in the company's estimate of expected return due to under performance of invested assets?[/QUOTE


Disclaimer: I am currently an accounting senior (graduate this week...yay) so with finals this week I didn't have time to research the exact treatment of pension accounting so I'm going basically off memory.


Companies are not required to adjust their expected rate of return, but their pension expense, which is the expense that shows up on the income statement. When calculating the pension expense, the company will used their expected rate of return. However if the expected return is significantly lower than the actual return, the company's pension expense would be increased. On the other hand, if actual returns were significantly higher than expected returns then pension expense would be reduced.

I believe that all public companies are required to disclose the funded status of their plans (Present value of obligations vs. Fair value of plan assets)


In the short time I spent researching this topic, here's what I found.

FAS 87:
http://72.3.243.42/pdf/aop_FAS87.pdf

Financial Statements: Pension Plans
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Old 05-06-2009, 09:54 PM   #8
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[quote=rjpatt;813242]
Quote:
Could you point me to the GAAP ruling that requires an adjustment in the company's estimate of expected return due to under performance of invested assets?[/QUOTE


Disclaimer: I am currently an accounting senior (graduate this week...yay) so with finals this week I didn't have time to research the exact treatment of pension accounting so I'm going basically off memory.


Companies are not required to adjust their expected rate of return, but their pension expense, which is the expense that shows up on the income statement. When calculating the pension expense, the company will used their expected rate of return. However if the expected return is significantly lower than the actual return, the company's pension expense would be increased. On the other hand, if actual returns were significantly higher than expected returns then pension expense would be reduced.

I believe that all public companies are required to disclose the funded status of their plans (Present value of obligations vs. Fair value of plan assets)


In the short time I spent researching this topic, here's what I found.

FAS 87:
http://72.3.243.42/pdf/aop_FAS87.pdf

Financial Statements: Pension Plans
The expected rate of return never has to be adjusted if the company can bakc up if they feel it is reasonable. However if they do not earn that rate the basis on which the future value of the pension will be lower than expected so that future years will have greater expense, but that is do to lower earnings, not a change in assumptions.

Good luck on your finals, when you get out in the real world you'll be surprised how many corners can be cut out of one FASB prounouncement.
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Old 05-07-2009, 03:41 PM   #9
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The story was nice but left out way to much that needs to be said. The cash balance conversions of traditional pensions were simply a means to create and then get out the excess funding money. I saw first hand how one CEO created a bonus plan for raising profits, then did the conversion creating a $200 million rise in profits. HIS TAKE? A cool $50 million bonus. He was the highest paid CEO for three years running then got the boot for running up the Stock price and selling his just before the truth caused the fall. A Wallstreet Article in 1998 illustrated the benefit for GE when it could convert a pension and take out the excess funding at a tax rate of 25% instead of 50%, LOOPHOLE! The 50% was created to stop company buyouts and closing the pensions to get the excess in the 70's.

And what about the change in interest rate calculation of lump sums via the PPA of 2006. It will cost about 40% of the value by full implementation in 2012.

The pension plans built up enough money in funding that they became targets of the Madoff look alikes from within.

If you really think people have been screwed, step up to the table and speak.

And Obama voted for the PPA of 2006 also.
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Old 05-07-2009, 03:57 PM   #10
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Roger Lowenstein's latest book, "While America Aged: How Pension Debts Ruined General Motors, Stopped the NYC Subways, Bankrupted San Diego, and Loom as the Next Financial Crisis" is a riveting accounting of three multi-decade train wrecks in action. The book's cover art says it all...
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Old 05-07-2009, 04:29 PM   #11
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CBT, this is an area that I'm sure you don't understand at all. First of all, I can't tell exactly what you are referring to when you say that he created a bonus plan and then did the conversion, but I think you are referring to what we call a "springy provision". If you tried to do one today most likely the IRS would come after you, but back then they were done to pay less taxes. But these things were created and then converted, and the tax savings doesn't just benefit a CEO. It is beneficial to all parties the stockholders, the employees, and the customers.

