Blogging Employee Benefits

October 26, 2006

415 and 401(k) COLAs Revisited

Filed under: 401(k), Pensions — Fuguerre @ 2:27 pm

So we have the official word from the IRS on next year’s 415 limits, as previously noted here. But what if you wish to project an advance estimate of a future threshold, such as we did back here? When I forwarded inquiries about the innards of the little spreadsheet I’d been given over to my pet actuary, I was sent a copy of this IRS information letter from 1993.

For current thresholds that employ the same methodology as Code §415(d), one needs monthly CPI-U results for the applicable base period and for the year preceding the year for the limit, the original level for the threshold for the year following the base year, a rounding multiple comparable to the numbers given in 415(d)(4), and the particular calculation methodology used by the IRS (including a curious truncate-round two-step in the middle of the calculation).

Let’s walk it through several instructive examples from this year’s edition -

  • Limitation on Annual Addditions to Defined Contribution Plan, Code §415(d)(1)(C).
    1. Base period is 2001. CPI-U index numbers for July, August, and September 2001 were 177.5, 177.5, and 178.3 respectively. The sum of those three numbers is 533.3.
    2. For the 2007 threshold, we need the comparable CPI-U numbers from 2006, which for July, August, and September 2006 were 203.5, 203.9, then quite surprisingly dropping to 202.9. The sum of those three numbers is 610.3.
    3. The ratio of the second sum to the first sum is something like 1.14438024 (i.e., 610.3/533.3, here carrying that result out to enough places to continue), but then here comes the odd little truncate-round two-step: (a) The 1.14438024 result is truncated to 5 decimal places, giving us 1.14438; then (b) That intermediate result is rounded to 4 decimal places, yielding 1.1444.
    4. For the threshold being adjusted, the original level in 2002 was $40,000, which is now multiplied by the truncated-rounded factor of 1.1444, giving $45,776, which doesn’t then require rounding to the nearest dollar since it is already an integer number of dollars.
    5. The truncating multiple for this particular threshold is $1,000. We round down, rather than to the nearest multiple, so dropping $45,776 down to the next lower $1,000 gives us $45,000 for the 2007 limitation on annual additions to a defined contribution plan.

    That drop in this year’s CPI-U index from August to September dropped the result here from my original estimate of $46,000 to the ultimate actual ceiling of $46,000, serving as warning to anyone attempting to play actuary or economist with future inflation expectations.

  • Limitation on Elective Deferrals, Code §402(g)(1).
    1. Base period this time is 2005, since EGTRRA hard-wired the recent years’ ceiling increases. CPI-U index numbers for July, August, and September 2005 were 195.4, 196.4, and 198.8 respectively. The sum of those three numbers is 590.6.
    2. For the 2007 threshold, we use the comparable CPI-U numbers for 2006 as described for the DC annual addition ceiling, yielding the same sum of 610.3 for the July-August numbers.
    3. Since we have a different base period, the ratio of the second sum to the first sum is of course different, looking something like 1.033355909, which truncated to 5 decimal places becomes 1.03335, which rounded to 4 decimal places turns into 1.0334.
    4. For the elective deferral threshold, the starting level is this year’s $15,000, which is now multiplied by the truncated-rounded factor of 1.0334, giving $15,501, which doesn’t then require rounding to the nearest dollar since it is already an integer number of dollars.
    5. The truncating multiple for the elective deferral limit is $500. Rounding $15,501 down to next lower $500 gives us $15,500 for the 2007 limitation on elective deferrals.

    We just barely made that increase! A smidge more of a drop in September’s CPI-U (or comparably different numbers in others of the 6 quarters used for the indexing), and we might have remained at $15,000 for 2007, instead of jumping up to actual ceiling of $15,500, echoing the warning expressed earlier.

  • Limitation on 401(k) Catch-Up Contributions, Code §414(v)(2)(C).
    1. Base period for this is also 2005, so the first step here repeats what we did for elective deferrals.
    2. Ditto.
    3. Ditto.
    4. But here, the starting level is this year’s $5,000, which is then multiplied by the truncated-rounded factor of 1.0334, giving us $5,167, which again doesn’t then require rounding to the nearest dollar since it is already an integer number of dollars.
    5. Although in 2006 the catch-up deferral ceiling is at one-third the level of the elective deferral ceiling, the truncating multiple is the same: $500. Rounding $5,167 down to next lower $500 leaves us at $5,000 for the 2007 limitation on catch-up contributions, and will likely continue to do so for several more years.

    In this instance, although the same warning about future projections, as expressed for the previous two calculations, still does hold (particularly when the unrounded amount nears $5,500 several years from now), for 2007 we were rather safe in expecting that number to remain the same as for 2006.

