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					    National Association of
Regulatory Utility Commissioners

  Employers’ Accounting for Pensions
          Discussion Guide
         September 15, 2003
                          Table of Contents

   FAS 87                                    FAS 88
                                                — Settlements
     – Overview
                                                — Curtailments
     – Attribution
                                                — Termination Benefits
     – Obligations
     – Components    of Net Periodic          Actuarial Assumptions
       Pension Cost
     – Balance Sheet Considerations           Other Retirement-Type     Benefit

                                              ERISA Funding of Pension Plans

                      FAS 87 Overview

   Requires single (actuarial) cost method
   Provides guidance on selection of assumptions
   Requires amortization of experience gains and losses in excess of a
    prescribed minimum
   Limits methods and time periods for amortization of plan amendments
   Requires transition amount computation and amortization
   Requires balance sheet reflection of additional minimum liability in
    certain under-funded situations
   FAS 132 supersedes FAS 87 for year-end disclosure requirements
   Applies to all pension-type arrangements; either qualified or non-
    qualified plans

                        FAS 87 Attribution

   Requires “Projected Unit Credit” method

   FAS 87 attribution follows plan formula

                               Benefit Obligations
   FAS 87 requires computation of:
      – Accumulated benefit obligation (ABO)
      – Projected benefit obligation (PBO)

   FAS 132 amended FAS 87 effective December 15, 1997 to expand year-end
    disclosure requirement
       - FASB currently considering further modifications to disclosure requirements.

        Components of Net Periodic Pension Cost
 Typically referred to as “pension expense”
 Pension expense equals:

    –   Service cost
    –   plus, Interest cost
    –   less, Expected return on plan assets
    –   plus, Amortization of:
          – Transition obligation
          – Prior service cost
          – Gain or loss
    –   plus any charges (or credits) for settlements, curtailments or
        special termination benefits

   Components of Net Periodic Pension Cost
• Impact on certain components due to recent economic changes.
Component                        Recent trend             Cause

Service Cost                     Increase significantly   Lower discount rates,
                                                          employee demographics

Interest Cost                    Increase                 Employer demographics

Expected return on plan assets   Decrease significantly   Large asset losses, lower
                                                          future return expectations

Actuarial loss amortization      Increase significantly   Large asset losses and
                                                          falling discount rates

 • All of the above have resulted in significant increases in
 pension expense.
                           Service Cost
   Actuarial present value of benefits attributed to services
    rendered during the year

   Comparable to normal cost used for funding purposes

                         Interest Cost
 Interest on obligation to reflect the fact that benefits are one
year closer to being paid.

                 Expected Return on Plan Assets

 Asset return based on beginning of year amount adjusted for
  contributions and benefit payments during the year
 Employers have choice of using market value of assets or an

  approach that smoothes asset-related gains/losses over period not
  to exceed five years
     –   A change to such a smoothing method is considered a change in
         accounting method
   Qualified plans typically have plan assets, while non-qualified
    plans do not

                  Transition Obligation / (Asset)

   Initial unfunded liability, net of any accrued pension liability (or
    prepaid pension asset) at adoption of FAS 87

   Recognized over time
     –   Under FAS 87, over expected future lifetime

                            Prior Service Cost

 Prior Service cost arises when plan is amended such that the
  PBO changes
 Amortization period

     –   May use straight-line amortization over expected future working
         lifetime (FWL) of employees expected to receive benefits
     –   Faster recognition may be necessary if there is a history of regular plan
         amendments (union negotiations)
   Negative plan amendments
     –   First offset against any positive prior service cost
     –   Amortize remainder, if any

                     Actuarial Gains and Losses

   Gains and losses arise from experience different than expected
    results, assuming all actuarial assumptions are met
     –   Liability higher than assumed is a loss
     –   Assets higher than assumed is a gain
     –   Assumption changes (such as discount rate) can create gains or losses
 Accounting rules do not require immediate recognition, but a
  delayed, amortized approach
 Corridor method

     –   Prescribed minimum -- 10% of greater of PBO or the smoothed value of
         plan assets
     –   Straight-line amortization over FWL for excess outside corridor

                      Miscellaneous Other Rules

   Measurement date
     –   May be no more than three months prior to the date of the financial
   Employers with two or more plans
     –   Pension expense, liabilities and assets are determined separately
     –   Calculation of additional minimum liability is determined
     –   Disclosures may be aggregated
   Acquisitions
     –   The difference between PBO and assets is the opening balance
         sheet position under purchase accounting

                        Balance Sheet Considerations

   Accrued pension liability (or prepaid pension asset)
      –   Based on employer's cumulative contributions compared to cumulative FAS 87
      –   Can be arrived at in non-actuarial way by increasing the prior year liability by
          pension expense and decreasing by contributions, see below

                   (in $ thousands)
                   (1) Prepaid (Accrued) Pension Cost        $    (800)
                       at 12/31/2001
                   (2) Fiscal 2002 pension expense                  50
                   (3) Fiscal 2002 contributions                    20
                   (4) Prepaid (Accrued) Pension Cost             (830)
                       at 12/31/2002: (1)-(2)+(3)

                        Balance Sheet Considerations

   Additional minimum liability (AML) is required for plans with un-funded
    ABO that exceeds the accrued pension liability at year end
      –   First, determine un-funded ABO. If none, then no AML
      –   Then compare to accrued pension liability. If un-funded ABO is less, then no
          AML. If un-funded ABO is greater, then AML is the amount necessary to
          increase the accrued pension liability to the un-funded ABO
      –   If un-funded ABO exists and there is a prepaid asset, then AML is the amount
          necessary to reverse the prepaid asset to create an accrued pension liability equal
          to the un-funded ABO
      –   The AML can be offset by an intangible asset up to amount of any un-recognized
          prior service cost and transition obligation
      –   Excess charged to other comprehensive income
      –   Contribution strategies can help to avoid, but sometimes difficult because it is a
          moving target

