Funny Money: The Increasing Irrelevance of Pensions Earnings

Based on industry observation and analysis, Oliver Wyman Financial Services and Mercer have jointly produced a new report on defined benefit (DB) pensions, highlighting the inhibitive impact of short-term U.S. corporate pension "earnings" on effective longer term risk management.

The report describes how current U.S. pension accounting standards cloud true economics by including a "funny money" component in pension earnings, presenting a fundamental obstacle to CFOs in pursuing rational risk management. The report estimates that this earnings component amounts to approximately $18 BN, or 4% of reported earnings at S&P 500 companies.

Our view is that reported pension earnings are becoming increasingly irrelevant, as the underlying economics become more transparent. Proposed amendments to international accounting standards would remove the offending component of pension earnings by 2013, and the Securities and Exchange Commission has indicated that convergence in U.S. and International GAAP standards may occur sometime around 2015.

A growing number of U.S. corporates are already announcing an intention to reduce the impact of defined benefit pension volatility on their balance sheets. Evolving accounting standards will likely hasten the need for others to adopt similar approaches to better manage market perception of their plans, similar to a trend observable in Europe.
The new joint report also details that while there are many and complex factors to consider in devising a pension risk reduction strategy, options available to corporates have also expanded - ranging from dynamic asset allocation to insurer buy-out. In particular, current conditions in the life insurance sector have afforded new options to companies willing to enact a plan for pension risk reduction - which may in turn be able to create substantial shareholder value in the long-term.

Funny Money: The Increasing Irrelevance of Pensions Earnings