Actually, there’s no official word that the IRS is still using exactly the same methodology (updated to use 3rd-quarter comparisons and to step up in terms of the rounding multiples, both of which were introduced after the 1993 IRS letter), or is there any particular guarantee that future methodology will remain the same. For all years since 1993, however, I’m told that this methodology has precisely reproduced all of the official figures published by the IRS, even when there were close calls such as this years $15,501. So unless and until anything more formal is published, this looks good enough for my needs.

(P.S. – In case I haven’t made it rather obvious by now, I absolutely adore what Cornell has done with its U.S. Code!! And as far as I can tell so far, all without making the blunder that some websites make of wrecking all of the links you had previously made to their material. Quite commendable.)

October 19, 2006

Pension Villain’s Elegy

Filed under: Pensions — Fuguerre @ 11:57 pm

The risk’s not worth the burden. Time to freeze.
But not to worry: we have a great 401(k)!
This cut will benefit our employees.

FAS 158 gives our balance sheet the squeeze
While our cash projections wobble from PPA.
The risk’s not worth the burden. Time to freeze.

Our workers need to be their own trustees.
Just educate them; they’ll learn to find their way.
So this cut will benefit our employees.

Our old plan’s tangled up in legalese.
The DB pension system’s seen its day.
The risk’s not worth the burden. Time to freeze.

Our competition’s boosted their DCs,
And what works for Wall Street’s good for the U.S.A.
This cut will benefit our employees.

We know you thought we promised more, but please,
Eventually as a hybrid plan we may.
The risk’s not worth the burden. Time to freeze,
And this cut will benefit our employees.

October 18, 2006

2007 Pension Thresholds

Filed under: Pensions — Fuguerre @ 8:35 am

With the BLS reporting the September 2006 CPI this morning, I can finalize my previous estimates of COLAs for key pension thresholds. These numbers remain unofficial, since of course only the IRS has the authority to publish the official numbers. But relying on the same rounding conventions used by the agency for prior years, the numbers I expect to see are as follows -

            2007   2006
    Limitation on Elective Deferrals   §402(g)(1)   $15,500   $15,000
    Limitation on Catchup Deferrals   §414(v)(2)(B)(i)   $5,000   $5,000
    Limitation on Benefits   §415(b)(1)(A)   $180,000   $175,000
    Compensation-Based Limitation Increase Factor   §415(b)(1)(B)   1.0334   1.0383
    Limitation on Annual Additions   §415(c)(1)(A)   $45,000   $44,000
    Limitation on Compensation   §401(a)(17), 404(l)   $225,000   $220,000
    Highly Compensated Employee Determination   §414(q)(1)(B)   $100,000   $100,000

For the elective deferral threshold, the numbers came in just barely over the line needed for the increase to $15,500, with the September CPI-U at 202.9. At 202.8, the limit would have remained level at $15,000.

October 14, 2006

FAS 158 Telegraphing Its Punch to Equity

Filed under: Accounting, OPEBs, Pensions — Fuguerre @ 10:20 am

If I were to run an office pool for the after-tax reduction in equity from implementation of FAS 158 for pensions and OPEBs of S&P500 companies, rounded to the nearest billion, what number would you be looking for? Mine would have three digits beginning with a 1, and I’m seriously mulling 9 for my second digit, although I might be convinced to go with an 8 if the markets keep pushing new records.

I’ve been reading with interest Merrill Lynch’s Market Impact of Pension Accounting Reform, which features an estimate of FAS 158’s projected hit to equity due to come this yearend for most U.S. sponsors of pension and other postretirement benefits. Intriguing is that whereas most other analysts who even ventured an estimate couched their appraisals in terms as though the new accounting standard had been implemented at the end of the 2005 fiscal year, Merrill projects forward to the end of the 2006 fiscal year, for most plan sponsors the point when the equity hit will actually land. Roughly capsualized, Merrill picks $217 billion as the after-tax reduction in equity for S&P500 companies. I think it likely that guess will turn out to have been too high.

