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Report to the Ranking Minority Member, Committee on Education and the 
Workforce, House of Representatives:

GAO:

March 2004:

PRIVATE PENSIONS:

Publicly Available Reports Provide Useful but Limited Information on 
Plans' Financial Condition:

GAO-04-395:

GAO Highlights:

Highlights of GAO-04-395, a report to the Ranking Minority Member, 
Committee on Education and the Workforce, House of Representatives

Why GAO Did This Study:

Information about the financial condition of defined benefit pension 
plans is provided in two sources: regulatory reports to the government 
and corporate financial statements. The two sources can often appear to 
provide contradictory information. For example, when pension asset 
values declined for most large companies between 2000 and 2002, these 
companies all continued to report positive returns on pension assets in 
their financial statement calculations of pension expense. This 
apparent inconsistency, coupled with disclosures about corporate 
accounting scandals and news of failing pension plans, has raised 
questions about the accuracy and transparency of available information 
about pension plans. GAO was asked to explain and describe (1) key 
differences between the two publicly available sources of information; 
(2) the limitations of information about the financial condition of 
defined benefit plans from these two sources; and (3) recent or 
proposed changes to pension reporting, including selected approaches to 
pension reporting used in other countries.

What GAO Found:

Information about defined benefit pension plans in regulatory reports 
and pension information in corporate financial statements serve 
different purposes and provide different information. The regulatory 
report focuses, in part, on the funding needs of each pension plan. In 
contrast, corporate financial statements show the aggregate effect of 
all of a company’s pension plans on its overall financial position and 
performance. The two sources may also differ in the rates assumed for 
investment returns on pension assets and in how these rates are used. 
As a result of these differences, the information available from the 
two sources can appear to be inconsistent or contradictory, as 
evidenced by the graph below.

Both sources of information have limitations in the extent to which 
they meet certain needs of their users. Under current reporting 
requirements, regulatory reports are not timely and do not provide 
information about whether benefits would all be paid were the plan to 
be terminated. Financial statements can supplement regulatory report 
data because they are timelier and provide insights into the 
probability of a company meeting its future pension obligations. 
However, through December 2003, financial statements have lacked two 
disclosures important to investors—allocation of pension assets and 
estimates of future contributions to plans. There is also debate about 
whether current methods for calculating pension expense accurately 
represent the effect of pension plans on a company’s operations.

Several changes have been made or proposed to provide further 
information. In July 2003, the administration called for public 
disclosure of more information about the sufficiency of a plan’s 
assets. However, no further steps have yet been taken. For financial 
statements, the Financial Accounting Standards Board issued a revised 
standard in December 2003 requiring enhanced pension disclosures, such 
as pension asset allocation and expected contributions to plans. 
Internationally, accounting standards boards have considered proposals 
to change the methodology for calculating pension expense. We have 
previously recommended changes to improve the transparency of plan 
financial information, but other challenges remain. Plan participants 
and regulators continue to need more timely information, including 
measures of plan funding in the event of plan termination.

www.gao.gov/cgi-bin/getrpt?GAO-04-395.

To view the full product, including the scope and methodology, click on 
the link above. For more information, contact Barbara Bovbjerg at 
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[End of section]

United States General Accounting Office:

Contents:

Letter:

Results in Brief:

Background:

Form 5500 Reports and Corporate Financial Statements Differ in Key 
Respects:

Both Reports Provide Complementary Pension Information but Do Not Fully 
Satisfy Users:

Changes to Pension Accounting and Regulatory Reporting Have Been 
Implemented or Proposed:

Concluding Observations:

Agency Comments:

Appendix I: Scope and Methodology:

Appendix II: Expected and Actual Returns in Financial Statements:

Appendix III: GAO Contacts and Staff Acknowledgments:

Contacts:

Staff Acknowledgments:

Tables:

Table 1: Differences in Measures of Pension Assets and Liabilities in 
Reports:

Table 2: Comparison of Pension Assets with Liabilities for a Fortune 
500 Company:

Table 3: Use of Expected Rate of Return in Form 5500 Schedule B and 
Corporate Financial Statements:

Table 4: Average Expected and Actual Rates of Return on Pension Assets 
from 1994 to 2002 for a Sample of Fortune 500 Companies:

Table 5: Corporate Financial Statement Example--Elements of Pension 
Footnote and Statement of Operations for Company X for Different 
Expected Rates of Return:

