Private Pensions: Publicly Available Reports Provide Useful but
Limited Information on Plans' Financial Condition (31-MAR-04,
GAO-04-395).
Information about the financial condition of defined benefit
pension plans is provided in two sources: regulatory reports to
the government and corporate financial statements. The two
sources can often appear to provide contradictory information.
For example, when pension asset values declined for most large
companies between 2000 and 2002, these companies all continued to
report positive returns on pension assets in their financial
statement calculations of pension expense. This apparent
inconsistency, coupled with disclosures about corporate
accounting scandals and news of failing pension plans, has raised
questions about the accuracy and transparency of available
information about pension plans. GAO was asked to explain and
describe (1) key differences between the two publicly available
sources of information; (2) the limitations of information about
the financial condition of defined benefit plans from these two
sources; and (3) recent or proposed changes to pension reporting,
including selected approaches to pension reporting used in other
countries.
-------------------------Indexing Terms-------------------------
REPORTNUM: GAO-04-395
ACCNO: A09609
TITLE: Private Pensions: Publicly Available Reports Provide
Useful but Limited Information on Plans' Financial Condition
DATE: 03/31/2004
SUBJECT: Financial disclosure
Financial statements
Pensions
Reporting requirements
Government information
Comparative analysis
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GAO-04-395
United States General Accounting Office
GAO Report to the Ranking Minority Member, Committee on Education and the
Workforce, House of Representatives
March 2004
PRIVATE PENSIONS
Publicly Available Reports Provide Useful but Limited Information on Plans'
Financial Condition
GAO-04-395
Highlights of GAO-04-395, a report to the Ranking Minority Member,
Committee on Education and the Workforce, House of Representatives
Information about the financial condition of defined benefit pension plans
is provided in two sources: regulatory reports to the government and
corporate financial statements. The two sources can often appear to
provide contradictory information. For example, when pension asset values
declined for most large companies between 2000 and 2002, these companies
all continued to report positive returns on pension assets in their
financial statement calculations of pension expense. This apparent
inconsistency, coupled with disclosures about corporate accounting
scandals and news of failing pension plans, has raised questions about the
accuracy and transparency of available information about pension plans.
GAO was asked to explain and describe (1) key differences between the two
publicly available sources of information; (2) the limitations of
information about the financial condition of defined benefit plans from
these two sources; and (3) recent or proposed changes to pension
reporting, including selected approaches to pension reporting used in
other countries.
www.gao.gov/cgi-bin/getrpt?GAO-04-395.
To view the full product, including the scope and methodology, click on
the link above. For more information, contact Barbara Bovbjerg at (202)
512-7215 or [email protected].
March 2004
PRIVATE PENSIONS
Publicly Available Reports Provide Useful but Limited Information on Plans'
Financial Condition
Information about defined benefit pension plans in regulatory reports and
pension information in corporate financial statements serve different
purposes and provide different information. The regulatory report focuses,
in part, on the funding needs of each pension plan. In contrast, corporate
financial statements show the aggregate effect of all of a company's
pension plans on its overall financial position and performance. The two
sources may also differ in the rates assumed for investment returns on
pension assets and in how these rates are used. As a result of these
differences, the information available from the two sources can appear to
be inconsistent or contradictory, as evidenced by the graph below.
Both sources of information have limitations in the extent to which they
meet certain needs of their users. Under current reporting requirements,
regulatory reports are not timely and do not provide information about
whether benefits would all be paid were the plan to be terminated.
Financial statements can supplement regulatory report data because they
are timelier and provide insights into the probability of a company
meeting its future pension obligations. However, through December 2003,
financial statements have lacked two disclosures important to
investors-allocation of pension assets and estimates of future
contributions to plans. There is also debate about whether current methods
for calculating pension expense accurately represent the effect of pension
plans on a company's operations.
Several changes have been made or proposed to provide further information.
In July 2003, the administration called for public disclosure of more
information about the sufficiency of a plan's assets. However, no further
steps have yet been taken. For financial statements, the Financial
Accounting Standards Board issued a revised standard in December 2003
requiring enhanced pension disclosures, such as pension asset allocation
and expected contributions to plans. Internationally, accounting standards
boards have considered proposals to change the methodology for calculating
pension expense. We have previously recommended changes to improve the
transparency of plan financial information, but other challenges remain.
Plan participants and regulators continue to need more timely information,
including measures of plan funding in the event of plan termination.
Billions of dollars 20
15
10
5
0 Assets Liabilities Assets Liabilities
Financial Statement Data Regulatory Report Data
Source: GAO analysis.
Contents
Letter
Results in Brief
Background
Form 5500 Reports and Corporate Financial Statements Differ in
Key Respects Both Reports Provide Complementary Pension Information but Do
Not Fully Satisfy Users Changes to Pension Accounting and Regulatory
Reporting Have
Been Implemented or Proposed Concluding Observations Agency Comments
1
3 4
9
16
27 29 30
Appendix I Scope and Methodology
Appendix II Expected and Actual Returns in Financial Statements
Appendix III GAO Contacts and Staff Acknowledgments 42
Contacts 42 Staff Acknowledgments 42
Tables
Table 1: Differences in Measures of Pension Assets and Liabilities in
Reports 11 Table 2: Comparison of Pension Assets with Liabilities for a
Fortune 500 Company 12 Table 3: Use of Expected Rate of Return in Form
5500 Schedule B and Corporate Financial Statements 13
Table 4: Average Expected and Actual Rates of Return on Pension Assets
from 1994 to 2002 for a Sample of Fortune 500 Companies 24
Table 5: Corporate Financial Statement Example-Elements of Pension
Footnote and Statement of Operations for Company X for Different Expected
Rates of Return 37
Table 6: Definitions of Pension Footnote Items in Table 5 39
Figure
Figure 1: Comparison of Average Expected Rates of Return Reported in Form
5500 Schedule B and Corporate Financial Statements for a Sample of Fortune
500 Companies
Abbreviations
DOL Department of Labor
EDGAR Electronic Data Gathering, Analysis, and Retrieval System
EIN employer identification number
ERISA Employee Retirement Income Security Act of 1974
FASB Financial Accounting Standards Board
IASB International Accounting Standards Board
IRS Internal Revenue Service
PBGC Pension Benefit Guaranty Corporation
SEC Securities and Exchange Commission
S&P Standard and Poor's
This is a work of the U.S. government and is not subject to copyright
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separately.
United States General Accounting Office Washington, DC 20548
March 31, 2004
The Honorable George Miller
Ranking Minority Member
Committee on Education and the Workforce
House of Representatives
Dear Congressman Miller:
Since the stock market decline of 2000 through 2002, policy makers and
pension plan participants have raised concerns about where they can
obtain clear and timely information about the financial condition of
defined benefit pension plans. Defined benefit plans, which promise their
participants a steady retirement income, usually based on years of service
and salary, tend to invest most of their assets in the stock market. These
plans cover some 44 million workers and retirees, concentrated in
industries such as automotive, airline, steel, telecommunications, and
manufacturing. The companies that sponsor defined benefit plans bear the
risks of investing these assets, and may be required to contribute money
to
the plans if the plans' asset values are less than certain measurements of
the benefits promised to plan participants as defined by law. When several
of these plans reported funding problems or were terminated in the wake
of the stock market's decline, policy makers, pension participants,
investors, and financial analysts alike began taking a closer look at the
health of defined benefit pension plans. The information they found often
appeared contradictory. For example, while the stock market was falling
and some information indicated that the value of companies' pension
assets was declining, other information implied that these same assets
were increasing in value. In fact, publicly reported values of pension
plan
assets and liabilities were routinely contradictory. Coupled with news of
corporate accounting scandals, these apparent contradictions have raised
questions about the accuracy and transparency of available information
about pension plans.
As you requested, this report examines the two main sources of financial
information about defined benefit pension plans and analyzes why these
sources generate different measures of the financial condition of these
plans. The first source is a report, commonly referred to as the Form
5500,
which plan sponsors are required to file each year with the agencies that
administer federal pension laws. Part of the Form 5500 report, called
Schedule B, provides actuarial and other information about a pension
plan's assets, liabilities, actuarial assumptions, and employer
contributions.1 The second source is a company's annual financial
statements, which among other information provide pension-related data as
they pertain to a company's overall financial position, performance, and
cash flows. This report explains and describes
o key differences between the two publicly available sources of
information, including their methodologies and assumptions;
o certain limitations of the information about the financial condition
of defined benefit plans in these two information sources; and
o recent or proposed changes to pension reporting, including selected
approaches to pension reporting in other countries.
For our analysis of how information in the Form 5500 is used, we reviewed
the laws that require the filing of regulatory reports on pensions and
interviewed pension actuaries and officials from federal agencies that use
this information. As a basis for our analyses of the information about
pension plans presented in corporate financial statements, we reviewed
relevant accounting standards from the Financial Accounting Standards
Board (FASB), which establishes standards of financial accounting and
reporting for nongovernmental entities, and interviewed board officials.
We also interviewed expert users of pension information in financial
statements, including financial analysts, credit rating agency officials,
pension actuaries, and federal officials. These experts described and
shared documentation about how they use financial statements to understand
the financial position of pension plans and the impact of pension plans on
companies' financial performance and cash flows. To identify approaches
used in other countries and proposals for pension reporting in this
country, we relied extensively on statements provided by officials at the
International Accounting Standards Board and the Financial Accounting
Standards Board. Our work also included analysis of Form 5500 filings and
corporate financial statements for a systematic random sample of 97
publicly traded Fortune 500 companies with defined benefit pension plans.
Appendix I explains the scope and methodology of our work in greater
detail. We conducted our work between January 2003 and January 2004 in
accordance with generally accepted government auditing standards.
1References to pension plan asset and liability values in Form 5500
throughout this report reflect information provided in Schedule B.
