(November 20, 2013) — Changes to mark-to-market valuations of defined benefit pension plans’ liabilities have a negligible impact on corporate finances, despite sponsors’ concerns, according to SEI research.
These new accounting practices—valuing assets on their current market prices—get rid of “smoothing methods” that aimed to decrease year-to-year volatility. Pensions must recognize gains or losses into their balance sheets as they occur, which allows for more transparent and accurate view of plans’ funding statuses. In theory, this change rendered corporate finances more vulnerable to pension funding volatility and thus negative earnings, the report found.
However, SEI's study of 23 major US companies that implemented mark-to-market accounting over the past two years found the shift had minimal impact on the functions of investors, analysts, internal management, and ratings agencies.
The report concluded that with “no cash implications,” investors also had little to no response to the change—share prices remained untouched.
The report also said that financial analysts had already been applied mark-to-market accounting to more accurately compare performance between companies. Earnings calls were also largely absent of direct concerns and criticisms of the change from generally accepted accounting principles (GAAP) to mark-to-market.
“In many analyst reports, the mark-to-market adjustment is out of annual earnings forecasts, for comparison purposes to historical results,” the report said.
Corporate management even enjoyed the methodology change, SEI said. It relished removing drags on earnings, reaping in better earnings per share as it avoided impact from past poor performance.
The study also revealed that ratings agencies such as S&P, Moody’s, and Fitch had already been using mark-to-market accounting—unwinding the GAAP accounting treatment. Even still, "pension-related factors" have a limited effect on credit ratings, SEI found.
“While significant changes to the funded status may limit upgrades, it would be unusual that this would lead directly to a downgrade on its own,” the report said.
This observation, however, might not apply to US public pensions.
In April, Moody’s decided to overhaul its valuation methodology for public plans, employing mark-to-market accounting to determine their liabilities—holding them to a higher standard. The result? A much lower average discount rate—5.5% from the industry average of 7% to 8%— and significantly larger total liabilities than those reported using GAAP.
These new calculations revealed some US public pensions are serious underfunded than previously thought, which impacted credit ratings. Illinois was recently downgraded by Moody’s—to A3 from A2—for its $100 billion pension debt crisis.
“I think the impact of Moody’s methodology change is really important to understand,” Dave Wilson, managing director and head of the customized strategies group at Cutwater Asset Management, told aiCIO last month. “Their ratings have a big impact on municipal financing levels, and they will punish you if your pension plan is too underfunded.”
Six state pensions, including Illinois, have already suffered a downgrade.
Thomas Harvey, SEI’s director of advice, maintains the change to mark-to-market may better service pension plans: “Plan sponsors that might have previously been hesitant about such a change should potentially re-evaluate their pension accounting options.”
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