Table 6: Definitions of Pension Footnote Items in Table 5:

Figure:

Figure 1: Comparison of Average Expected Rates of Return Reported in 
Form 5500 Schedule B and Corporate Financial Statements for a Sample of 
Fortune 500 Companies:

Abbreviations:

DOL: Department of Labor:

EDGAR: Electronic Data Gathering, Analysis, and Retrieval System:

EIN: employer identification number:

ERISA: Employee Retirement Income Security Act of 1974:

FASB: Financial Accounting Standards Board:

IASB: International Accounting Standards Board:

IRS: Internal Revenue Service:

PBGC: Pension Benefit Guaranty Corporation:

SEC: Securities and Exchange Commission:

S&P: Standard and Poor's:

United States General Accounting Office:

Washington, DC 20548:

March 31, 2004:

The Honorable George Miller: 
Ranking Minority Member: 
Committee on Education and the Workforce: 
House of Representatives:

Dear Congressman Miller:

Since the stock market decline of 2000 through 2002, policy makers and 
pension plan participants have raised concerns about where they can 
obtain clear and timely information about the financial condition of 
defined benefit pension plans. Defined benefit plans, which promise 
their participants a steady retirement income, usually based on years 
of service and salary, tend to invest most of their assets in the stock 
market. These plans cover some 44 million workers and retirees, 
concentrated in industries such as automotive, airline, steel, 
telecommunications, and manufacturing. The companies that sponsor 
defined benefit plans bear the risks of investing these assets, and may 
be required to contribute money to the plans if the plans' asset values 
are less than certain measurements of the benefits promised to plan 
participants as defined by law. When several of these plans reported 
funding problems or were terminated in the wake of the stock market's 
decline, policy makers, pension participants, investors, and financial 
analysts alike began taking a closer look at the health of defined 
benefit pension plans. The information they found often appeared 
contradictory. For example, while the stock market was falling and some 
information indicated that the value of companies' pension assets was 
declining, other information implied that these same assets were 
increasing in value. In fact, publicly reported values of pension plan 
assets and liabilities were routinely contradictory. Coupled with news 
of corporate accounting scandals, these apparent contradictions have 
raised questions about the accuracy and transparency of available 
information about pension plans.

As you requested, this report examines the two main sources of 
financial information about defined benefit pension plans and analyzes 
why these sources generate different measures of the financial 
condition of these plans. The first source is a report, commonly 
referred to as the Form 5500, which plan sponsors are required to file 
each year with the agencies that administer federal pension laws. Part 
of the Form 5500 report, called Schedule B, provides actuarial and 
other information about a pension plan's assets, liabilities, actuarial 
assumptions, and employer contributions.[Footnote 1] The second source 
is a company's annual financial statements, which among other 
information provide pension-related data as they pertain to a company's 
overall financial position, performance, and cash flows. This report 
explains and describes:

* key differences between the two publicly available sources of 
information, including their methodologies and assumptions;

* certain limitations of the information about the financial condition 
of defined benefit plans in these two information sources; and:

* recent or proposed changes to pension reporting, including selected 
approaches to pension reporting in other countries.

For our analysis of how information in the Form 5500 is used, we 
reviewed the laws that require the filing of regulatory reports on 
pensions and interviewed pension actuaries and officials from federal 
agencies that use this information. As a basis for our analyses of the 
information about pension plans presented in corporate financial 
statements, we reviewed relevant accounting standards from the 
Financial Accounting Standards Board (FASB), which establishes 
standards of financial accounting and reporting for nongovernmental 
entities, and interviewed board officials. We also interviewed expert 
users of pension information in financial statements, including 
financial analysts, credit rating agency officials, pension actuaries, 
and federal officials. These experts described and shared documentation 
about how they use financial statements to understand the financial 
position of pension plans and the impact of pension plans on companies' 
financial performance and cash flows. To identify approaches used in 
other countries and proposals for pension reporting in this country, we 
relied extensively on statements provided by officials at the 
International Accounting Standards Board and the Financial Accounting 
Standards Board. Our work also included analysis of Form 5500 filings 
and corporate financial statements for a systematic random sample of 97 
publicly traded Fortune 500 companies with defined benefit pension 
plans. Appendix I explains the scope and methodology of our work in 
greater detail. We conducted our work between January 2003 and January 
2004 in accordance with generally accepted government auditing 
standards.

