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The AAO Weblog covers accounting issues and current events as they relate the practice of investment analysis.

 
 
Aug 24

Written by: Jack Ciesielski
8/24/2006 6:40 AM 

Auto parts manufacturer Tenneco announced yesterday that it is "freezing" its three defined benefit pension plans (including one supplemental plan for executive officers), effective January 1, 2007. By freezing the plans, employees will accrue no more benefits under the plans; their existing benefits are preserved but they earn no new future credits. This is a similar move to the IBM change announced in January, one that was expected to kick off many copycat moves. There have been a number of them, and probably the most notable was General Motors. It's not a bad idea, and there'll probably be many more in the near future. More on that later; back to the Tenneco freeze.

It's not all a one-way street: Tenneco will be replacing the benefits that the employees lose with increased benefits in their existing defined contribution plans. No telling from if the employees get shafted, though I'm sure that someone will always run the numbers on these plan benefit swaps to show that they will. And the companies will always run them to show that they don't. It's one of those numerical exercises where you're comparing a fixed amount (the defined benefit plan give-ups) against a variable amount (the defined contribution give-back), so your assumptions in figuring the amount to be received in the give-back are critical. And whoever's running the numbers will introduce their own biases.

That's not the point here; sorry to stray. The point is that this move, as we all know, takes the investment risk off the employer and puts it onto the employee. That's not terribly new at this point; I think it's safe to say that most U.S. employees have become familiar with their 401K plans over the last 25 years, and especially in the last five (since Enron made them more conscious of what can happen to their retirement savings). And we also know that defined benefit plans, by their nature, are volatile creatures. The accounting for benefit plans has many awkward devices that are designed to reduce that volatility, while introducing lots of non-economic information into the financials. As FASB enters Stage 2 of its pension overhaul project, some of those volatility-flatteners may be headed for extinction. In the meantime, the newly-signed Pension Protection Act of 2006 will increase the funding requirements for defined benefit plans - adding another dimension of discomfort for sponsors. Expect then, that the Big Freeze to become much more common in the last quarter of 2006 as companies prepare to comply with the FASB "Phase 1" plan for moving pension and OPEB obligations directly onto the balance sheet. (Sidenote: Tenneco also replaced a couple of health care plans with one lower-cost plan).

The saying goes, "you manage what you measure." Firms will be measuring pensions and other postemployment benefits much more precisely now that the amounts will become visible to investors - and taking steps to minimize growth in the obligations. Freezing defined benefit plans is one way to get there, and there's every reason to expect more of these actions in the months ahead. Maybe the fourth quarter of 2006 is going to be the start of a new Ice Age for defined benefit plans...

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