Just the S&P 500: First, let’s get through the fog that has had some pointing to that estimate as the anticipated equity hit for all pension/OPEB sponsors. As best as I know, the only guess for the entire population of U.S. companies was extrapolated by the SEC in its mid-2005 Report and Recommendations Pursuant to Section 401(c) of the Sarbanes-Oxley Act of 2002 On Arrangements with Off-Balance Sheet Implications, Special Purpose Entities, and Transparency of Filings by Issuers: $414 billion off-balance sheet liability for pensions and $121 billion for OPEBs, adding up to $535 billion. As that was a pre-tax off-balance sheet number, using Merrill’s tax rate assumption of 35% would trim even that half-trillion number down to an after-tax equity hit of $348 billion. And then as the SEC extrapolations depended on data from 2004, a year earlier than the data gathered by Merrill, and since 2005 improved the forthcoming FAS 158 outlook for most companies, it’s not difficult to imagine that were the SEC’s extrapolations to mimic Merrill’s projection to the end of 2006, we might see a number for the expected after-tax equity hit for the entire universe in the neighborhood of $300 billion. Which would not be altogether inconsistent with Merrill’s $217 billion, as long as Merrill’s figure is properly reported as representing the S&P 500 set, versus all companies.

Pension Cost Projection. So far, the part of Merrill’s report I find the least credible is its projection of net periodic costs during the 2006 fiscal year. For Boeing, which they use to illustrate their methodology, they project a net periodic pension cost of $608 million and a net periodic OPEB cost of $602 million for fiscal year 2006. That OPEB estimate might not actually be all that distant, but Boeing’s second quarterly report for the 2006 fiscal year shows net periodic pension cost for the first 6 months of 2006 ringing in at $529 million, on course to top $1 billion for the full year. That as compared with a 2005 net periodic pension cost for Boeing of $751 million (with the $552 of “Other” cost cited by the Merrill report constituting FAS 88 recognition). And although Boeing’s increase in net periodic pension cost of over 33% from 2005 to 2006 will be near the top of the list of cost increases, anticipate the median for S&P 500 pension sponsors to be in the same direction: conversely to the very much criticized early 2000s, when net periodic pension credits continued to be reported by many pension sponsors despite the onset of the perfect storm of market crashes and interest rate declines, 2006 will be a year when pension costs increase for the majority of companies, despite favorable markets and rising interest rates. (One wonders if we’ll now see the same criticism coming back in the other direction, arguing that corporate profits ought be higher for 2006 because pension costs are presumably being “overstated.”) Anyway, if Merrill’s estimate for Boeing’s pension cost serves fair indication for the entire study set, I think we can almost dismiss that part of the methodology. I’m not yet sure how their number went so far astray, and am engaged in checking with several close actuarial and accounting colleagues to get their take on the matter: even without poring through interim financial reports, these projections ought not be so significantly off target, else one starts to seriously wonder whether the remainder of the projection methodology has any similar disabling deficiencies.

OK, but if Merrill’s pension cost projection is similarly understated for the entire S&P 500, what does that do to their $217 billion result? Actually, less than one might think. Material underestimation of net periodic pension cost might mean we should increase Merrill’s projection of a $397 balance sheet liability, yes. But much in the same way that, as Merrill points out, employer contributions do nothing to the hit to shareholder equity arising from FAS 158 implementation, likewise that hit is relatively immune to 2006 cost. The only cost components that matter, actually, are the amortization pieces, since they will affect the amount of unrecognized balances that are the basis for the equity hit. So back to comparing Merrill’s Boeing with Boeing’s 10-Q: Merrill projects amortization cost components of $823 million for 2006, while annualizing the second quarter report suggests the actual number will be $1.1 billion. Still a significant difference between projection methodology and reality, but less than for the full pension cost, and particularly less in the context of the understatement relative to the full balance of unrecognized amounts. And interestingly, of the opposite effect as with the overall cost understatement. So here’s another one for those who actually believe that we’ve made pension accounting more understandable: although by underestimating net periodic pension cost, Merrill may have underestimated the projected balance sheet liability, underestimating the amount of reduction in unrecognized balances means that they overestimated the expected hit to shareholder equity, at least with respect to that piece of the puzzle.

Ignoring the Freeze. Merrill’s recent reports have done as much if not more than any other research to track and analyze the pension ice age, and this report continues that commendable effort. Yet despite the intricate complexity of the rest of its projection methodology, Merrill stopped short of incorporating known pension freezes into its estimate of the FAS 158 hit, stating that, “For these companies, a figure closer to their ABO is likely more accurate; appropriate adjustments should be made for these specific situations as the charge to equity will not be as severe.” Yes, to put it rather mildly so. In practice, although the decrease from PBO to ABO can be significant enough to add up to some billions for the pension ice cubes out there, for some cases the effect on our hit to equity can actually exceed that PBO-ABO number, since there we’re looking at an immediate acceleration of recognition of significant accumulated net losses. Which under FAS 88 sends the effect of the freeze through the company’s P&L, but then accordingly removes that effect from FAS 158’s equity hit. In other words, as Merrill implicitly acknowledges but without fully completing the thought, some of that $217 billion number represents amounts that will have already been recognized in 2006 net income.