Results in Brief:

The information in a pension plan's Form 5500 report serves a 
substantially different purpose from the pension information disclosed 
in a corporate financial statement; therefore, these two reports do not 
provide the same measures of pension funding. As required by law, the 
Form 5500 requires, among other things, plan financial information 
including measures of assets, liabilities, and an estimated rate of 
return on plan assets. One purpose of this information is to determine 
whether plans are funded in accordance with statutory requirements. In 
contrast, as required by financial accounting standards, the pension 
information in corporate financial statements is intended to explain 
how a company's pension plans, in aggregate, affect its overall 
financial position, performance, and cash flows, and is not intended to 
measure pension funding needs. The different purposes and reporting 
requirements lead to differences in how the pension information is 
developed and presented. Basic methodological steps--such as whether 
calculations are based on values at the beginning or the end of the 
year--can vary substantially between the two sources. For example, one 
company in our sample based its Form 5500 filing on plan assets valued 
on June 30, 2001, while its financial statement was based on values for 
December 31 of the same year, contributing to a difference of almost 
$600 million in reported assets. Additionally, both sources use a rate-
of-return estimate, but they apply this estimate differently. As a 
result of the different purposes and reporting requirements, the 
information available from the two sources can appear to be 
inconsistent or contradictory.

Under current reporting requirements, information in both the Form 5500 
and corporate financial statements has limitations in the extent to 
which it meets certain needs of regulators, plan participants, and 
investors. The Form 5500 provides detailed information about individual 
defined benefit plans, but this information is limited in two main 
ways. The first limitation is timeliness: Pension funding data are 1 to 
2 years old by the time the Form 5500 is filed with cognizant federal 
agencies. However, current statutory reporting requirements provide 
little flexibility to improve the timeliness of Form 5500 reporting. 
The second limitation is that the form does not require information 
about whether plans have sufficient assets to meet their obligations in 
the event of the plan's termination. The information in corporate 
financial statements can help regulators and others supplement 
available Form 5500 data because it is more timely and can provide 
insights into whether a company is likely to meet its future pension 
obligations. According to financial analysts we spoke with, corporate 
financial statements have heretofore lacked two important disclosures-
-the composition of pension assets and an estimate of the amount a 
company is likely to contribute to its pensions for the coming year. In 
addition, some analysts are concerned that accounting methods designed 
to smooth out asset values' year-to-year fluctuations in favor of 
reporting longer-term trends do not really reflect the effect that 
significant fluctuations may have on the operations of the plan 
sponsor. However, others argue that current pension accounting 
standards are appropriate for reflecting the long-term nature of 
pension obligations.

Several changes have been made or proposed to provide additional 
information about the financial condition of defined benefit plans. In 
an effort to improve the transparency of pension plan information, the 
administration proposed in July 2003 that additional information be 
made available to the public about plans' financial condition. This 
information, which until now has been available only to government 
regulators under certain conditions, includes computations that provide 
a more accurate picture of a plan's ability to meet its obligations if 
it were to be terminated, as well as more detailed information about 
plans when companies' pensions are collectively underfunded by at least 
$50 million. As of March 2004, no action has yet been taken on the 
administration's proposal. For financial statements, the Financial 
Accounting Standards Board in December 2003 issued a revised accounting 
standard requiring disclosure of more information, such as the 
allocation of plan assets and the company's expected pension plan 
contributions in the upcoming year. Outside the United States, 
accounting standards boards have been considering proposals that would 
change the methodology for calculating pension cost. We have previously 
recommended changes to improve the transparency of plan financial 
information, but other challenges remain. Plan participants, 
regulators, policy makers, and investors continue to need more timely 
information, including measures of plan funding in the event of plan 
termination.

Background:

Once the most prevalent type of pension plan, defined benefit plans no 
longer predominate, but they still constitute a significant part of the 
nation's retirement landscape. They usually base retirement income on 
salary and years of service (for example, a benefit of 1.5 percent of 
an employee's highest annual salary multiplied by the number of years 
of service) and are one of two pension types. The other type of 
pension, called a defined contribution plan, bases benefits on 
contributions to, and investment returns on, individual investment 
accounts. Among workers covered by pensions in 1998, about 56 percent 
were covered only by defined contribution plans (including 
401(k)[Footnote 2] plans), compared with about 14 percent who were 
covered only by defined benefit plans, and about 30 percent who were 
covered by both types of plans.[Footnote 3]

Under a defined benefit plan, the employer is responsible for funding 
the benefit, investing and managing plan assets, and bearing the 
investment risk.[Footnote 4] To fund their defined benefit pension 
plans, companies set up dedicated trust funds from which they cannot 
remove assets without incurring significant tax penalties. To promote 
the security of participants' benefits, the Employee Retirement Income 
Security Act of 1974 (ERISA), among other requirements, sets minimum 
pension funding standards. These funding standards establish the 
minimum amounts that defined benefit plan sponsors must contribute in 
each year to help ensure that their plans have sufficient assets to pay 
benefits when due. If plan asset values fall below the minimum funding 
targets, employers may have to make additional contributions.