Results in Brief
The information in a pension plan's Form 5500 report serves a
substantially different purpose from the pension information disclosed in
a corporate financial statement; therefore, these two reports do not
provide the same measures of pension funding. As required by law, the Form
5500 requires, among other things, plan financial information including
measures of assets, liabilities, and an estimated rate of return on plan
assets. One purpose of this information is to determine whether plans are
funded in accordance with statutory requirements. In contrast, as required
by financial accounting standards, the pension information in corporate
financial statements is intended to explain how a company's pension plans,
in aggregate, affect its overall financial position, performance, and cash
flows, and is not intended to measure pension funding needs. The different
purposes and reporting requirements lead to differences in how the pension
information is developed and presented. Basic methodological steps-such as
whether calculations are based on values at the beginning or the end of
the year-can vary substantially between the two sources. For example, one
company in our sample based its Form 5500 filing on plan assets valued on
June 30, 2001, while its financial statement was based on values for
December 31 of the same year, contributing to a difference of almost $600
million in reported assets. Additionally, both sources use a
rate-of-return estimate, but they apply this estimate differently. As a
result of the different purposes and reporting requirements, the
information available from the two sources can appear to be inconsistent
or contradictory.
Under current reporting requirements, information in both the Form 5500
and corporate financial statements has limitations in the extent to which
it meets certain needs of regulators, plan participants, and investors.
The Form 5500 provides detailed information about individual defined
benefit plans, but this information is limited in two main ways. The first
limitation is timeliness: Pension funding data are 1 to 2 years old by the
time the Form 5500 is filed with cognizant federal agencies. However,
current statutory reporting requirements provide little flexibility to
improve the timeliness of Form 5500 reporting. The second limitation is
that the form does not require information about whether plans have
sufficient assets to meet their obligations in the event of the plan's
termination. The information in corporate financial statements can help
regulators and others supplement available Form 5500 data because it is
more timely and can provide insights into whether a company is likely to
meet its future pension obligations. According to financial analysts we
spoke with, corporate financial statements have heretofore lacked two
important disclosures-the composition of pension assets and an estimate of
the amount a company is likely to contribute to its pensions for the
coming
year. In addition, some analysts are concerned that accounting methods
designed to smooth out asset values' year-to-year fluctuations in favor of
reporting longer-term trends do not really reflect the effect that
significant fluctuations may have on the operations of the plan sponsor.
However, others argue that current pension accounting standards are
appropriate for reflecting the long-term nature of pension obligations.
Several changes have been made or proposed to provide additional
information about the financial condition of defined benefit plans. In an
effort to improve the transparency of pension plan information, the
administration proposed in July 2003 that additional information be made
available to the public about plans' financial condition. This
information, which until now has been available only to government
regulators under certain conditions, includes computations that provide a
more accurate picture of a plan's ability to meet its obligations if it
were to be terminated, as well as more detailed information about plans
when companies' pensions are collectively underfunded by at least $50
million. As of March 2004, no action has yet been taken on the
administration's proposal. For financial statements, the Financial
Accounting Standards Board in December 2003 issued a revised accounting
standard requiring disclosure of more information, such as the allocation
of plan assets and the company's expected pension plan contributions in
the upcoming year. Outside the United States, accounting standards boards
have been considering proposals that would change the methodology for
calculating pension cost. We have previously recommended changes to
improve the transparency of plan financial information, but other
challenges remain. Plan participants, regulators, policy makers, and
investors continue to need more timely information, including measures of
plan funding in the event of plan termination.
Background Once the most prevalent type of pension plan, defined benefit
plans no longer predominate, but they still constitute a significant part
of the nation's retirement landscape. They usually base retirement income
on salary and years of service (for example, a benefit of 1.5 percent of
an employee's highest annual salary multiplied by the number of years of
service) and are one of two pension types. The other type of pension,
called a defined contribution plan, bases benefits on contributions to,
and investment returns on, individual investment accounts. Among workers
covered by pensions in 1998, about 56 percent were covered only by
defined contribution plans (including 401(k)2 plans), compared with about
14 percent who were covered only by defined benefit plans, and about 30
percent who were covered by both types of plans.3
Under a defined benefit plan, the employer is responsible for funding the
benefit, investing and managing plan assets, and bearing the investment
risk.4 To fund their defined benefit pension plans, companies set up
dedicated trust funds from which they cannot remove assets without
incurring significant tax penalties. To promote the security of
participants' benefits, the Employee Retirement Income Security Act of
1974 (ERISA), among other requirements, sets minimum pension funding
standards. These funding standards establish the minimum amounts that
defined benefit plan sponsors must contribute in each year to help ensure
that their plans have sufficient assets to pay benefits when due. If plan
asset values fall below the minimum funding targets, employers may have to
make additional contributions.
The financial stability of defined benefit pension plans is of interest
not only to workers whose retirement incomes depend on the plan, but also
to the cognizant federal agencies and to investors in the companies that
sponsor the plans. Federal policy encourages employers to establish and
maintain pension plans for their employees by providing preferential tax
treatment under the Internal Revenue Code for plans that meet applicable
requirements. ERISA established a federally chartered organization, the
Pension Benefit Guaranty Corporation (PBGC), to insure private sector
defined benefit pension plans, subject to certain limits, in the event
that a
2A 401(k) plan generally allows participants to make contributions that
are not taxed until the funds are used. Earnings on these contributions
likewise accumulate tax-free until the funds are used.
3Private Pension Plan Bulletin: Abstract of 1998 Form 5500 Annual Reports,
U.S. Department of Labor Pension and Welfare Benefits Administration,
Number 11 (Washington, D.C.: Winter 2001-2002).
4In contrast, under a defined contribution plan, the employee bears the
investment risk. Hybrid plans, such as cash balance plans, are defined
benefit plans, which combine some of the characteristics of defined
contribution plans. The characteristics of these various types of plans
are explained more fully in our publication Answers to Key Questions about
Private Pension Plans, GAO-02-745SP (Washington, D.C.: September 2002),
pp. 22-24.
plan sponsor cannot meet its pension obligations.5 As part of its role as
an insurer, PBGC monitors the financial solvency of those plans and plan
sponsors that may present a risk of loss to plan participants and the
PBGC. We recently designated PBGC's single-employer insurance program as
high-risk because of its current financial weaknesses,6 as well as the
serious, long-term risks to the program's future viability.7 Investors'
interest in pension plans is prompted by the fact that a company's pension
plans represent a claim on its current and future resources-and therefore
potentially on its ability to pay dividends or invest in production and
business growth. Thus, all three groups-regulators, participants, and
investors-need information about these plans.
To meet the information needs of the federal agencies that administer
federal pension laws, ERISA and the Internal Revenue Code require the
filing of an annual report, which includes financial and actuarial
information about each plan.8 The PBGC, the Department of Labor, and the
Internal Revenue Service (IRS) jointly develop the Form 5500, Annual
Return/Report of Employee Benefit Plan, to be used by plan administrators
to meet their annual reporting obligations under ERISA and the Internal
Revenue Code.9 Plan administrators of private sector pension
5PBGC receives no direct federal tax dollars to support this insurance
program; rather it is funded by premiums paid by the corporate sponsors of
defined benefit plans insured by PBGC. The program receives the assets of
terminated underfunded plans and any of the sponsor's assets that PBGC
recovers during bankruptcy proceedings. PBGC finances the unfunded
liabilities of terminated plans with (1) premiums paid by plan sponsors
and (2) income earned from the investment of program assets.
6On January 15, 2004, PBGC released its fiscal year 2003 financial results
and reported a current deficit of $11.2 billion for the single-employer
insurance program.
7See U.S. General Accounting Office, Pension Benefit Guaranty Corporation
Single-Employer Insurance Program: Long-Term Vulnerabilities Warrant
"High-Risk" Designation, GAO-03-1050SP (Washington, D.C.: July 23, 2003).
8ERISA sections 103 and 104 of Title I and Internal Revenue Code sections
6057, 6058, and 6059 provide the statutory authority for the filing of an
annual return/report, which includes financial information pertaining to
the plan.
9The Internal Revenue Service enforces standards that relate to such
matters as how employees become eligible to participate in benefit plans,
how they become eligible to earn rights to benefits, and how much, at a
minimum, employers must contribute. The Department of Labor enforces
ERISA's reporting and disclosure provisions and fiduciary responsibility
standards, which among other things concern the type and extent of
information provided to the federal government and plan participants and
how pension plans are operated in the interests of plan participants.
and welfare plans are generally required to file a Form 5500 each year.10
The filing includes a short document for identification purposes and
general information, plus a series of separate statements and schedules
(attachments) that are filed as they pertain to each type of benefit plan.
This form and its statements and schedules are used to collect detailed
plan information about assets, liabilities, insurance, and financial
transactions, plus financial statements audited by an independent
qualified public accountant, and for defined benefit plans, an actuarial
statement.11 More than 1 million of the forms are filed annually, of which
approximately 32,000 represent defined benefit pension plans insured by
PBGC. The information on the form is made available to plan participants
upon request and serves as the basis for a summary annual report provided
to plan participants and their beneficiaries.
One part of the Form 5500 filing, called Schedule B, includes information
about a defined benefit pension plan's assets, liabilities, actuarial
assumptions, and employer contributions. The various measures of plan
assets and liabilities are required by ERISA and the Internal Revenue Code
to determine whether plans are funded according to the statutory
requirements. Specifically, under Schedule B, IRS requires, among other
things, the disclosure of assets and liabilities and an expected rate of
return, which is called the valuation liability interest rate. IRS reviews
this information to ensure compliance with the minimum funding
requirements for pension plans. In addition, according to PBGC officials,
PBGC may use Schedule B information to help them identify plans that may
be in financial distress and thus represent a risk to the insurance
program and plan participants. Some plan sponsors also use information in
the Schedule B to calculate certain insurance premiums they pay to PBGC.
In addition to the annual reporting requirement, PBGC has authority to
require plans to provide the agency with detailed financial information.
Specifically, if a company's pension plans reach a certain level of
underfunding in aggregate, ERISA requires the company to provide
information to PBGC in what is called a 4010 filing. The 4010 filing
10The Department of Labor has issued regulations exempting certain pension
and welfare plans from the requirement to file a Form 5500 based on size
and type of plan. Welfare plans provide participants and their
beneficiaries various nonpension benefits such as for health care,
unemployment, disability, training programs, and legal services. Welfare
plans are not subject to the same funding requirements as pension plans.
11For plans with fewer than 100 participants the agencies have developed
simplified reporting requirements that do not include audited financial
statements.
includes proprietary information about the plan sponsor, its total pension
assets, and its total benefit obligations were the company to terminate
its pension plans immediately. However, under current law, PBGC is not
permitted to disclose this information to the public.
