Letter of Comment No: 2/:) File Reference: May 16,2006

Transcription

1 Letter of Comment No: 2/:) File Reference: Technical Director-File Reference No Financial Accounting Standards Board 401 Merritt 7 P. O. Box 5116 Norwalk, Connecticut Re: "Exposure Draft on FAS 87, 88,106 and 132(R)" Dear Director: On March 31, 2006, the Financial Accounting Standards Board (FASB) issued an exposure draft, which is entitled the Employers' Accounting for Defined Benefit Pension and Other Postretirement Plans-an amendment of FASB Statements No. 87, 88, 106, and 132(R) (Proposed Statement of Financial Accounting Standards). The FASB has sought written comments on the proposal by May 31, These comments represent the opinion of all the actuaries of our firrn-stanley, Hunt, DuPree & Rhine, lnc., which is a subsidiary of Branch Banking and Trust Co. (BB&T). Any comments expressed here are our professional opinion and not necessarily the opinion of our employer. One aspect of the proposed amendment is a particularly bad idea-marking retirement liabilities to market based on projected benefit obligation (PBO) or accumulated postretirement benefit obligation (APBO). Because of fluctuating discount rates, this aspect of the amendment would make pension cost volatile and erratic to no purpose. A better approach would be 1. to disclose an additional minimum liability (AML) whenever it is a positive number-instead of just when the accumulated benefit obligation (ABO) exceeds the assets and 2. to recognize the AML like a curtailment or settlement. This would achieve the goal of marking to market without destroying the smooth nature of expense year to year. It would also keep the pension cost during the period consistent with the disclosure at the beginning and end of the period. The following pages present this better approach in greater detail. Although Paragraphs 26, 33 and 38 offasb Statement No. 87 and Paragraphs 53 and 60 of FASB Statement No. 106 arguably might permit this approach already, we are recommending that the board require this approach in lieu of the accounting treatment for retirement plans that leads to intangible assets and other comprehensive income.

2 Page 2 If the FASB goes through with the amendment as drafted, there is a distinct possibility that some corporations in order to manage volatility-would eliminate their retiree medical plans and freeze then terminate their defined benefit pension plans. This may happen slowly over tbe next five to ten years, but the critical decision point is now. Sincerely, Stanley, Hunt, DuPree & Rhine, Inc. A Subsidiary of BB&T Steven M. Bull, EA, MAAA, FCA Senior Vice President! Consulting Actuary Lane B. West, FSA, EA, MAAA Senior Vice President! Consulting Actuary David P. Rigby, AS A, EA, MAAA, FCA Vice President!Consulting Actuary Paul B. Burdulis, ASA, EA, MAAA, FCA Vice President!Consulting Actuary Linda G. Reed, ASA, EA, MAAA Vice President! Actuary Thomas M. Zavist, FSA, EA Vice President! Actuary Peter N. Strong, AS A, EA Assistant Vice President! Actuary Derek A. Scott, EA, FCA Assistant Vice President! Actuary Enclosure

3 Page 3 March 31, 2006, Proposed Amendment to FASB Statements No. 87, 88, 106 and 132(R) On March 31, 2006, the FASB issued an exposure draft, which is entitled the Employers' Accountingfor Defined Benefit Pension and Other Postretirement Plans-an amendment of FASB Statements No and 132(R) (Proposed Statement of Financial Accounting Standards). While the exposure draft has flaws, the existing rules also have flaws. Flaws of FASB Statement No. 87 as Currently in Effect Paragraphs 36 through 38 of FASB Statement No. 87 include a concept of additional minimum liability, which is flawed in two regards, as follows: First, the disclosure of the funding of the ABO is inconsistent. Instead of requiring an employer to keep on the books the greater of the difference of the ABO minus the assets or the unfunded accrued pension costl(prepaid pension cost), the current rules only require the greater of the two in the case of an unfunded ABO. Whenever assets exceed the ABO, by contrast, only the unfunded accrued pension costl(prepaid pension cost) needs to be disclosed. Thus, if there is a large prepaid pension cost for several years and the assets and the ABO stay similar to each other, an employer can have erratic accounting of retirement liabilities, as the AML is disclosed some years but not others. Second, AML is included like an afterthought to the rest of the accounting. There is no attempt to have the net periodic pension cost (NPPC) reflect the impact of an AML. How to Fix the Flaws Whenever the unfunded accrued pension cost/(prepaid pension cost) is less than the difference of the ABO minus the assets, the shortfall (the AML) should be recognized as a recognition of unrecognized items (just like a curtailment or a settlement). In this way the accrued pension c~st/(prepaid pension cost) would be increased to equal the difference.of the ABo,.minus the assets, and the NPPC in future years would be decreased. This sort of accounting treatment, which turns an AML into an event similar to a curtailment or settlement, would eliminate these two flaws. It would also make pension accounting less volatile year to year. Flaws of the FASB Proposal The American Academy of Actuaries' Committee on Pension Accounting has made comments on the proposal, and all its criticisms are valid, particularly as to the question ofpbo versus ABO. FASB Statements No. 87 and 106 specify a firm's accounting treatment of its retirement benefits. They start with expected benefit obligation (EBO) and expected postretirement benefit obligation (EPBO) which are fundamental quantities that represent a firm's liability for all of its projected retirement benefits. The statements attribute these quantities, partitioning them into the service cost that is assigned to each year of an employee's service with the firm. Service cost thus is a derivative quantity-a smooth allocation ofebo or EPBO across an employee's service. Service cost is accumulated to define another derivative quantity-pbo or APBO. In other words PBO or APBO, which is treated as the retirement benefit liability of the firm, is an attribution of EBO or EPBO pro rata.