Example of Minimum Liability Calculation
     (in $ thousands)
     (1) ABO at 12/31/2002                                   $ 6,000
     (2) Assets at 12/31/2002                                  4,000
     (3) Unfunded ABO: (1)-(2)                                 2,000
     (4) Prepaid (accrued) pension liability at 12/31/2002    (1,250)
     (5) Additional minimum liability: (3)+(4)                   750
     (6) Sum of unrecognized prior service cost and               25
         transition obligation

     Amounts recognized in the statement of financial
     position as of 12/31/2002
            - Accrued pension cost                           (1,250)
            - Additional minimum liability                     (750)
            - Prepaid pension cost                                0
            - Intangible asset                                   25
         Accumulated other comprehensive income                 725
         Total amount recognized                              1,250

                             FAS 88 Settlement

   A transaction that:
     –   Is an irrevocable action
     –   Relieves the employer (or the plan) of primary responsibility for the
         pension benefit obligation
     –   Eliminates significant risks related to the obligation
         and the assets used to effect the settlement
   Typical examples of a settlement:
     –   Lump sum payments
     –   Annuity purchases
   If the total value of lump sums (or annuity purchases) exceed
    the sum of the interest cost and service cost, settlement
    accounting is required

                       Accounting for Settlements
   Calculations of settlement gain or loss required immediate
    recognition of a percentage of:
     –   Prior un-recognized net gain or loss
     –   Gain or loss first measured at settlement
     –   Un-recognized transition asset (not un-recognized transition obligation)
   If, for example, 10% of the PBO is settled, then 10% of the
    above items are recognized

                          FAS 88 Curtailment

   A curtailment is an event which:
     –   Significantly reduces expected years of future service of present
         employees or,
     –   Eliminates accrual of benefits for a significant number of employees

   Typical examples include:
     –   Closing of a division
     –   Discontinuing a segment of business
     –   Freezing benefit accruals in a pension plan
     –   Possibly, Early Retirement Windows - depending on number of people
         accepting the window

                   Accounting for Curtailments

   Accounting for curtailments:
     –   Recognize change in benefit obligation
     –   Potentially recognize some of the unrecognized amounts (prior service
         cost, transition obligation and gain/loss)

                     Special Termination Benefits

   Special or additional benefits provided during limited period
     –   The extra benefits provided under an early retirement window
         whether provided in or outside of the plan

   Contractual termination benefits
     –   Specific event (e.g., plant closing)

   Termination benefits may also involve curtailment (and/or

   Recognize value of extra benefits

                        Actuarial Assumptions

   Actuarial assumptions should individually represent a best
    estimate of future experience

   Key assumptions include:
     –   Discount rate
     –   Expected return on assets
     –   Salary scale
     –   Retirement rates
     –   Employee turnover

                              Discount Rate

   Interest rate used to discount future benefit payments
     –   Interest rate at which company can effectively settle obligations
     –   Reconsidered at each measurement date
     –   Typically companies look to high-quality bond rates as benchmarks
     –   Plans that pay large lump sums should theoretically incorporate lump
         sum rates
     –   The lower the discount rate, the higher the obligations

   Sample of benchmark over last 4 years (Moody’s Aa)
     –   12/31/99          7.90%
     –   12/31/00          7.41%
     –   12/31/01          7.10%
     –   12/31/02          6.52%
                              Discount Rate

   Approximate effect of 1% decrease in discount rate
     –   15% increase in PBO
     –   20% increase in service cost
     –   Negligible effect on interest cost
     –   Gain/loss amortization can be effected, but varies on a case by case

              Expected Return on Assets

 Theoretically, a long-term assumption based on investment
  policy and future expectations
 Most plans have assumptions of 8.00% to 9.50%

 A lower expected return assumption directly impacts pension


                               Salary Scale
   Typically a long-term assumption consisting of three
     –   Merit increases
     –   Promotion increases
     –   Inflation increases
   Because of inflation component to assumption, some
    companies adjust salary scale each year in the FAS 87 valuation
    to reflect current economic environment

         Other Retirement-Type Benefit Accounting

   FAS 106, Post-retirement medical/life/dental
     –   Expense is accrued over active employee’s lifetime until fully eligible
         for benefit

   FAS 112, Post-employment, pre-retirement benefits
     –   Includes severance, disability, and death benefits, among others
     –   Benefits that can vary with service are typically accrued over working
         career, while others are accrued at date of event

       ERISA Funding of Pension Plans

• ERISA funding of pension plans is based on a different set of
  actuarial methods and assumptions than accounting.

• However, the same causes of increases in FAS 87 expense result in
  increases in ERISA funding.

• ERISA funding also has similar delay mechanisms as accounting.

• Therefore, cash contributions are expected to increase, however
  timing and impact may differ.

      Regulatory Accounting Implications

• Application of FAS 71 will determine ability to capitalize costs or
  classify OCI as a regulatory asset. FAS 71 paragraph 9:
•   Rate actions of a regulator can provide reasonable assurance of the
    existence of an asset. An enterprise shall capitalize all or part of an incurred
    cost that would otherwise be charged to expense if both of the following
    criteria are met:.
     a. It is probable that future revenue in an amount at least equal to the
         capitalized cost will result from inclusion of that cost in allowable costs for
         rate-making purposes.
     b. Based on available evidence, the future revenue will be provided to
         permit recovery of the previously incurred cost rather than to provide for
         expected levels of similar future costs. If the revenue will be provided
         through an automatic rate-adjustment clause, this criterion requires that
         the regulator's intent clearly be to permit recovery of the previously
         incurred cost.