The Securities Exchange Act of 1934 requires publicly traded corporations
to annually file a 10-K report, which is often referred to as the
corporate financial statement, with shareholders and the Securities and
Exchange Commission (SEC). The SEC uses 10-K reports to ensure that
companies are meeting disclosure requirements so that investors can make
informed investment decisions. The 10-K report describes the business,
finances, and management of a corporation. For companies whose defined
benefit pension plans are material to their financial statements,
accounting standards require a footnote to the financial statements that
details the cost, cash flows, assets, and liabilities associated with
these plans. Footnote disclosures provide more detailed information about
data presented in the company's financial statements.12 Standards for
reporting this information are set by the Financial Accounting Standards
Board.13
Actuaries estimate the present value of pension liabilities using economic
and demographic assumptions. These assumptions are needed to estimate the
amount of money required now and in the future to meet a pension plan's
future benefit obligation. Economic assumptions include rates of
inflation, returns on investments, and salary growth rates. Demographic
assumptions include changes in the workforce from retirement, death, and
other service terminations. Most actuarial assumptions for measuring
pension plan funding are not specifically prescribed by law or subject to
advance approval from the IRS or any other government agency. However,
12The statement of earnings and comprehensive income measures
profitability of the company by showing the income earned and expenses
incurred during the year. Comprehensive income would include accounting
adjustments and holding gains and losses for certain securities and
investments. The statement of financial position provides information
about a company's assets, liabilities, and equity and their relationships
to one another at the end of the company's fiscal year. The statement of
cash flows reflects a company's major sources of cash receipts and its
major uses of cash. The statement of stockholder's equity reflects the
company's transactions during the year related to capital contributions
and distributions to company stockholders.
13FASB's mission is to establish and improve standards of financial
accounting and reporting for the guidance and education of the public,
including issuers, auditors, and users of financial information. FASB,
which is part of a structure that is independent of all other business and
professional organizations, develops broad accounting concepts, standards
for financial reporting, and guidance on how to implement the standards.
Form 5500 Reports and Corporate Financial Statements Differ in Key Respects
ERISA requires the plan actuary to select assumptions that are
individually reasonable and represent the actuary's "best estimate of
anticipated experience under the plan."14
The pension plan financial information reported in Form 5500 Schedule B
serves a different purpose from the pension information disclosed in
corporate financial statements. The information in each source is subject
to different reporting requirements; therefore, measurements of pension
funding are unlikely to be the same in the two reports. Government
regulators and others use Form 5500 information for many purposes,
including to determine whether plans are meeting minimum funding
requirements and required contributions for each defined benefit plan that
a company sponsors, while financial analysts and investors use pension
information in corporate financial statements to determine how the
company's plans in aggregate affect its overall financial position,
performance, and cash flows. Because of their different purposes and
reporting requirements, these two sources use different measures and
assumptions to generate information. For example, in providing information
about the values of their pension assets and the present value of their
future pension obligations, the Form 5500 and the corporate financial
statements often base their valuations at different points in time and use
different methods of calculation. Both of these reports also include an
assumption about rates of return on the investment of pension assets.
However, these rates may differ, and this assumption serves a different
purpose in each report. As a result of such differences, information in
the two reports is generally not similar, and because the two sources of
information use similar terminology-for example, both refer to asset
values and investment returns-the results can appear contradictory.
Form 5500 Reports and Corporate Financial Statements Serve Different
Purposes
One objective of the Form 5500 is to provide financial and other
information about the operations of an individual employee benefit plan.
For defined benefit pension plans, the Form 5500 Schedule B provides
measures of plan assets and liabilities; actuarial information, such as
economic assumptions and demographic assumptions about plan participants;
and information about how much the plan sponsor is contributing to meet
ERISA funding requirements. If a company sponsors more than one plan, it
must file a Form 5500 for each plan. While analysts
14ERISA Section 103(a)(4)(B).
and investors may use this information, it is primarily used by federal
regulators to measure plan funding and ensure compliance with applicable
laws and regulations.
The pension information in a company's financial statement, by contrast,
primarily serves a different purpose. The financial statement is intended
to provide financial and other information about a company's consolidated
operational performance as measured primarily by earnings. In this
context, pension information is mostly provided in a footnote to give
financial statement users information about the status of an employer's
pension plans and the plans' effect on the employer's financial position
and profitability. For example, certain details about the company's annual
cost of providing pension benefits are presented in the pension footnote
disclosure because this cost, or expense, affects the company's
profitability. The users of corporate financial statements are primarily
financial analysts and investors who are trying to assess the company's
financial condition, profitability, and cash flows, and whose concern is
not so much the financial condition of individual pension plans but the
effect that the company's pension obligations may have on its future cash
flows and profitability.
Measures of Pension Even where the Form 5500 and corporate financial
statements provide Assets and Liabilities similar types of information,
such as pension assets and liabilities, their Differ in Form 5500 values
usually differ. Among the key reasons for this are different dates of
measurement, different definitions of reporting entity, differentReports
and Corporate methodologies for determining costs of benefits, and
different methods ofFinancial Statements measuring assets and liabilities.
Table 1 summarizes some of the
differences.
Table 1: Differences in Measures of Pension Assets and Liabilities in Reports
Form 5500 Schedule B Corporate financial statement Significance
Measurement dates May be any day during the plan The last day of the plan
sponsor's The use of different dates year. Large companies typically
fiscal year or, if used consistently, generally results in different use
the first day of the plan year, a date not more than 3 months asset and
liability values as while many small companies use prior to the end of the
fiscal year. asset prices fluctuate and, with the last day. Plan years
normally the passage of time, additional run concurrently with the
liabilities accrue. company's fiscal year.
Number of plans covered in One form is filed for each Regardless of number
of plans report qualifying plan sponsored by a sponsored by a company,
total
company. pension assets and liabilities are generally reported in
aggregate for all plans, including those not required to file a Form 5500
(e.g., plans for employees overseas).
Method of determining ERISA allows companies Accounting standards
to mandate a
annual cost of benefits choose one of six single method of measuring
different the
methods. annual cost of benefits
earned.
This method is one of the
six
allowed in Form 5500.
Method of calculating asset Assets are valued on an actuarial Assets are
reported at their fair and liability values basis, and liabilities are
reported value and liabilities are calculated A company may sponsor
multiple plans that have different benefit provisions and are funded at
different levels. These potential differences may be masked by the
aggregation of data.
Methods for spreading out the cost of benefits over the working life of
employees may differ, resulting in different measures of cost and
obligations each year.
Actuarial asset values represent average asset values over some time
period while fair values reflect asset values at a specific time. Using
different interest rates to calculate present values of plan liabilities
will yield different results.
two ways: (1) actuarial liability, calculated using an interest rate
selected by the plan actuary, and (2) current liability, based on an
a
interest rate prescribed by law.
using an interest rate that is typically equal to the rate for longterm
investment in corporate bonds - this rate is typically different from the
interest rates used in Form 5500.b
Source: GAO analysis.
aIn calculating current liability for purposes of the funding rules, the
Internal Revenue Code requires plans to use an interest rate from within a
permissible range of rates. See 26 U.S.C. 412(b)(5)(B). Plan sponsors may
select a rate within 90 to 105 percent of the weighted average interest
rate on 30-year Treasury bond securities during the 4-year period ending
on the last day before the beginning of the plan year. The top of the
permissible range was increased to 120 percent of the weighted average
rate for 2002 and 2003. The Department of the Treasury does not currently
issue 30-year securities. As of March 2002, the IRS publishes the average
yield on the 30-year Treasury bond maturing in February 2031 as a
substitute.
bThe interest rate used to calculate pension liabilities in corporate
financial statements should reflect the rate at which the benefits could
be effectively settled by purchasing a group annuity for plan
participants. The interest rates used to determine the current prices of
annuity contracts and the rates of return on high-quality long-term
corporate bonds should be considered in developing this discount rate
assumption.
These differences in asset and liability measurements can result in
significantly divergent results for the Form 5500 and the corporate
financial statements. As an example, table 2 shows the different asset and
liability values presented in a plan's Form 5500 filing and in the plan
sponsor's corporate financial statements for a Fortune 500 company in
1999-2001 and the resulting effects on the reported pension funding ratios
(pension assets divided by pension liabilities).
Table 2: Comparison of Pension Assets with Liabilities for a Fortune 500 Company
Form 5500 Schedule B Corporate financial statement
Fair value Projected
of
Actuarial Actuarial Actuarial Current company's benefit
asset
Year value liability asset liability pension obligation
value assets
1999 $18.081 $11.822 $18.081 $13.883 $21.861 $17.719
Funding 152.9 percent 130.2 123.4
ratio percent percent
2000 $18.505 $11.008 $18.505 $13.862 $20.314 $17.763
Funding 168.1 percent 133.5 114.4
ratio percent percent
2001 $17.324 $11.151 $17.324 $14.159 $17.923 $18.769
Funding 122.4 95.5
ratio 155.4 percent percent percent
Source: GAO analysis.
Note: Asset and liability values are in billions of dollars. Funding
ratios in italics are calculated by dividing assets by liabilities.
One reason for the significant differences in measures of assets and
liabilities between the Form 5500 and corporate financial statement
filings in table 2 is that the company sponsors more than one pension
plan. When companies sponsor multiple pension plans, the details of
specific plans are generally aggregated in corporate financial statements
to show their net effect on the plan sponsor and are not intended to
provide details about the funding of each plan. Thus, the pension
information of a sponsor with both underfunded and overfunded plans may
show little or no funding deficiencies, although the consequences to
participants in the underfunded plans could be quite severe in the event
of plan termination.
Form 5500 Reports and Corporate Financial Statements Use Expected Rates of
Return Differently
One of the most confusing aspects of these two information sources is
their difference with regard to the expected rate of return on pension
assets. The expected rate of return is the anticipated long-term average
investment return on pension assets. The Form 5500 Schedule B and the
corporate financial statements both use an expected rate of return in
calculating financial information about pension plans. In this regard, the
expected rate of return is one of many assumptions, such as inflation and
mortality rates, that affect a key pension reporting measure. In theory,
the expected rates of return reported in each source should be similar
because the assumption is derived from similar, or even the very same,
assets. However, between these two sources there are differences in the
rate's
purpose, selection, and method of application that may, in fact,
contribute to differences between the assumed rates of return used in the
two sources. Key differences in expected rates of return between the
reports are shown in table 3.
