Underfunded pension plans now mean more company liability.

• Author: Levit, Alan D.

Underfunded pension plans now mean more company liability

Pension expense for overfunded plans has generally been lower under the Financial Accounting Standards Board's (FASB) Statement 87 than under previous pension accounting rules. However, it has often been higher for underfunded plans, including most collectively bargained plans and supplemental executive retirement plans (SERPs).

Sponsors of underfunded pension plans have yet to feel the full impact of Statement 87, however, due to a dealy in the effective date of one of its harshest requirements. Beginning in 1989, Statement 87 is requiring companies with plans in which the accumulated benefit obligation (ABO) exceeds the sum of pension assets and unfunded accrued pension cost to show additional balance sheet liabilities to account for the deficit. What will be the impact of this new rule on net worth and the ratio of debt to stockholders' equity? And how can companies minimize the negative impact on their balance sheets?

In the past, a company had to include a liability on its balance sheet for any pension costs that were expensed but not funded. (An asset was shown if pension contributions exceeded expensed amounts.) FASB Statement 87 does not change this practice, but it specifies that a company must also report an "additional minimum liability" equal to the difference between the ABO plus the sum of unfunded accrued pension cost and the assets specifically set aside to provide for those benefits. The ABO is the current liability for pension benefits that have already been earned. Thus, a company with a pension plan that is underfunded for accrued benefits may have to report an additional minimum liability.

Some foreseeable problems

Statement 87 strictly defines which assets qualify to offset a company's obligation to pay benefits. Therefore, a company may have an additional minimum liability even though its benefit obligations seem well secured. Assets do not qualify as such under Statement 87 unless they have been specifically segregated and pledged to pay pension plan benefits, usually in a qualified pension trust, even if they were purchased with the intent of funding benefits. For instance, life insurance purchased in connection with SERPs falls into this "intended but not segregated" category. The cash value of the life insurance may be reported as a general asset of the company, but it may not be used as an offset to the obligation to pay SERP benefits.

Assume XYZ Company establishes a new pension plan with a first-year Statement 87 expense of $1,500. The employer's contribution is $1,000. Thus, there is a balance sheet...