4 Page 4 While PBO and APBO are treated as if they were fundamental quantities, they are nol. They are attributions of EBO and EPBO. They are a derivative concept based on smoothing. A firm may hold the PBO for its pension plan on its books--as required by the amendment the FASB is proposing to be effective in but the PBO is not really a liability. The firm can choose to freeze its pension plan at any time, and the PBO immediately decreases to become equal to the ABO. Likewise, a ftrm can choose to tenninate a pension plan, and the PBO will change to a quantity approximating the ABO. Similarly, a firm may hold the APBO for its retiree medical,. plan on its books-as required by the amendment the FASB is proposing to be effective in but the APBO is not really a liability. The ftrm can choose to eliminate the retiree medical plan at any time, and in many cases the APBO will immediately decrease to zero. It is inappropriate for the FASB to compel employers to hold liabilities on the books that are erratic and nearly entirely fictitious. For example consider a hypothetical unfunded postretirement benefit plan, in which the employer has no legal obligation to continue to provide benefits. The last two columns show the impact of the proposed amendment by the FASB. I 8% % % (46) 2 4 7% (41) 5 5 8% % % (45) 2 8 7% (41) 5 9 8% I 45 In reality, the employer pays 25 each year gratuitously, with no legal obligation to continue. Current rules require the employer to treat the net periodic postretirement benefit cost (NPPBC) each year as an expense. Over time, the excess of the NPPBC over the actual benefits paid accumulates as the net postretirement benefit liability, which in the long run tends to approximate the APBO. The APBO swings up and down each year, because it is discounted like a bond and the discount rate changes each year. The last two columns show the impact of the proposal. It makes the expenses of the employer appear erratic and inconsistent period to period. In reality, the expense is smooth-25 each year-but discount rate changes make it appear erratic. Tbe result is a fictitious, inconsistent accounting of a retirement plan. Although the PBO and APBO are needed to compute the NPPC and NPPBC, they are not appropriate quantities for marking to market, because they do not represent real liabilities as of a particular date. For marking to market, a beller measure is the liability for benefits a ftrm is required to pay (the ABO).

5 PageS A Better Approach to Accounting for Retirement Plans Accountants are grappling with two conflicting principles. One has to do with marking to market. The other has to do with consistency period to period. The best way to combine the two conflicting principles involves two steps. The first step is to compute the NPPC or NPPBC under the current rules. H the unfunded accrued pension cost/(prepaid pension cost) or the net postretirement benefit Iiability/(asset) is less than the difference of whatever the employer is " legally obligated to pay (e.g., the ABO) minus the assets, then the second step should be a onetime recognition of unrecognized items equal to the AML. The first step reflects the principle of consistency. The second step reflects the principle of marking to market. This two step process is the proper way to fix the flaws in the current rules (FASB Statement No. 87) and it reduces the volatility of pension accounting under current rules. ]t is more consistent period to period, and it better reflects the principle of marking to market. Comparison of the Two Approaches The proposed amendment, by contrast, fails to fix the flaws in the current rules, and it makes pension accounting more erratic to no purpose. Actuaries developed the concept of attributing retirement liabilities (transforming EBO and EPBO into PBO and APBO) in a framework in which the discount rate is held fixed. Attribution is a smoothing technique. Applied properly, a smoothing technique will produce a smooth result. The proposed changes to FASB Statements No. 87 and 106 do not produce a smooth result. Rather, they produce an erratic, volatile result, which will prompt employers to eliminate their retiree medical plans, freeze their pension plans and ultimately terminate their pension plans. These employers will not be eliminating retirement benefits because they cannot afford the liabilities (the ABO) nor because they cannot fund the ultimate cost (the EBO and EPBO) over time. Rather they will be eliminating these retirement benefits because they are compelled to hold an artificial liability on the books (the PBO and APBO) which varies erratically year to year. There is no reason for a firm to be required to book liabilities that exceed both what a firm is required to pay and also what the firm can reasonably. attribute to the current period. Forcing firms to book erratic liabilities (the PBO and APBO) that do not conform to real obligations will tend to lead employers to get rid of the retirement plans that are the source of these artificial liabilities. Since employers are only on the hook for their actual liabilities (the ABO) they have every incentive to rid themselves of the artificial liabilities, to the extent these liabilities vary erratically. The FASB proposal, as it stands now, can be expected to aggravate a pension crisis in the United Stales. Alvin Lurie in his article-'this Time Is the Sky Really Falling on Defined Benefit Plans? Has FASB Administered the Coup de Gra.ce?'" -quotes Senator Harty Reid of Nevada. Although Senator Reid is addressing statutory proposals, his conclusion extends equally to accounting proposals. "Minority Leader Reid put it very well: 'The conference agreement should strike a proper balance between improving pension funding and keeping these plans an attractive benefit option for employers. While there is a trend away from defined benefit pension plans and this trend is likely to continue, rules should not be enacted that exacerbate this problem.' I couldn't have said it better." 'ht!p:/lbenefitslink.com/aniclesl lurie.pdf