Table 3: Use of Expected Rate of Return in Form 5500 Schedule B and
Corporate Financial Statements
Corporate financial Form 5500 Schedule B statement
Purpose of expected rate To calculate pension funding. To calculate pension
a
of return expense.
How is the rate applied? Serves as the interest rate used to measure the
present value of plan liabilities.
Multiplied by the "marketrelated" value of pension assets to obtain a
dollar value for the expected return on
b
pension assets for the year.
To which plan/plans For each individual pension does the rate apply?
plan a rate of return is selected. For companies with multiple plans, the
rate may differ from plan to plan because of different plan provisions and
investments.
A rate is determined for each plan. However, only a single
weighted-average rate is reported, regardless of the number of plans.
Who selects rate? Plan actuary, in consultation Company management. with
company management.
Source: GAO analysis.
aPension expense refers to net periodic pension cost or net periodic
pension expense, which is a calculated value. We heretofore refer to net
periodic pension cost or net periodic pension expense as pension expense.
bMarket-related value is either the fair value of pension assets or an
average value of pension assets over a period not exceeding 5 years.
In Form 5500 Schedule B, the expected rate of return is used to calculate
pension funding-that is, the measurements of pension assets and
liabilities, which determine whether, and in fact, what amount the company
needs to contribute to its pension plan to meet the statutory minimum
funding requirements.15 The expected rate of return is usually derived
from the pension plan's investment experience and assumptions about
long-term rates of return on the different classes of assets held by
15There are additional measures of pension funding required by ERISA and
the Internal Revenue Code, but this measure of pension funding is the
first one used to determine compliance with pension funding requirements.
the plan.16 Actuaries calculate a present value of plan liabilities using
the expected rate of return, which is called the valuation liability
interest rate on the Form 5500 Schedule B. If plan liabilities exceed
assets, the resulting difference is used, in part, to determine the amount
the company may have to contribute to the pension plan for that year. The
amount of contributions required under the minimum funding rules of the
Internal Revenue Code is generally the amount needed to fund benefits
earned during that year plus that year's portion of other liabilities that
are amortized over a period of years.17 Amendments to ERISA in 1987 and
1994 made significant changes to the funding rules, including the
establishment of a deficit reduction contribution requirement if plan
funding is inadequate.18 The 1987 amendments to ERISA established the
current liability measure, which is based on a mandated interest rate
rather than a rate selected at the discretion of the plan actuary.
For financial statements, the expected rate of return is used to calculate
the annual expected investment return on pension assets, which factors
into the measurement of pension expense. Pension expense represents the
company's cost of benefits for the year and generally includes (1) service
cost-benefits earned by plan participants for a period of service; (2)
interest cost-increases in the benefit obligation because of the passage
of time;19 (3) expected returns on pension assets, which offset some or
all of the net benefit costs; (4) amortization of prior service cost
resulting from plan amendments; and (5) amortization of gains or losses,
if any, that may result from changes in assumptions or actual experience
that differs from assumptions. To calculate a dollar amount for the
expected return, the expected rate of return is multiplied by the value of
16A class of assets is composed of assets that share similar
characteristics, such as risks and expected rates of return. Examples
include equities, corporate bonds, government bonds, and real estate.
17Minimum funding rules permit certain plan liabilities, such as past
service liabilities, to be amortized over specified time periods. See 26
U.S.C. 412(b)(2)(B). Past service liabilities occur when benefits are
granted for service before the plan was established or when benefit
increases after establishment of the plan are made retroactive.
18See the Omnibus Budget Reconciliation Act of 1987, (P.L. 100-203, Dec.
22, 1987) and Retirement Protection Act of 1994 (P.L. 103-465, Dec. 8,
1994).
19For each additional period of employment (for example, 1 year), active
plan participants normally earn additional pension benefits, which
increase a company's pension costs. Furthermore, as employees get closer
to retirement with each passing year, the present value of the company's
benefit obligation increases because there is less time available to
invest pension assets and earn interest on them.
pension assets.20 This expected return is used instead of the actual
return on pension assets in the calculation of pension expense, which has
the effect of smoothing out the volatility of investment returns from year
to year. Furthermore, if the expected return on plan assets is high
enough, a company may report a negative pension expense-or pension income.
Form 5500 reports and, until recently, corporate financial statements have
not provided specific information about how expected rates of return are
selected.21 Actuaries told us that they estimate rates of return on the
basis of several economic forecasting measures and also take into account
how asset allocations may change in the future based on the demographics
of plan participants. In contrast, financial analysts and actuaries told
us that many companies select their expected rates of return on the basis
of their pension asset returns in past years.22 However, in December 2002
a Securities and Exchange Commission staff member publicly stated that the
SEC would likely review expected rates of return higher than 9 percent if
the rate was not clearly justified in the company's financial statement.
The SEC determined the 9 percent rate on the basis of studies on the
historical returns on large-company domestic stocks and corporate bonds
between 1926 and the first three quarters of 2002. According to actuaries
and financial analysts we spoke with, this statement by the SEC has been a
primary factor in the selection of lower rates of return in 2002.
Figure 1 shows the average expected rates of return reported for 1993 to
2002 by the companies and their pension plans in our sample.
20Financial analysts told us that most large companies substitute a
"market-related" value of pension assets for the reported market value for
the purpose of this calculation. See example in appendix II.
21In December 2003 FASB revised its pension disclosure standard, Statement
of Financial Accounting Standards No. 132, to require a narrative
description of the basis used to determine the overall long-term expected
rate of return on assets assumption.
22For a Form 5500 filing, ERISA requires an enrolled actuary to certify
that all assumptions used are individually reasonable and represent the
actuary's "best estimate of anticipated experience under the plan." For
corporate financial statements, actuaries told us that they provide
companies an actuarial report, which states whether the actuary believes
the rate of return assumption used by company management falls within a
reasonable range. The company's independent auditor must separately
evaluate the reasonableness of all significant assumptions.
Figure 1: Comparison of Average Expected Rates of Return Reported in Form
5500 Schedule B and Corporate Financial Statements for a Sample of Fortune
500 Companies
Average expected rate of return
10.00%
9.75%
9.50% Corporate financial statement 9.25%
9.00% 8.75% 8.50%
8.25% 8.00% 7.75% 7.50%
0% 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002
Source: GAO analysis.
Note: Companies in this sample were all listed in the 2003 Fortune 500.
Data from Form 5500 reports for 2002 were not fully available at the time
of this analysis. PBGC analysis of its entire Form 5500 dataset shows that
the average expected rate of return for plans with at least 10,000
participants ranged from 8.371 percent in 1994 to 8.473 percent in 2001
before falling to 8.408 percent in 2002 for the 80 percent of plans with
data available. The number of observations per year for corporate
financial statements and Form 5500 ranged from 63 to 89 and 61 to 84,
respectively. See appendix I for further description of the methodology.
Both the Form 5500 Schedule B and corporate financial statements have
limitations in the extent to which their required information meets
certain needs of regulators, plan participants, and some investors. The
Form 5500 takes considerable time for companies to prepare and for federal
agencies to process, so it is not available to pension plan participants
and others on a timely basis. The required asset and liability measures in
the Form 5500 Schedule B are used by regulators to monitor compliance with
statutory funding requirements. However, these funding measures are not
intended to indicate whether plans have sufficient assets to cover all
benefit obligations in the event of plan termination. In addition to using
the Form 5500, regulators can also use corporate financial statements to
try to determine whether a plan sponsor will be able to meet its
obligations to its pension plans. However, some investors have concerns
about whether corporate financial statements accurately reflect the effect
of pensions on plan sponsors. According to financial analysts we spoke
with, the pension information in corporate financial statements is also
limited because it has
Both Reports Provide Complementary Pension Information but Do Not Fully
Satisfy Users
not, until recently, included key disclosures, and the methodology used to
calculate pension expense does not reflect the potential impact of actual
investment returns on a company's future cash flows and profitability.
However, others argue that the current accounting for pension expense is
appropriate for reflecting the long-term nature of pension obligations and
their effect on the plan sponsor.
Form 5500 Information Is Untimely but Statutory Reporting Requirements
Limit Opportunities to Improve Timeliness
Information in the Form 5500 is plan-specific and identifies the value of
assets a plan must have to comply with ERISA funding requirements.
However, this information is at least 1 to 2 years old by the time it is
fully available, making it an unreliable tool for determining a plan's
current financial condition. The value of plan assets can significantly
change over this period of time, and the value of plan liabilities may
also change because of changes in interest rates, plan amendments,
layoffs, early retirements, and other factors. For plans that experience a
rapid deterioration in their financial condition, the funding measures
required in Form 5500 may not reveal the true extent of a plan's financial
distress to plan participants and the cognizant federal agencies.
The Form 5500 Schedule B information is not timely for three main reasons.
First, the plan's assets and liabilities can be measured at the beginning
of the plan fiscal year instead of the end of the year, resulting in
information that is over a year old when the Form 5500 is filed. In 2001,
of the 61 companies in our sample with both Form 5500 and corporate
financial statement data, at least 48 used the beginning of the plan
sponsor's fiscal year for the plan's measurement date.23 Second, ERISA
allows plan sponsors 210 days, plus a 2 1/2 month extension, from the end
of the plan fiscal year to file their Form 5500. According to PBGC
officials and actuaries we spoke with, most plans file at the extension
deadline, almost 10 months after the end of the fiscal year, and almost 2
years from the measurement date if it is the beginning of the fiscal year.
Third, according to Department of Labor officials, it has taken an average
of 6 1/2 months to process Form 5500 filings, though actuaries and PBGC
officials told us that recently, some processing has been completed within
1 to 2 months of receiving the forms. Even with this improvement in
processing time, most large companies' 2003 pension data in Form 5500 will
be based
23Actuaries for small pension plans told us that they normally use
end-of-year data because it is not difficult to assemble information about
all plan participants and their clients usually prefer to have
contributions to the plan in synchronization with the benefits earned
during the year.
on valuations as of January 1, 2003, and will not be available to the
public until January 2005.24
There are several difficulties in making the filing of Form 5500 reports
more timely. According to actuaries we spoke with, collecting and
preparing the necessary information is time-consuming and
resourceintensive for plan sponsors. Large companies' human resource data
are often not well organized for this purpose, according to two pension
experts we spoke with. Common problems include merging information from
different databases, dealing with retiree data that may not be
computerized, and identifying vested participants who have left the
company.25 The data collection and analysis becomes much more complicated
when companies go through mergers, acquisitions, or divestitures.
