Back to Basics - DB 101

[2muchstress]

Sorry for such a remedial question, but could somebody please take the time to explain the differences between the NPPC as calculated under FAS 87 and the pension expense calculated under ERISA?

Thanks in advance for any clarification.

[david rigby]

Terminology is important. "Expense" usually refers to the charge a plan sponsor makes on its financial records for the year. This is separate from the cash contribution made to the plan's trust fund.

The latter is bounded by the minimum required, as determined primarily under Internal Revene Code Section 412, and the maximum deductible amount, as determined under IRC section 404. (That is, ERISA and the tax laws are concerned with cash contributions, particularly minimums and maximums, not with what shows up on the company books.)

The expense (NPPC) is determined under SFAS No. 87, and is (generally) not concerned with the actual cash contribution.

The explanation can go on for hours (days). If you have more specific questions, please post.

[2muchstress]

Thanks Pax,

I guess I should have been a little more careful to not confuse expense and contribution. My real question is about the differences between how the two are calculated.

Specifically (and I may be wrong) - It is my understanding that the ERISA contribution is calculated based on the plan's funding formula which may or may not include using a "smoothed" value of plan assets, i.e. earnings spread out over a 5-year period.

The FAS 87 expense does not use this type of smoothing.

I don't know if what I just said is factually correct or not so I'm hoping someone can enlighten me.

Also, what other differences are factored into the calculations.

Thanks again.

[SoCalActuary]

FAS has a specific funding method (pro-rata unit credit), and a unique amortization of past service liabilities that do not match the funding rules under IRC 412 or 404.

FAS allows projection of 415 benefit limits, 401(a)(17) pay limits and other items that are not used in 412 or 404.

FAS explicitly counts assets based on the actual time separated from the employer's control, while 412 & 404 have provision for receivables. Asset smoothing is not used in FAS calculations.

FAS has extra requirements for underfunded plans that are not related to the extra funding applied to larger plans under 412.

FAS requires recognition when benefit settlements are made before they were assumed to occur, treating the gain or loss immediately.

Both are based on the plan formulas, although FAS may require recognition of benefits that are scheduled to occur in the future but not already in effect.

There's more, but these are the major points.

[david rigby]

Actually, it is possible to have a smoothed asset value in the determination of the FAS expense. Called "market-related value."

However, it is not the norm, nor is it likely that an auditor will approve changing from market value to market-related value. For funding processes, the decision to use an asset smoothing technique is between the actuary and the plan sponsor, not the auditor.

[AndyH]

I'll give this a shot.

ERISA permits numerous funding methods, assumptions, and techniques for purposes of determining cash contribution requirements.

This caused one company's financial statement pension disclosures to be difficult to compare to another because the methodologies might be apples versus oranges. It could also be difficult to determine for solvency/lending purposes if a plan was well funded or if in fact a sponsor had a huge debt.

FAS#87 was a way of standardizing such reporting so as to allow comparisons, and to theoretically allow someone to determine whether or not a plan sponsor had a huge debt related to the pension plan.

Since the FASB was not in a position to alter ERISA, it required a second computation using a more rigid and standard method and assumption set.

[mwyatt]

Ah, but for you M&A vultures out there, remember ABO isn't a true measure of a plan's termination liability (had a college friend who went to work for Shearson Lehman in the late 80s, and had to point out this fact to him before they went on of those fabled acquisitions - obviously pre 50% excise tax on reversions).

[2muchstress]

Thanks to all who replied - this was very helpful to me.

[MGB]

The AAA Pension Practice Council recently posted a discussion of the differences:

http://www.actuary.org/pdf/pension/fundamentals_0204.pdf

Since this was posted, I did a lot of wordsmithing of it. A newer version should be posted soon.