FAS Implementation Date or FYE 2006? As near as I can make out, Merrill is updating data from fiscal years ending in 2005 to the end of the 2006 fiscal year. For employers with calendar fiscal years, that does in fact bring us to the FAS 158 effective date. But for almost all others (other than the very rare employer with fiscal year ending from 9/29 through 12/15 who could delay implementation until the year ending in 2007, but instead elects early adoption), the projection leaves us a year short of actual FAS 158 adoption. And for almost every one of those employers, we’re leaving out a good year, one when the much-discussed new volatility inherent in FAS 158 goes in the employer’s favor, significantly cutting into the eventual hit to shareholder’s equity. OK, the overwhelming majority of the S&P 500 have a calendar fiscal year, but characterizing FYE 2006 numbers as projected FAS 158 numbers still overstates what the aggregate hit to equity will eventually be at actual FAS 158 implementation by at least several billions.

Is Merrill Warning of a Q4 Bear? Assets during 2006 projected using a 5% rate of return?! Not only have we already seen a median pension asset return exceeding 10% for the S&P 500 companies with non-calendar fiscal years (such as those ending 6/30/2006) that have already released their 2006 annual financial statements, but these past several months have been more than kind to pension funds. OK, sure, reports such as this one do not constitute any formal Merrill prediction of future markets; and granted, a firm in Merrill’s position probably does better to err on the conservative side rather than risk raising false hopes. Even so, we’re close if not well beyond the point at which in order for Merrill’s 5% to be anywhere near reasonable for the full year, they essentially had to be factoring in a very major bear market for the final quarter of 2006. Interestingly, their assumption on the liability side of the equation of a 25-basis-point increase in discount rates might not be so far off the mark: although 2005-to-2006 rates roller coastered for companies with mid-year financial yearends so that some increased discount rates by 100 basis points and more, we’re already back down to levels where Merrill’s view of interest rates makes sense. But that investment return assumption! Sorry, but I don’t buy that one.

All of Which Drops My Own Guess Below $200 Billion. I see enough right in the background data and in the rest of Merrill’s work that says if I can start with their $217 billion, then shave off some of the unrecognized balance for underestimated cost amortizations, drop some more unrecognized balance for 2006 freezes, put everything in terms of FAS 158 implementation in lieu of FYE 2006, and be a little more relaxed with my investment return expectations, I’m going to be pretty solidly below $200 billion if I go into my hypothetical office pool. For the S&P 500. (And completing the loop back to the SEC’s estimate, I’d see that as consistent with about a quarter trillion after-tax hit to equity for the entire universe at the point of FAS 158 implementation.) Just one blogger’s guess, though.

October 12, 2006

Embroidering on Early FAS 158 Boilerplate

Filed under: Accounting, OPEBs, Pensions — Fuguerre @ 10:34 pm

In September 2006, the FASB issued SFAS No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans – an amendment of FASB Statements No. 87, 88, 106 and 132(R)” (SFAS No. 158”). SFAS No. 158 requires an employer that sponsors one or more single-employer defined benefit plans to (a) recognize the overfunded or underfunded status of a benefit plan in its statement of financial position, (b) recognize as a component of other comprehensive income, net of tax, the gains or losses and prior service costs or credits that arise during the period but are not recognized as components of net periodic benefit cost pursuant to SFAS No. 87, “Employers’ Accounting for Pensions”, or SFAS No. 106, “Employers’ Accounting for Postretirement Benefits Other Than Pensions”, (c) measure defined benefit plan assets and obligations as of the date of the employer’s fiscal year-end, and (d) disclose in the notes to financial statements additional information about certain effects on net periodic benefit cost for the next fiscal year that arise from delayed recognition of the gains or losses, prior service costs or credits, and transition asset or obligation. SFAS No. 158 is effective for the Company’s fiscal year ending February 22, 2007. The Company is in the process of evaluating SFAS No. 158.

So reads an excerpt from New Albertson’s recently filed 10-Q filing for the quarterly period ended August 31, 2006. Almost verbatim is an excerpt from the recent quarterly statement filed by Levi Strauss, and close variants or simplified versions appear in the 10-Qs of OMNOVA Solutions, Apogee Enterprises, Circuit City, Sealy, Bed Bath & Beyond, Constellation Brands, RPM International, A.G. Edwards, Herman Miller, The Mosaic Company, U.S. Cellular, Telephone and Data Systems, and Chattem, to point out but a few of the statements filed since the September 29 publication of the new accounting standard.