According to one senior pension actuary we spoke with, data preparation
efforts can consume as much as 75 percent of the time involved in
preparing the Form 5500 filing. Other issues include scheduling the work
of auditors and actuaries who must review and work with the information
once it has been assembled.
Once the forms are completed and submitted to the Department of Labor,
speeding up the processing also has complications. While the process is
significantly faster now than it used to be, it depends on paper rather
than electronic filing and is slowed because the Form 5500 is also used
for defined contribution and welfare benefit plans. Only about 32,000 of
the more than 1 million Form 5500 filings pertain to PBGC-insured defined
benefit plans, and the filings for defined benefit plans are not readily
identifiable in order to receive priority when the Department of Labor
processes these forms. Additionally, if errors in the Form 5500 filing are
identified, the filing is returned to the plan sponsor with a 30-day
deadline for making corrections and refiling. If errors are not properly
corrected in
24In practice, PBGC has taken steps to allow for timelier monitoring of
those plans that may pose a financial risk to the single-employer pension
insurance program. In 1993 PBGC established the Form 5500 intercept
program, which has speeded up the process for obtaining information on the
largest and most underfunded plans. For about 2,100 plans on the intercept
list, the Department of Labor mails copies of their Form 5500 filings to
PBGC before it begins to process them.
25A vested participant has earned the nonforfeitable right to his or her
accrued benefit. There are certain rules that private plan sponsors must
follow regarding the length of time that participants must work in order
to be fully vested in their accrued benefits. Participants are 100 percent
vested in any contributions they make to a qualified plan, but may have to
work for a certain period of time before earning a right to their
employer's contributions.
the first response, the administrator is notified and given an additional
30 days to correct the amended filing.
ERISA Does Not Require Reporting of Plan Termination Funding in Form 5500
A second limitation in Form 5500 is that it is not required to furnish
information about the ability of a plan to meet its obligations to
participants if it were to be terminated.26 Compliance with ERISA funding
rules, as reported in Form 5500, is often based on the plan's current
liability, which is the sum of all liabilities to employees and their
beneficiaries under the plan. In theory, keeping a pension plan funded up
to its current liability will ensure that the plan has assets to meet its
benefit obligations to plan participants as long as the plan sponsor
remains in business. However, if a plan is suddenly terminated because of
its sponsor's financial distress, the plan liabilities are likely to
increase and plan assets are less likely to cover the cost of all benefit
obligations. Therefore, Form 5500 information often does not accurately
indicate the ability of the plan to meet its benefit obligations to plan
participants in the event that the plan sponsor goes bankrupt. A different
measure, called the termination liability, comes closer to expressing the
pension plan's cost of discharging the promised benefits to participants
in a distress termination. The termination liability, which is usually
higher than current liability, reflects the cost to a company of paying an
insurer to assume its pension obligations were the plan to be
terminated.27 PBGC has found no simple relationship between measures of
current and termination liability, and therefore a fixed set of factors
cannot be applied to the plan's current liability funding level (or its
components) to estimate termination liability. For plans whose vested
benefits are underfunded by at least $50 million, PBGC receives a
termination liability measure in a separate filing called a Section 4010
filing (named after the ERISA section that requires companies to submit
such reports). However, this information is available only to PBGC and by
law may not be publicly disclosed.
26Terminating an underfunded plan is termed a distress termination if the
plan sponsor requests the termination or an involuntary termination if
PBGC initiates the termination. PBGC assumes responsibility for terminated
underfunded plans and pays the pension obligations to plan participants up
to the amount guaranteed under Title IV of ERISA. PBGC also makes a claim
on the employer's assets in bankruptcy proceedings as an unsecured
creditor. However, PBGC officials told us that the agency's claims usually
amount to only a few cents per dollar claimed.
27Termination liability is calculated by using a PBGC interest factor,
which is based on a survey of insurance companies and, along with a
specified mortality table, reflects group annuity purchase rates.
The differences in the two types of liability measures are substantial
enough that a plan can appear in reasonable condition under the current
liability measure that serves as the basis for the minimum funding
standard, but not have sufficient resources to settle plan termination
liabilities. For example, Bethlehem Steel's pension plan was 97 percent
funded on a current liability basis in its 1999 Form 5500 filing. However,
when the plan was terminated, in December 2002, it was funded at only 45
percent on a termination liability basis.28 Plan terminations often result
from a plan's sponsor entering bankruptcy, which, according to PBGC
officials, cannot usually be predicted more than a few months in advance.
Some of the reasons that a plan can have a reasonable ratio of assets to
liabilities under the current liability measure but a less than adequate
ratio under the termination liability include
o Different retirement ages. When companies shut down, many long-time
employees retire and begin collecting pension benefits at an earlier age.
o Different discount rates. Termination liability discount rates have
usually been lower than for current liability in recent years, making the
present value of termination liability larger.
o Different plan provisions. Terminations may coincide with factory
shutdowns, which often trigger provisions that increase retirement
benefits.
Corporate Financial While the information about pensions in corporate
financial statements Statement Information Can does not serve the same
purpose as the information in Form 5500, it can Supplement Form 5500 also
be useful to the PBGC. This information is useful in two primary Data
ways:
o Its overall measures of the company's financial condition provide
indications about the company's ability to meet its pension obligations.
According to PBGC officials, most large plans that were terminated by PBGC
were sponsored by companies whose debt was rated below
28See U.S. General Accounting Office, Pension Benefit Guaranty
Corporation: Single-Employer Pension Insurance Program Faces Significant
Long-Term Risks, GAO-04-90 (Washington, D.C.: October 2003), pp. 17-19,
for further discussion of the failure of the Bethlehem Steel pension plan.
investment grade for a number of years prior to plan termination.29 Though
plan asset-to-liability ratios are not dependent on the health of the plan
sponsor, participants in underfunded pension plans at financially
distressed companies face the risk that the plan sponsor will lack the
cash resources to meet the ERISA funding requirements. In contrast, a
company in a strong financial position is much more likely to be able to
make up funding shortfalls.
o It provides the timeliest public data about pension plans, which may
be useful if the company sponsors only one pension plan. Within 60 to 90
days from the end of their fiscal years, publicly traded companies must
file their financial statements, which provide data based on measurements
on the last day of a company's fiscal year.30
Pension Accounting Disclosures and Methods Have Been Subjects of Debate
Some primary users of corporate financial statements have expressed
concerns about the extent to which these reports show how pension plans
affect a company's profitability, cash flow, and financial position. This
information is particularly important for companies with large pension
plans because the greater the value of a company's pension assets relative
to the company's market value, the more sensitive its cash flows and
profits will be to changes in pension asset values. According to analysis
by Standard and Poor's (S&P), a leading corporate debt rating agency,
defined benefit pension plans significantly affect the earnings of about
half of the companies in the S&P 500 index. As conveyed to us by financial
analysts, investors' concerns about financial reporting on pensions have
been twofold: First, financial statements have heretofore lacked adequate
disclosures about how pension plans affect the sponsoring companies' cash
flow and overall risk. Second, some investors believe that current
standards for measuring pension expense do not adequately recognize the
financial condition of pension plans and distort measures of company
earnings. However, others argue that these standards provide a more
29Corporate debt rated below investment grade by the main debt rating
agencies (Standard & Poor's, Moody's, Fitch Ratings) pays a higher
interest rate to bondholders and is more expensive for companies than if
their debt is rated investment grade. A below-investmentgrade rating
indicates a significant risk that the company will not be able to repay
its debt to bondholders. This risk is usually derived from a combination
of a company's profitability, cash flow, total debt, and other factors
that are reported in corporate financial statements.
30In 2002, the SEC adopted accelerated filing dates for 10-K reports for
companies with a market capitalization of at least $75 million. Under
these rules these companies must file their 10-K reports within 75 days
for fiscal years ending on or after December 15, 2003, and within 60 days
for fiscal years ending on or after December 15, 2004.
appropriate accounting of a company's annual pension costs over the long
term.
Disclosure concerns, to date, have been of two main types:
o First, according to financial analysts we spoke with, it has been
difficult to reasonably estimate a pension plan's claims on a company's
cash resources in the coming year and near future. Contributions are
determined primarily by ERISA funding requirements, but the plan funding
status reported in the Form 5500 is not current enough to be used by
financial analysts and investors. Large required contributions to pension
plans can reduce the cash available to companies to apply to shareholder
dividends or invest in their business so that profits may continue to
grow. For industries in which investors are concerned primarily with a
company's cash flow, estimates of such future contributions would be
critically important, but have been unavailable to date.31
o Second, to date it has been difficult to accurately evaluate the risk
that pension investments pose to the plan sponsor. The allocation of
pension assets can pose additional risk to the company's cash flow and
profitability, especially for companies with very large pension plans.
Investments in more volatile assets, such as equities, are likely to
create a wider range of potential cash contributions for the company in
the future, as companies may need to make contributions to meet statutory
funding requirements following negative returns on pension assets.
In addition to raising these disclosure concerns, some financial analysts
and investors have also expressed opposition to current accounting
standards for measuring pension expense, while others support these
standards.32 Pension expense is included in the calculation of corporate
earnings, which investors use to track a company's performance, in
comparison both with other firms and with a company's own past
performance. In order to reduce the potential volatile effect of pension
plans on their sponsors' earnings, the accounting standards call for three
main smoothing mechanisms to calculate pension expense: (1) expected
31In December 2003 FASB revised its pension disclosure standard (FAS 132)
to require disclosure of the employer's best estimate of contributions
expected to be paid during the next fiscal year. In addition, companies
must disclose each major category of pension plan assets.