Its stupid to draw a causal relationship between a tax saving scheme and a big CEO salary. They are largely independent events. Furthermore for a global 500 company 200 million increase in one years profits is a drop in the bucket.

"And what about the change in interest rate calculation of lump sums via the PPA of 2006. It will cost about 40% of the value by full implementation in 2012."
That one is going to hurt. Lump sum valuation is what my fathers class action will be about. The company that he is dealing with is trying to claim that the stuff that benefits them is grandfathered going back to pre 1990s(when the plan was written) and the stuff that benefits my father was subject to change even though my father has a contract. Even then they aren't even following the changed laws. The good news is that the lady that we have been dealing with at the company(who should be representing the company) basically told us that we had an open and shut case, and we now will have a huge law firm behind us.
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Old 05-07-2009, 05:05 PM   #12
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DSHIBB

The cash balance conversion was done the year following the implementation of an EVA - Economic Value Added Bonus program for the CEO. His bonus was structured to kick in a large percentage of the increased profits. The $200 million counted as increased profits. They slowly rolled this bonus structure out to entire corp and then abandoned it 10 years later.

So how did this all come into play industry wide? One knowledgable person took it out of a corporate tax office to a very well known consultant firm. WWW Here they orchestrated it over and over for a percentage of savings. They also arranged favorable news coverage and the lobbying arm for legislation. After ten years of getting the excess funded plans to convert, they had no problem switching to other tactics in support of the PPA of 2006 changes.

As for the older employees getting screwed in the conversions. The PPA requires new conversions to be caluculated using the old plan accrued benefit (A) to added to the new plan benefitys accrued (B).

THIS IS THE A + B method of benefit calculation required after 2006 which eliminates wearaway.

For the earlier conversions the unscrupulous plans still use the A or B method, the which ever is larger method, which hurts the older indiviudals thru wearaway. This is where the new benefits earned are lower that the old benefits so you earn nothing for a period of years. I heard it said first hand by a Congress person, "They can decide if the past conversions need to use this method in court." Now that is something our new president should correct, being in the Senate and a lawyer should allow him to understand the problems of correcting wrongs in the courts.

The one thing central in most of these articles is 'THE NEXT FINANCIAL CRISIS is RETIREMENT FUNDING' or I like better stated with

"OLD PEOPLE DOMINATE THE FAST FOOD LABOR INDUSTRY'
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Old 05-10-2009, 10:37 PM   #13
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I'll admit that I'm not all that familiar with EVA bonus, but it doesn't look like anything new(at least in terms of its purpose). It appears as another way to defer taxes and/or lower tax liability of company assets.

If you are claiming it does something else, just think about logically. There are only two things that you can do with your return on assets. You can either set things up to lower your taxes or you can try to increase your return. I think that it is obvious that this plan falls in the former.
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Old 05-11-2009, 07:28 AM   #14
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Quote "Personally I think it is a good thing that many companies are blocking new hirees from joining there pension system. 401K and personal control is much better.

Pensions shouldn't exist for average employees. Instead they should get very generous 401K, HSA matches and higher compensation. Executives should decide for themselves whether or not they want to trust their company to pay their top hat or not. "



There are all sorts of opinions on these topics and some seem to be supported by the following:

1 All people can think for themselves and take care of themselves

2 People in responsible positions will be inherently honest and therefore people will be fairly treated

A week does not go by where people have made the wrong decision and during that same week there will be mutiple examples of 'returns on assets' not going to where they were intended legally to go.

Foreclosures and Bernie Madoff as example.

So what should have been done originally with SS and what should we do with it now?

? Should never have started? Should be turned over to the indiviual for their own management of investments?

DSHIBB
As you know me well enough to know I am not familiar at all with pensions, please enlighten me more.
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Old 05-11-2009, 10:45 AM   #15
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Well I take back my earlier statement, it does appear that you have more understanding of these than most. My father is a true pension freak, and I'm sure it will take me 10+ years for me to even get to the level where he is.

