New rules for re-porting by pension plans will give investors a clearer idea of the assets and liabilities in a company’s plan, and show more clearly the fluctuations in the plan over the course of a year.

The new reporting system, which will be implemented in Canada over the next five years, is called “mark-to-market valuation.” It requires that pension plans be valued the same way the marketplace values them — by assessing current assets and liabilities to determine the overall health and value of the investments at one point in time.

At present, defined-benefit plans (the majority of pension plans in this country) are not reported in this way. Liabilities, for example, are often amortized over a 15- to 20-year period.

“Under the old system, you are no longer showing the real value of the pension plan. It is fictitious,” says Ian Markham, director of pension innovation at Watson Wyatt Worldwide in Toronto.

“The existing reporting is terrible,” agrees Mary Keogh, managing director of policy and regulatory affairs with Dominion Bond Rating Service Ltd. in Toronto. “Part of the impetus for the new rules is to present economic reality as it truly is. Ac-counting can mask this.”

Although the new approach to reporting will provide a more accurate picture of a pension’s value, it will also introduce more volatility, warns Markham: “CFOs don’t like volatility. Neither do shareholders.”

Volatility enters the picture as a result of having to incorporate into one income statement the ups and downs of a plan over the course of a year. For large plans, with changing numbers of contributors and retirees, as well as interest rate fluctuations, huge variations may be recorded.

“Everybody will be affected,” says Markham. Watson Wyatt looked at the balance sheets and income statements of 100 publicly traded companies at the end of fiscal 2005 and calculated the impact of the new rules — had they been in place — on shareholders’ equity. Hardest hit were durable manufacturing firms, which showed a paper loss of 24% in shareholders’ equity. Next was agriculture/forestry, which had a 19% paper loss. Transportation firms and utilities were tied, with a 13% drop in shareholders’ equity.

“The total [drop] for all industries is 9%,” says Markham. “That’s a pretty big potential swing factor.”

The greatest impact of the upcoming rule change will be on labour-intensive industries with strong unions such as manufacturing, says Keogh. These companies often have generous early-retirement provisions, which can lead to increasing solvency deficits, or unfunded liabilities.

In Canada, the accounting changes are being introduced by the Canadian Institute of Chartered Accountants. Existing rules will be replaced by 2011 at public companies with international financial reporting standards, developed by the International Accounting Standards Board. Draft rules are expected to be released within the next two months.

In the U.S., the Financial Ac-counting Standards Board has already implemented Phase I of its new rules, requiring public companies, including Canadian companies that report in the U.S., to recognize fully in their financial statements the obligations associated with single-employer DB pension, retiree health care and other retirement plans. This reporting will be front and centre in the financial statements. Past standards required an employer to disclose only the complete funded status of its plans in the notes to its financial statements.

“This information will help users make more informed assessments of a company’s financial position and its ability to carry out the benefit promises of these plans,” says George Batavick, former controller of Texaco Inc., and a board member of the FASB.

The new standards are being implemented in direct response to pressure from investors, analysts and others who want to improve the transparency and usefulness of the information reported about corporate pension plans.

The changes, says Niels Veldhuis, director of fiscal studies with The Fraser Institute in Vancouver, “are absolutely a good thing. Having the full accounting is necessary.”

“These changes improve transparency for everyone,” says Keogh. “It’s not just analysts who will have a better understanding. Everyone will.”

The changes south of the border probably won’t have an impact on credit ratings, says Markham. That will probably hold true when the changes are implemented in Canada. Credit-rating firms have been using mark-to-market analysis in setting their ratings for the past few years.

@page_break@Still, he predicts, it will take companies two to three years to adjust to the new regulations, and perhaps to explain to their shareholders what is happening to the pension funds under their management.

That news is often bad news. “Pension liabilities are a big liability for many companies,” notes Keogh.

A report prepared by DBRS, entitled Pension Plans: It’s all about assumptions, found that in 2005, only about 58% of pension plan assets in North America covered more than 80% of their liabilities. Fewer companies are also reporting pension income: 7.3% in 2005 compared with 30.4% in 2002. Not surprising, perhaps, the study, which reviewed the funded status of 330 pension plans across all sectors, discovered that companies are abandoning DB plans and shifting the onus for pension performance onto employees.

Ultimately, says Keogh, “Un-funded liabilities need to be brought under control.” That is especially true for companies such as Stelco Inc. and Air Canada, for which an underfunding crisis looms in the shadow of potential insolvency.

Air Canada has already received relief from the Office of the Superintendent of Financial Institutions, which worked out a deal with the airline to amortize existing deficiencies in its employee pension plans — a $1.2-billion shortfall — over a period of 10 years instead of the five years federal pension regulations usually require.

Investors, government and employees are looking for the assurance that pension plans can meet their obligations. With the new accounting rules in place, they will no longer have to search through the fine print. IE