32See appendix II for an example of how pension expense is calculated in a
corporate financial statement.
return is used instead of actual return on pension assets, (2) the
expected return may be based on an average value of pension assets rather
than their current fair value,33 and (3) differences between actual
experience and assumptions are recognized systematically and gradually
over many years rather than immediately when they arise. Therefore, when
the expected return on pension assets significantly differs from the
actual return, this difference does not immediately affect a company's
reported pension cost or earnings.
As actual experience differs from assumptions on such things as expected
rates of return, inflation rates, and plan participant mortality rates,
the differences are added to or subtracted from an account for
unrecognized gains or losses.34 When unrecognized gains or losses exceed
10 percent of either the market-related value of pension assets or the
projected benefit obligation, whichever is greater, the company must
factor a fraction of the excess unrecognized gain or loss (difference
between the total gain or loss and the 10 percent threshold) into its
calculation of pension expense.35 For example, a company may experience 3
years of unusually high gains on its pension assets, and at the end of
year 3, the cumulative difference between expected and actual returns on
pension assets surpasses the minimum threshold for recognition of the
difference. The company must record part of its unrecognized cumulative
gain in its calculation of pension expense, thereby decreasing the pension
expense for the year.
Although actual and expected rates of return may differ sharply in any
given year, or even over 2 to 3 years, the variance between them should
decrease over the longer term, provided that expected rates of return are
reasonably accurate. Table 4 shows the results of our comparison of
expected and actual rates of return for 52 companies from our sample of
Fortune 500 companies that had data available over the 9 years from 1994
33Statement of Financial Accounting Standards No. 87, Employers'
Accounting for Pensions, requires companies to determine the expected
return on plan assets based on the expected long-term rate of return on
plan assets and the market-related value of plan assets. The
market-related value of plan assets is defined as "either fair value or a
calculated value that recognizes changes in fair value in a systematic and
rational manner over not more than five years."
34The unrecognized gains or losses account appears in the pension footnote
to the corporate financial statement but is not recognized on the plan
sponsor's balance sheet.
35The excess amount is amortized over the average remaining working years
of active plan participants or average remaining life expectancy of
retired plan participants if all or most participants are inactive.
through 2002. During this period the average expected rate of return used
in the financial statements was 9.29 percent, while the average actual
rate of return was 7.56 percent and ranged from a low of -8.85 percent to
a high of 22.36 percent in any given year.
Table 4: Average Expected and Actual Rates of Return on Pension Assets
from 1994 to 2002 for a Sample of Fortune 500 Companies
Average expected Average difference
rate of return Average actual rate (actual minus
Year (percent) of return (percent) expected)
1994 9.19 0.52 -8.67
1995 9.26 22.36 13.10
1996 9.26 14.21 4.95
1997 9.33 19.04 9.71
1998 9.32 12.55 3.23
1999 9.35 14.26 4.91
2000 9.45 5.07 -4.38
2001 9.45 -6.45 -15.90
2002 8.98 -8.85 -17.83
1997-1999 average 9.33 15.25 5.92
2000-2002 average 9.29 -3.59 -12.88
Nine-year average 9.29 7.56 -1.73
Source: GAO analysis of pension footnotes in corporate financial
statements.
Note: The average rates of return for multiyear periods in table 4 are
geometric means, which are used to calculate the compound average, or the
average annual return that would yield the same total change in asset
values over a multiyear period. 52 companies in our sample had data
available for this entire 9-year period.
In comparison with the results of our analysis, a study by one investment
bank revealed an average actual return on pension assets of greater than
12 percent between 1985 and 1998.36 Therefore, average actual rates of
return will vary according to the time period being measured. For example,
for the companies in our sample, the average actual return on pension
assets was 15.25 percent from 1997 through 1999 and -3.59 percent from
2000 through 2002.
36Goldman Sachs, Global Economics Weekly, "US: Pension Costs-Another Hit
to Cash Flow," November 13, 2002.
Opponents of current methods of accounting for pension expense argue that
the smoothing mechanisms lack transparency because reported pension
expense (1) does not reflect the current financial condition of pension
plans and (2) distorts measures of corporate earnings. Under the current
methodology for calculating pension expense, the cumulative net effect of
pension asset gains or losses may not be reflected in reported pension
expense for a few years, if at all. While alternating years of gains and
losses may keep reported pension expense relatively smooth from year to
year, consecutive years of gains or losses can eventually result in
significant changes in reported pension expense. Many companies that
reported pension income in 2001 and 2002, while their pension assets were
in fact decreasing in value, benefited from the use of the market-related
value of pension assets (the average asset values over not more than the
previous 5 years) rather than the lower actual value of these assets. For
example, of the 97 companies in our sample, 26 reported net pension income
in 2002, but only one of these companies saw an increase in the value of
its pension assets. Conversely, it is likely that many of these companies
will report net pension expenses in the next few years, even if their
pension asset values rise, because their market-related values of pension
assets will reflect, in part, the decline in the stock market between 2000
and 2002.
In contrast, employer contributions, which are only indirectly related to
pension expense, may better reflect the current financial condition of
pension plans. Employer contributions to pension plans are determined by a
complex set of factors, including the tax deductibility of contributions,
minimum funding requirements, the employer's expected cash flows, and PBGC
premiums. In 2002, when most large companies saw declines in their pension
asset values, many were required to make contributions to their pension
plans to meet the statutory funding requirements. The 93 Fortune 500
companies in our sample with available financial statement data reported
aggregate contributions to pension plans of $10.1 billion in 2002, while
their aggregate pension expense totaled $622.6 million. Financial analysts
pay close attention to companies' cash contributions to pension plans
because large contributions to plans represent resources that companies
will not have available to use for other purposes, such as expanding their
businesses.
Investors have also been concerned about the extent to which defined
benefit pensions contribute to a company's total profits. According to one
investment bank study, 150 of the 356 Fortune 500 companies with defined
benefit plans reported net pension income (negative expense) in their
financial statements in 2001.37 However, the value of pension assets for
313 of these companies actually declined in 2001. To try to address these
apparent inconsistencies in the financial reporting on pensions, many
financial analysts and investors try to strip out the effects of pensions
to determine a "true" measure of a company's earnings that reflects its
performance from ongoing operations. For example, Standard and Poor's
issued a proposal in 2002 to standardize measures of corporate earnings
that excludes several items from the earnings calculation, including
investment returns on pension assets.
Proponents of current pension accounting standards argue that the
smoothing mechanisms are beneficial because (1) pension obligations are
long-term liabilities that do not have to be funded all at once and (2)
sponsoring pension plans and investing plan assets are not the primary
business activities of plan sponsors. Pension obligations are normally
paid out over a long period of time; therefore, pension assets have a
similar time period to meet those obligations. The smoothing mechanisms
allow plan sponsors to gradually and systematically attribute portions of
the long-term cost of pension plans to each year. Without smoothing
mechanisms, companies would potentially face year-to-year fluctuations in
their reported pension expense that some investors may also consider
misleading given that unexpected losses on pension assets in one time
period may be offset by unexpected gains in another.
The Financial Accounting Standards Board adopted the smoothing mechanisms
in part to reduce the volatility of reported earnings caused by investment
returns on pension assets. Because investing pension plan assets is not
the primary business activity of plan sponsors, FASB determined that
earnings volatility caused by immediately recognizing all changes in the
value of plan assets and liabilities as they occur would be misleading to
investors. Furthermore, such volatility could make comparisons of earnings
more difficult when looking at different firms, some of which may not
sponsor defined benefit plans.
37Credit Suisse First Boston, The Magic of Pension Accounting, September
27, 2002.
Changes to Pension Accounting and Regulatory Reporting Have Been Implemented
or Proposed
Both in this country and abroad, changes have been proposed-and in a few
cases, implemented-to make information about defined benefit plans more
transparent or complete. These changes relate to information associated
with both Form 5500 and corporate financial statements. The administration
has proposed augmenting current Form 5500 information by making available
certain data that currently are not made public, such as measurements of
termination liabilities. The Financial Accounting Standards Board has
recently amended one of its accounting standards to require, among other
things, that companies provide more information about the composition and
market risk of their pension plan assets and their anticipated
contributions to plans in the upcoming year. Outside the United States,
proposals are being discussed that would move toward eliminating or
reducing the use of smoothing mechanisms in calculating pension expense.
The Administration Has Proposed Making Additional Information Available
Relating to Pension Risk
In July 2003 the Department of the Treasury announced "The Administration
Proposal to Improve the Accuracy and Transparency of Pension Information."
The proposal presented four areas of change, and one of them would broaden
the public's access to pension information currently available only to
PBGC.38 The proposal would expand the public's access to pension
information in two main ways:
o Reporting termination liability. Under the proposal, information about
a plan's termination liability would be included in ERISA-required summary
annual reports to workers and retirees. The annual reports, which are
based on data from the Form 5500 reports, now report the plan's financial
condition based on the plan's current liability. Termination liability
information is reported to PBGC by companies whose plans are collectively
underfunded by more than $50 million.
o Public disclosure of underfunding of at least $50 million. Section
4010 of ERISA requires companies with more than $50 million in aggregate
plan underfunding to file annual financial and actuarial information with
the PBGC. This information is reported separately from Form 5500
information and must generally be filed no later than 105 days after the
end of the company's fiscal year. PBGC uses this information to monitor
plans that may be at greater risk of failure, but under current law, PBGC
38The four areas to improve pension security for Americans were (1) the
accuracy of the pension liability discount rate, (2) the transparency of
pension plan information, (3) safeguards against pension underfunding, and
(4) comprehensive funding reforms.
cannot make the information public. According to the administration, the
information is more timely and better in quality than publicly available
data. Under the proposal, the market value of assets, termination
liability, and termination funding ratios contained in these reports would
all be publicly disclosed.
Since the announcement of the administration's proposal, no further action
has been taken by either the administration or Congress to implement these
proposals.