The financial stability of defined benefit pension plans is of interest 
not only to workers whose retirement incomes depend on the plan, but 
also to the cognizant federal agencies and to investors in the 
companies that sponsor the plans. Federal policy encourages employers 
to establish and maintain pension plans for their employees by 
providing preferential tax treatment under the Internal Revenue Code 
for plans that meet applicable requirements. ERISA established a 
federally chartered organization, the Pension Benefit Guaranty 
Corporation (PBGC), to insure private sector defined benefit pension 
plans, subject to certain limits, in the event that a plan sponsor 
cannot meet its pension obligations.[Footnote 5] As part of its role as 
an insurer, PBGC monitors the financial solvency of those plans and 
plan sponsors that may present a risk of loss to plan participants and 
the PBGC. We recently designated PBGC's single-employer insurance 
program as high-risk because of its current financial 
weaknesses,[Footnote 6] as well as the serious, long-term risks to the 
program's future viability.[Footnote 7] Investors' interest in pension 
plans is prompted by the fact that a company's pension plans represent 
a claim on its current and future resources--and therefore potentially 
on its ability to pay dividends or invest in production and business 
growth. Thus, all three groups--regulators, participants, and 
investors--need information about these plans.

To meet the information needs of the federal agencies that administer 
federal pension laws, ERISA and the Internal Revenue Code require the 
filing of an annual report, which includes financial and actuarial 
information about each plan.[Footnote 8] The PBGC, the Department of 
Labor, and the Internal Revenue Service (IRS) jointly develop the Form 
5500, Annual Return/Report of Employee Benefit Plan, to be used by plan 
administrators to meet their annual reporting obligations under ERISA 
and the Internal Revenue Code.[Footnote 9] Plan administrators of 
private sector pension and welfare plans are generally required to file 
a Form 5500 each year.[Footnote 10] The filing includes a short 
document for identification purposes and general information, plus a 
series of separate statements and schedules (attachments) that are 
filed as they pertain to each type of benefit plan. This form and its 
statements and schedules are used to collect detailed plan information 
about assets, liabilities, insurance, and financial transactions, plus 
financial statements audited by an independent qualified public 
accountant, and for defined benefit plans, an actuarial 
statement.[Footnote 11] More than 1 million of the forms are filed 
annually, of which approximately 32,000 represent defined benefit 
pension plans insured by PBGC. The information on the form is made 
available to plan participants upon request and serves as the basis for 
a summary annual report provided to plan participants and their 
beneficiaries.

One part of the Form 5500 filing, called Schedule B, includes 
information about a defined benefit pension plan's assets, liabilities, 
actuarial assumptions, and employer contributions. The various measures 
of plan assets and liabilities are required by ERISA and the Internal 
Revenue Code to determine whether plans are funded according to the 
statutory requirements. Specifically, under Schedule B, IRS requires, 
among other things, the disclosure of assets and liabilities and an 
expected rate of return, which is called the valuation liability 
interest rate. IRS reviews this information to ensure compliance with 
the minimum funding requirements for pension plans. In addition, 
according to PBGC officials, PBGC may use Schedule B information to 
help them identify plans that may be in financial distress and thus 
represent a risk to the insurance program and plan participants. Some 
plan sponsors also use information in the Schedule B to calculate 
certain insurance premiums they pay to PBGC.

In addition to the annual reporting requirement, PBGC has authority to 
require plans to provide the agency with detailed financial 
information. Specifically, if a company's pension plans reach a certain 
level of underfunding in aggregate, ERISA requires the company to 
provide information to PBGC in what is called a 4010 filing. The 4010 
filing includes proprietary information about the plan sponsor, its 
total pension assets, and its total benefit obligations were the 
company to terminate its pension plans immediately. However, under 
current law, PBGC is not permitted to disclose this information to the 
public.

