SEC Offers View on Pension Measurement Considerations

Staff of the Securities and Exchange Commission have indicated they are open to the new approaches some companies are considering to revise their approach to certain pension accounting assumptions, especially the discount rate used to compute interest costs on pension plan obligations, but they also caution companies to observe all the provisions of accounting rules.

The SEC recently consulted with companies and accounting firms on two different approaches, a single weighted-average approach and a disaggregated or ‘spot rate’ approach. “After considering their specific facts and circumstances, we have viewed these revisions to be enhancements to their computations,” said Ashley Wright, professional accounting fellow with the Office of the Chief Accountant at the SEC, in a recent speech at a national accounting conference.

Under the single weighted-average approach, which is permitted under current accounting guidance and applied commonly in practice, companies use a single weighted-average rate as of the pension plan measurement date based on the projected future benefit payments used in developing the pension benefit obligation, Wright said. That single discount rate would represent the constant annual rate that would be required to discount all future benefit payments related to past service from the date of expected future payment to the measurement date.

By contrast, the spot-rate approach would use individual, duration-specific spot rates or discount rates from the yield curve that was used in the most recent measurement period of the pension obligation when calculated for purposes of the interest cost component of the net periodic benefit cost, said Wright. The use of individual or disaggregated discount rates leads to a different amount of interest costs, but both approaches use source data about market interest yields taken from the measurement of the pension benefit obligation to arrive at the discount rate, she said.

“In a recent consultation, OCA did not object to a registrant changing from the use of the single-weighted average approach to the spot rate approach,” said Wright. “In addition, OCA did not object to the registrant accounting for the change as either a change in estimate or as a change in estimate inseparable from a change in accounting principle.”

Wright says some registrations are using a hypothetical bond matching methodology, based on a bond portfolio expected to generate cash flows similar to the estimated benefit payments of the pension plan, and some are pondering whether they could change to a yield curve methodology since a spot rate approach can be generated directly from the yield curve model. Here’s where Wright started offering caution.

Under accounting rules, “the measurement of the pension obligation is the relevant starting point,” she said. “A company should evaluate the basis for its current selection of the market information.” A method change is only warranted to the extent it would produce better information to measure the obligation, she said.

Ken Stoler, a partner at PwC, says the question of changing the method of setting assumptions has been a “hot topic” in pension accounting. “We are definitely seeing a lot of interest,” he said. “Many companies have been educating themselves over the last few months on what this is about and deciding whether they want to make this change.”

In an alert to clients, PwC points out that accounting rules say a company may change its approach for determining discount rates, but only if there is a change in facts and circumstances from the prior period and only if it results in a better estimate of the rates at which the obligation could be settled.

“A spot rate yield curve is typically developed from many more bonds than exist in a bond matching bond portfolio,” PwC points out. “So it could be challenging to conclude that changing from a bond matching approach to a yield curve approach would result in a better and more refined estimate of the settlement rate.” In addition, the firm points out, many companies that utilize the bond matching approach changed to that approach from a yield curve or other technique in the recent past, often asserting that the bond-matching approach produced a better estimate of settlement rates.

Companies that would change their approach would do so at year-end, Stoler explained.