The best reason for individual control(particularly when it involves a corporation) is because no one(that isn't subject to your control) will have a more vested interest in the outcome of how your money is invested(as well as spent) than the person whos money is on the line or the beneficiary of that money. That is actually a major tenant of modern economics(and is largely obvious).

I personally don't think it is worth it for a young employee, to take the risk on a corporation. It is much more important that they have control and gain complete control upon leaving that company or retiring.

I do think that an executive can realize the risks vs. rewards of entering into a top hat plan more than an employee can about entering into a pension. This is usually one of the reasons why executives negotiate "golden parachutes". They will enter into a top hat "golden handcuffs" plan and they are worried that for example the company gets sold and the new owner will try to invalidate their top hat or try to raid it, and so a way to cover yourself is by negotiating a "golden parachute".

Also did you know that the laws excluding non key employee/executives from top hats were written for the protection of average employees. They were written after the COLI(aka dead peasant insurance) starting making headlines. It was done to try to end a practice that didn't harm individual employees at all.

So what should have been done originally with SS and what should we do with it now?
Allow me to quote myself from another forum.
"Social Security has problems because people have raided the accounts turning it into a ponzi scheme(literally the definition of a ponzi scheme is using current investors to pay old ones that is exactly what they are doing--they don't work as evidenced by Madoff). It is also crap because the average rate of return that baby boomers will receive on their money will be 1 percent a year and for the next generation most likely 0 or negative. And by definition the government can't produce "good returns" on anything. If the democrats can't stomach SS going into the markets(and they fail to acknowledge that a portion of the money would purchase secondary guarantees that specifically stated that if the market crashed, the secondary guarantee would bring your balance to the same amount that you would have gotten under the current system) then fine allow people to move the money out of the government into fixed income investments earning 3 to 5 percent(with no risk) instead of the 1 percent they are getting now. Anybody that says that people would end up with less in private accounts instead of government run is either A) a liar or B) ignorant."
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Old 05-11-2009, 10:59 AM   #16
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The best reason for individual control(particularly when it involves a corporation) is because no one(that isn't subject to your control) will have a more vested interest in the outcome of how your money is invested(as well as spent) than the person whos money is on the line or the beneficiary of that money. That is actually a major tenant of modern economics(and is largely obvious).
This is, I suspect, why some of the pension plans managed by unions are more sound than those managed by external advisors. It's easy to take outsized risks with leverage and hedge funds when it's someone else's retirement you're playing with.
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Old 05-11-2009, 11:05 AM   #17
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"It's easy to take outsized risks with leverage and hedge funds when it's someone else's retirement you're playing with."
That is exactly what I'm trying to say.
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Old 05-11-2009, 11:42 AM   #18
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The average person is barely keeping their head above water right now. The pension laws as well as all the rules involving other similar things like SS and IRA and 401K and HSA seldom are clear enough for the average persons.

DSHIBB our minds are very close on these issues apparently. There are so many loopholes in them that the most knowlegdable and connected have the advantage. Some individuals will always game the system for their own advantage.

There are those that will always live beyond thier means, those that live within, and those that do not know what thier means are.

I always say those that can hunt for themselves will not go hungry, at least not till they disarm them.
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Old 05-11-2009, 12:55 PM   #19
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I think so, too.

But I would argue that those problems are going to be inherent in a pension system. If you allow people to manage other people's money/benefits/compensation without those people being able to have some control of it, problems will happen. And there is no way to regulate your way out of it. The best way is for personal control.

Some people are stupid, but at least they are going to try to do whats in there best interests. In situations like pensions, you can't even count on those people to do whats in the best interests of the employees.

There are only two ways(so far) that I agree will lower the financial stupidity of the many Americans. More financial education early and harsher treatment for those that screw up. The first one seems obvious since we place vastly more attention on music appreciation than we do on basics like not paying off your credit card balance when it has 15%+ interest is the definition of a moron. The second isn't to appealing, but it does get people to start actually paying attention. I would rather see a person hurt for a little bit because of stupidity and learn that lesson for the rest of their life, than see a person engage in stupidity every several years for the rest of their life. I'd say that subsidizing stupidity is the worst thing we can do in a situation like this.
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