Stretching slightly farther is Lehman Brothers, whose 10-Q supplements the boilerplate norm with the most basic financial conclusion of a retrospective calculation that FAS 158 itself neither requires nor permits, but which can nonetheless provide some indication of potential effect, provided one factors in the rise in interest rates and the gains in the equity markets since the prior yearend -

Based on information available at November 30, 2005, we would have reduced Accumulated other comprehensive income (net of tax) by approximately $300 million. The actual impact of adopting SFAS 158 will be dependent upon the then current fair value of plan assets and the amount of projected benefit obligation measured as of the adoption date.

But so far, Hartmarx takes the first 10-Q batch’s award for the best FAS 158 commentary, managing in its brief summary not only to provide an estimate of financial effect more recent than the 2005 yearend, but also to assure investors that debt covenants will remain unaffected, as well as to point to the distinct possibility that the company could decide to be a FAS 158 early adopter. A great model, a standard other employers should reach for in making their own statements during this brief period prior to the effective date of the new rules -

In September 2006, FASB issued Statement of Financial Accounting Standards No. 158, “Employer’s Accounting for Defined Benefit Pension and Other Postretirement Plans – an Amendment of FASB Statements No. 87, 88, 106 and 132(R) (“SFAS 158″). SFAS 158 requires an employer that is a business entity and sponsors one or more single employer benefit plans to (1) recognize the funded status of the benefit in its statement of financial position, (2) recognize as a component of other comprehensive income, net of tax, the gains or losses and prior service costs or credits that arise during the period but are not recognized as components of net periodic benefit cost, (3) measure defined benefit plan assets and obligations as of the date of the employer’s fiscal year end statement of financial position and (4) disclose in the notes to financial statements additional information about certain effects on net periodic benefit cost for the next fiscal year that arise from delayed recognition of the gains or losses, prior service costs on credits, and transition asset or obligations. SFAS 158 is effective no later than the end of the Company’s fiscal year ended November 30, 2007. Since SFAS 158 was recently issued, management has not yet determined whether SFAS 158 will be adopted early in its statement of financial position as of November 30, 2006 or if SFAS 158 will be adopted in its statement of financial position as of November 30, 2007. If SFAS 158 had been effective as of August 31, 2006, total assets would have been approximately $18 million lower, total liabilities would have been approximately $9 million higher and shareholders’ equity would have been approximately $27 million lower. Because our net pension liabilities are dependent upon future events and circumstances, the impact at the time of adoption of SFAS 158 may differ from these amounts. Adoption of SFAS 158 will not have any effect on the Company’s compliance with its debt covenants.

October 10, 2006

Which Way the Pension Fund’s Equity Benchmark?

Filed under: Investment, Pensions — Fuguerre @ 6:56 am

The UK’s Pension Protection Fund, which covers insolvent UK pension funds, has published a Statement of Investment Principles that includes a 20% benchmark for equity investment. PPF’s restriction of equity investment echoes that of the PBGC during recent years, reflecting the goal of minimizing mismatch between assets and liabilities for the fixed annuities under trusteed pension plans.

Should on-going pension plans sponsored by companies, governmental employers, and other sponsors follow the pension insurers’ lead? The Administration, which has characterized currently prevalent pension fund investment policies as “hazardous,” presumably hopes so, although one supposes the hope is that such hazardous investments would then be bought up by individual retirement account holders enlightened by new investment education/marketing programs freed from fiduciary liability claims.

September 29, 2006

FAS 158: Pensions and Other Postretirement Benefits

Filed under: Accounting, OPEBs, Pensions — Fuguerre @ 10:29 am

The Financial Accounting Standards Board has published Statement of Financial Accounting Standards No. 158, Employers’ Accounting for Defined Benefit Pension Plans and Other Postretirement Plans, requiring sponsors to recognize the funded status of their retirement programs on the company’s statement of financial position. [News Release] For pension plans, the funded status is determined as the excess or deficit of the market value of plan assets over the projected benefit obligation. For other postretirement benefit plans, such as retiree health benefit plans or life insurance for retirees, the funded status is determined as the excess or deficit of the market value of any plan assets over the accumulated postretirement benefit obligation.

Plan assets and obligations must be measured as of the employer’s fiscal year-end statement of financial position.

An employer with publicly traded securities must apply the new reporting requirements and related new footnote disclosure rules for fiscal years ending after December 15, 2006. The new measurement date requirement applies for fiscal years ending after December 15, 2008.

Older Posts »

The WordPress Classic Theme. Create a free website or blog at WordPress.com.

Follow

Get every new post delivered to your Inbox.