FASB Has Changed U.S. Pension Disclosure Standards; Other Changes Being
Considered Abroad
In regard to corporate financial statements, one change designed to
address users' concerns about pension-related information has recently
been enacted. In December 2003 FASB issued a revision to its accounting
standard on pension disclosures.39 The revised standard incorporates all
of the disclosures required by the prior standard and requires more
informative pension disclosures.40 FASB added the new disclosures because
users of financial statements, such as financial analysts, requested
additional information that would assist them to evaluate, among other
things, the composition and market risk of the pension plan's investment
portfolio and the expected long-term rate of return used to determine net
pension costs. As a result, some of the new disclosure requirements
include listing the percentage of pension assets invested in major asset
classes such as equity securities, debt securities, real estate, and other
assets. Companies must also provide a narrative description of the basis
used to determine the overall expected rate of return on assets
assumption. The FASB believed that this new information would allow users
to better understand a company's exposure to investment risk from its
pension plans and the expected rate of return assumption. Another required
disclosure is the employer's estimated contribution to pension plans in
the following year. However, the revised standard does not change the
general approach used in the financial statements of aggregating this
information across all pension plans.
39See Statement of Financial Accounting Standards No. 132 (revised 2003),
Employers' Disclosures about Pensions and Other Postretirement Benefits.
40In GAO's response to the FASB's exposure draft for new pension
disclosures, we supported the initiative to enhance disclosures for
pension and other postretirement benefits. We believe that improved
transparency in plan funding and funded status, investment strategies, and
market risk could reduce the risks to the federal government's pension
insurance programs and promote the retirement security of workers and
retirees.
Outside the United States, other standard-setting boards have been
addressing issues related to the use of smoothing techniques designed to
smooth out the volatility of reported pension expense. One of these boards
is the International Accounting Standards Board (IASB), an independent
accounting standard-setting organization. Many countries require publicly
traded companies to prepare their financial statements in accordance with
IASB's financial reporting standards. IASB's current pension accounting
standard is very similar to the current standard promulgated by FASB, in
that both allow a smoothing mechanism to reduce the volatility of pension
expense. However, IASB is considering a revision to its current standard
to allow companies to calculate pension expense using actual investment
returns instead of expected returns, on a voluntary basis. According to
the IASB manager in charge of the project, the exposure draft will be
issued in 2004, and a final standard is expected in March 2005. Separately
from the IASB action, the United Kingdom's Accounting Standards Board has
already issued its own accounting standard that would require companies to
report the differences between actual and expected returns on pension
assets in their financial statements.41 Full adoption of this standard has
been delayed out of concern that the changes made by firms to comply with
the Accounting Standards Board standard might need to be modified again in
subsequent years to meet a potentially different IASB standard.
Form 5500 reports and corporate financial statements both provide key
pension financial data, but they serve different purposes and, as a
result, provide significantly different information. To date, neither
report in isolation provides sufficient information for certain users to
fully determine the current financial condition of an individual pension
plan or how pension obligations could affect the financial health of the
plan sponsor. While particular concerns have been raised about differences
between expected and actual pension asset rates of return reported on
corporate financial statements, expected rates of return do not have a
significant effect on the actual financial condition of plans.
Continued concerns about the financial condition of plans and how this
information is disclosed have been highlighted by the administration's
proposal to provide information about funding in the event of plan
termination to plan participants and regulators. We have previously
41The United Kingdom's Accounting Standards Board issued Financial
Reporting Standard 17, Retirement Benefits, in November 2000, and it was
amended in 2002.
Concluding Observations
reported that an essential element of pension disclosure should include
requiring plans to calculate liabilities on a termination basis and
disclosing this information to all participants annually. Likewise, we
recommended that Congress consider requiring that all participants receive
information about plan investments and the minimum benefit amount that
PBGC guarantees should their plan be terminated.42 While such new
requirements could help improve the transparency of pension plans'
financial condition, there are other challenges to be addressed as well.
For example, plan participants and regulators continue to need more timely
information. However, there appear to be few opportunities to improve the
timeliness of Form 5500 information under the current statutory reporting
requirements. One challenge to improving the timeliness of this
information on pensions will be to find a solution that does not impose
undue burdens on plan sponsors. Resolving this challenge will prove
crucial to providing policy makers, plan participants, and investors with
more timely and transparent information on the financial condition of
defined benefit plans.
Agency Comments We provided a draft of this report the Department of the
Treasury, the Department of Labor, the Pension Benefit Guaranty
Corporation, the Securities and Exchange Commission, and the Financial
Accounting Standards Board. We received technical comments from each
agency that we incorporated as appropriate.
We are sending copies of this report to the Secretary of Labor, the
Secretary of the Treasury, the Executive Director of the Pension Benefit
Guaranty Corporation, the Chairman of the Securities and Exchange
Commission, the Chairman of the Financial Accounting Standards Board,
appropriate congressional committees, and other interested parties. We
will also make copies available to others on request. In addition, the
report will be available at no charge on GAO's Web site at
http://www.gao.gov.
42See GAO-04-90.
If you have any questions concerning this report please contact me at
(202) 512-7215 or George Scott at (202) 512-5932. Other contacts and
acknowledgments are listed in appendix III.
Sincerely yours,
Barbara D. Bovbjerg Director, Education, Workforce, and Income Security
Issues
Appendix I: Scope and Methodology
To explain the two sources of pension financial information, we
interviewed federal agency officials from the Pension Benefit Guaranty
Corporation (PBGC) and the Department of Labor (DOL). These federal
agencies use Form 5500 information in performing their oversight and
monitoring responsibilities. In addition, we reviewed the Form 5500
instructions, form, and schedules to understand the information they
provide. For the financial statements, we reviewed relevant accounting
standards from the Financial Accounting Standards Board, which sets
standards for financial statements, and spoke with board officials. We
also reviewed many financial statements of large domestic companies.
Our work also included analyses of a sample of corporate financial
statements of Fortune 500 companies and the corresponding Form 5500
filings for those companies with available data. We chose to sample from
the universe of publicly owned Fortune 500 companies with defined benefit
plans because (1) the pension plans sponsored by these firms represent a
large percentage of the total private defined benefit pension plan
participants, assets, and liabilities in the United States; (2) these
firms tend to have the largest defined benefit plans, and if these plans
fail they would create the largest burdens for PBGC and possibly the
government; and (3) most of these firms are publicly traded, so their
corporate financial statements are publicly available.
We drew a systematic random sample of 100 of the 2003 Fortune 500
companies with defined benefit plans, after excluding governmentsponsored
entities. The sampling process accounted for the companies' revenues in
2002 and the distribution of expected rates of return on pension assets.
This distribution was available in a Compustat database for approximately
290 of the 329 companies in the population. From the initial sample of 100
companies, 3 companies were removed because one is not publicly traded,
another is European and filed its financial statements in euros, and the
third changed its end-of-fiscal-year date in 2001, which made it more
difficult to compare with other firms. For the 97 remaining companies, we
obtained as much as 10 years of pension data from these companies'
corporate financial statements using the Securities and Exchange
Commission's Electronic Data Gathering, Analysis, and Retrieval System
(EDGAR), depending on data availability. Data were available from 1993
through 2002 for 68 companies. However, others did not have 10 years of
data available because, for example, they were formed, or only began to
publicly trade their stock, at some time between 1993 and 2002. Nine
companies in our sample reported more than one expected rate of return for
their pension plans and a weighted average could not be determined
accurately. Most of these companies sponsor
Appendix I: Scope and Methodology
pension plans for employees outside the United States and provide separate
assumptions for domestic and international plans. These companies did not
report the weighted average expected rate of return that was used to
calculate their expected return on pension assets.
We also obtained the corresponding Form 5500 filings for the companies in
our sample from PBGC for plan years 1993 through 2001.1 To identify these
filings, we matched the sample of 97 Fortune 500 companies to their
pension plans on the basis of their employer identification number (EIN).
An EIN, known as a federal tax identification number, is a nine-digit
number that the IRS assigns to organizations. We developed a list of EINs
reported on the companies' financial statements and provided this list to
the PBGC. PBGC matched the EINs to their Form 5500 database and provided
information to us. However, in several cases, PBGC did not find matches to
our list of EINs, either for all 10 years or for just some of the years.
Based on the number of companies with data available in any of the 10
years, we decided on a threshold of 7 years' worth of data in order to
achieve a sample size that would allow us to compare data over most of the
10-year period. In other words, to be included in this analysis, a company
must have at least 7 years of Form 5500 data. One hundred and fifty plans
had at least 7 years of Form 5500 data.2 The years in which data were
missing were spread sporadically among the 10-year period covered in this
analysis.
Before deciding to use the Form 5500 data, we investigated its
reliability. Prior to plan year 1999, the Internal Revenue Service was
responsible for keypunching Form 5500 information into a database, and DOL
officials explained that some of the data contained errors. DOL officials
explained that since plan year 1999, Form 5500 data have been recorded
with optical scanning devices and have been subject to edit and validity
tests. In 1999, some Form 5500 filings were not captured because many plan
administrators did not send forms on the correct paper and the scanner
could not capture some information. However, DOL officials explained that
this problem has not occurred since. We obtained the Form 5500 data from
PBGC's Corporate Policy and Research Department. PBGC officials explained
that as errors surface in their use of the Form 5500 data, corrections are
made to PBGC's database. In the past hard copies of
1Because of the filing requirements of Form 5500, no data were available
for 2002 during the course of our study.
2Some of the 97 companies in our sample sponsor more than one pension
plan.
Appendix I: Scope and Methodology
original Form 5500 filings were obtained for making corrections. Today
PBGC can view electronic images of the actual plan filings. As PBGC
receives the data on Form 5500 Schedule B, it screens the data for errors,
particularly in the asset and liability fields. Information we received
from pension actuaries corroborates the data we used from Form 5500
filings and the data on expected rates of return, as presented in figure
1, show consistency from year to year. Taking all these factors into
consideration, we feel that the data we used were sufficiently reliable
for the purpose of differentiating between expected rates of return
reported in Form 5500 filings and corporate financial statements.
In obtaining financial information for the sample companies, we had to
account for companies that had merged with another company during the
10-year period under review. In the event of a merger between a company
with a defined benefit pension plan and a company without a defined
benefit plan, we selected the company with the defined benefit plan. In
the case of a merger between two companies that both had defined benefit
plans prior to the merger, we selected the company indicated by the EDGAR
database as the predecessor company.
While our sample is designed to represent our population for calendar year
2002, it is not representative of any population in prior years. The
makeup of the Fortune 500 changes from year to year, and our method of
tracking the same companies across several years precludes us from making
specific statements about any larger population prior to 2002. Thus, while
we believe that the trends identified in our sample could be indicative of
trends in the population of large firms with defined benefit plans and
that this supposition is supported by other studies, we do not claim these
trends are representative of past populations of Fortune 500 companies.
To explain the usefulness and limitations of the information from the two
information sources, we interviewed expert users of pension information in
Form 5500 reports and corporate financial statements, including federal
officials from DOL, PBGC, and SEC; pension actuaries; corporate debt
rating agency officials; financial analysts; and Financial Accounting
Standards Board officials. Some experts explained the uses of information
available in the Form 5500 reports and limitations of these reports. Other
experts described and shared documentation about how they analyze
financial statements to understand the impact of pension plans on the plan
sponsors' financial statements. Some experts explained the need for
additional pension information in companies' financial statements. As part
of our review of pension information in corporate financial statements, we
used several research reports published by different investment banks. We
Appendix I: Scope and Methodology
reviewed the methods used in these studies and found them to be
sufficiently reliable for the purpose of corroborating our own data
analysis and illustrating trends in pension accounting.
To explain the recent and proposed changes to the current information
sources, we interviewed officials from the International Accounting
Standards Board and the Financial Accounting Standards Board. These boards
set standards for financial statements for international companies and
United States companies, respectively. We also reviewed the recently
revised accounting standards issued by the Financial Accounting Standards
Board. We also reviewed congressional testimony regarding the
administration's proposal for more transparency of pension data.
We conducted our work between January 2003 and January 2004 in accordance
with generally accepted government auditing standards.
Appendix II: Expected and Actual Returns in Financial Statements
This appendix shows two things: (1) how a company may experience an actual
loss on its pension assets while reporting income from its pension plans
in the same year and (2) how a change in the expected rate of return
affects other items in the financial statement. The information is based
on numbers taken from the corporate financial statement of a real company
from its 2002 fiscal year.
Company X's pension assets lost $512 million in value during its fiscal
year, yet Company X still reported pension income of $90 million. This
apparent inconsistency is possible because the expected return on assets
is used in place of actual returns to calculate net periodic pension cost.
The second column of table 5 shows the effect of changing the expected
long-term rate of return on pension assets from 9.8 percent to 8.5
percent. The figures affected by this change are in bold text. All of the
changes caused by the change in the expected rate of return are related to
measurements of Company X's pension expense and measures of overall
profitability. The change has no impact at all on measures of pension
assets and liabilities.
Appendix II: Expected and Actual Returns in Financial Statements
Table 5: Corporate Financial Statement Example-Elements of Pension
Footnote and Statement of Operations for Company X for Different Expected
Rates of Return
Dollars in millions except earnings per share
Item Key pension footnote elements 2002 2002 Change in benefit obligation Change
in plan assets
A Benefit obligation at beginning of year $7,382 $7,382
B Service cost 115 115
Interest cost 529 529
D Plan amendments 0
E Actuarial losses 395 395
F Benefits paid (611) (611)
G Benefit obligation at end of year $7,810 $7,810
H Fair value of plan assets at beginning of year $7,431 $7,431
Actual return on plan assets (512) (512)
J Employer contributions 135 135
K Participant contributions 0
Benefits paid (611) (611)
M Fair value of plan assets at end of year $6,443 $6,443
Rate assumptions:
N Expected long-term rate of return on plan 9.8% 8.5%
assets
O Discount rate 7.0% 7.0%
P Expected rate of compensation increase 4.0% 4.0%
Components of net periodic cost of defined benefit
plans
Q Service cost $115 $115
R Interest cost 529 529
S Expected return on plan assets (783) (679)
T Amortization of prior service cost 50 50
U Amortization of net actuarial (gain) loss (1) (1)
V Total (benefit) cost included in results of $(90) $14
operations
Not reported in pension footnote
W Market-related value of plan assets $ 7,990 $ 7,990
X Total sales and revenues $20,152 $20,152
Y Total operating costs 18,833 18,947
Z Operating profit 1,319 1,205
Appendix II: Expected and Actual Returns in Financial Statements
Item Key pension footnote elements 2002 2002
AA Consolidated profit before taxes 1,114 1,000
BB Provision for income taxes 312 280
CC Net profit 802 720
DD Earnings per share $2.33 $2.09
Source: GAO analysis.
An explanation of the pension elements in table 5 follows in table 6.
Appendix II: Expected and Actual Returns in Financial Statements
Table 6: Definitions of Pension Footnote Items in Table 5 Item Definition
A The projected benefit obligation is the present value of all future
retirement benefits earned and not yet paid to date, including estimates
of salary growth over time. Measurements of the projected benefit
obligation are provided for both the beginning and the end of the year.
B The service cost represents the actuarial value of benefits earned by
employees during the year. It is used to show the change in benefit
obligation from the beginning to the end of the year and in the
calculation of net periodic pension cost.
The interest cost represents the increase in the company's projected
benefit obligation as a result of the passage of time. The deferred
compensation arrangement of pension plans entails a time value of money
aspect. It is used to show the change in benefit obligation from the
beginning to the end of the year and in the calculation of net periodic
pension cost.
D Plan amendments include the initiation of new plans and provisions that
grant increased benefits based on services rendered in prior periods.
E Actuarial losses (gains) reflect changes to any assumption that
increase (decrease) the value of the projected benefit obligation.
Assumptions include the discount rate, salary inflation, mortality,
retirement age, and other factors.
F Benefits paid represent the amount of cash payments from the pension
plan to retired plan participants. These payments are cash outflows
primarily from the pension plan(s). Benefits paid reduce the outstanding
value of total pension obligations to plan participants.
G See Item A.
H The fair value of assets is the market value of the stocks, bonds, real
estate, and other assets held by the company's pension plan(s) on the
measurement date. Values of pension assets are provided for both the
beginning and the end of the company's fiscal year.
The actual return on plan assets is the change in the value of pension
assets from changes in market prices on the assets held by the plan(s).
The actual return includes dividends and interest income. Company X's
pension plans lost $512 million.
J Employer contributions are the total contributions (usually cash) made
by the company to its pension plan(s). Employer contributions are not the
same as the net cost to the company sponsoring the pension plans.
K Participant contributions are the total amount of cash paid into the
pensions plan(s) by employees. The employees of Company X did not
contribute to their defined benefit pension plans in this year.
Benefits paid-this is generally the same as in Item F. Benefits paid
reduce the value of assets held by the company's pension plan(s).
M See Item H.
N The expected long-term rate of return on plan assets is the company's
assumption about the long-term average rate of return on its pension plan
assets. The rate disclosed in the current year is used to calculate the
expected return on plan assets (Item S) in the components of net periodic
cost of defined benefit plans.
O The discount rate should reflect the interest rate on high-quality
corporate bonds. It is used to the measure the present value of the
projected benefit obligation in the current year and will be used to
calculate the service cost and interest cost in the following year.
P The expected rate of compensation increase is used to calculate the
projected benefit obligation and service cost when benefits take future
salary into account.
Q See Item B. R See Item C.
Appendix II: Expected and Actual Returns in Financial Statements
Item Definition
S The expected return on plan assets is an estimate of what the company
expects to earn from the investment of pension plan assets; it reduces the
company's periodic pension expense and is used to keep this expense
relatively smooth over many years. It is calculated by multiplying the
expected rate of return (Item N) by the "market-related" value of plan
assets (Item W). The expected return is reported as a negative number
because it reduces the overall periodic pension cost.
T The amortization of prior service cost is the periodic cost recognized
by the company for pension benefits credited to employees for service
prior to their enrollment in a pension plan.
U Amortization of net actuarial (gain) loss is used when the cumulative
difference between actual experience and assumptions reaches a threshold
of 10 percent of either the market-related value of total pension assets
or obligations, whichever is greater. Company X is recognizing $1 million
in this year for past actual gains that exceeded expected gains. This
amortization reduces its pension cost by $1 million for this year.
The total (benefit) cost included in results of operations is the total of
Items Q - U and may also be called the net periodic pension cost. It is
the amount included in the company's labor costs, which are reported in
the consolidated statement of operations (income statement).
W The market-related value of plan assets is not required to appear
anywhere in the financial statement but is used to calculate the expected
return on plan assets (Item S). The market-related value of plan assets
can either be the fair market value of plan assets or an average value of
the assets over a period not exceeding 5 years. It is possible to closely
estimate the market-related value of plan assets by dividing the expected
return on plan assets by the expected long-term rate of return on plan
assets.
Source: GAO analysis.
A company's total operating costs include its labor costs, which include
the net periodic pension cost. Therefore the net periodic pension cost is
factored into the calculation of total operating costs, which affects
operating profit, consolidated profit before taxes, the calculation of tax
to be paid, and net profit (Items Y-CC in table 5).
Changing the expected rate of return on plan assets from 9.8 percent to
8.5 percent has the following effects:
In the components of net periodic cost of defined benefit plans, the
expected return on plan assets (Item S) falls from $783 million to $679
million.1 This increases the total periodic pension cost by $114 million,
which is enough to turn Company X's periodic pension income of $90 million
into a cost of $14 million.
The increase in net periodic pension cost of $114 million increases the
companies total operating costs (Item Y) and decreases the operating
profit (Item Z) and consolidated profit before taxes (Item AA) by the same
1The expected return on plan assets of $679 million was calculated by
multiplying the market-related value of plan assets (Item W) by the new
expected long-term rate of return on plan assets (Item N) of 8.5 percent.
Appendix II: Expected and Actual Returns in Financial Statements
amount. Because taxable income is reduced, Company X pays less in
corporate income tax (Item BB). Last, net profits (Item CC) decline from
$802 million to $720 million, which for Company X's shareholders of
approximately 344 million shares of common stock would have meant a drop
of about 24 cents in earnings per share (Item DD).
Appendix III: GAO Contacts and Staff Acknowledgments
Contacts
Staff Acknowledgments
(130217)
George A. Scott, Assistant Director (202) 512-5932 Richard L. Harada,
Analyst-in-Charge (206) 287-4841
In addition to those named above, Joseph Applebaum, Kenneth Bombara,
Richard Burkard, David Eisenstadt, Elizabeth Fan, Michael Maslowski, Scott
McNulty, Stan Stenerson, Roger Thomas, and Shana Wallace made important
contributions to this report.
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Public Affairs U.S. General Accounting Office, 441 G Street NW, Room 7149
Washington, D.C. 20548
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