The Securities Exchange Act of 1934 requires publicly traded 
corporations to annually file a 10-K report, which is often referred to 
as the corporate financial statement, with shareholders and the 
Securities and Exchange Commission (SEC). The SEC uses 10-K reports to 
ensure that companies are meeting disclosure requirements so that 
investors can make informed investment decisions. The 10-K report 
describes the business, finances, and management of a corporation. For 
companies whose defined benefit pension plans are material to their 
financial statements, accounting standards require a footnote to the 
financial statements that details the cost, cash flows, assets, and 
liabilities associated with these plans. Footnote disclosures provide 
more detailed information about data presented in the company's 
financial statements.[Footnote 12] Standards for reporting this 
information are set by the Financial Accounting Standards 
Board.[Footnote 13]

Actuaries estimate the present value of pension liabilities using 
economic and demographic assumptions. These assumptions are needed to 
estimate the amount of money required now and in the future to meet a 
pension plan's future benefit obligation. Economic assumptions include 
rates of inflation, returns on investments, and salary growth rates. 
Demographic assumptions include changes in the workforce from 
retirement, death, and other service terminations. Most actuarial 
assumptions for measuring pension plan funding are not specifically 
prescribed by law or subject to advance approval from the IRS or any 
other government agency. However, ERISA requires the plan actuary to 
select assumptions that are individually reasonable and represent the 
actuary's "best estimate of anticipated experience under the 
plan."[Footnote 14]

Form 5500 Reports and Corporate Financial Statements Differ in Key 
Respects:

The pension plan financial information reported in Form 5500 Schedule B 
serves a different purpose from the pension information disclosed in 
corporate financial statements. The information in each source is 
subject to different reporting requirements; therefore, measurements of 
pension funding are unlikely to be the same in the two reports. 
Government regulators and others use Form 5500 information for many 
purposes, including to determine whether plans are meeting minimum 
funding requirements and required contributions for each defined 
benefit plan that a company sponsors, while financial analysts and 
investors use pension information in corporate financial statements to 
determine how the company's plans in aggregate affect its overall 
financial position, performance, and cash flows. Because of their 
different purposes and reporting requirements, these two sources use 
different measures and assumptions to generate information. For 
example, in providing information about the values of their pension 
assets and the present value of their future pension obligations, the 
Form 5500 and the corporate financial statements often base their 
valuations at different points in time and use different methods of 
calculation. Both of these reports also include an assumption about 
rates of return on the investment of pension assets. However, these 
rates may differ, and this assumption serves a different purpose in 
each report. As a result of such differences, information in the two 
reports is generally not similar, and because the two sources of 
information use similar terminology--for example, both refer to asset 
values and investment returns--the results can appear contradictory.

Form 5500 Reports and Corporate Financial Statements Serve Different 
Purposes:

One objective of the Form 5500 is to provide financial and other 
information about the operations of an individual employee benefit 
plan. For defined benefit pension plans, the Form 5500 Schedule B 
provides measures of plan assets and liabilities; actuarial 
information, such as economic assumptions and demographic assumptions 
about plan participants; and information about how much the plan 
sponsor is contributing to meet ERISA funding requirements. If a 
company sponsors more than one plan, it must file a Form 5500 for each 
plan. While analysts and investors may use this information, it is 
primarily used by federal regulators to measure plan funding and ensure 
compliance with applicable laws and regulations.

The pension information in a company's financial statement, by 
contrast, primarily serves a different purpose. The financial statement 
is intended to provide financial and other information about a 
company's consolidated operational performance as measured primarily by 
earnings. In this context, pension information is mostly provided in a 
footnote to give financial statement users information about the status 
of an employer's pension plans and the plans' effect on the employer's 
financial position and profitability. For example, certain details 
about the company's annual cost of providing pension benefits are 
presented in the pension footnote disclosure because this cost, or 
expense, affects the company's profitability. The users of corporate 
financial statements are primarily financial analysts and investors who 
are trying to assess the company's financial condition, profitability, 
and cash flows, and whose concern is not so much the financial 
condition of individual pension plans but the effect that the company's 
pension obligations may have on its future cash flows and 
profitability.

Measures of Pension Assets and Liabilities Differ in Form 5500 Reports 
and Corporate Financial Statements:

Even where the Form 5500 and corporate financial statements provide 
similar types of information, such as pension assets and liabilities, 
their values usually differ. Among the key reasons for this are 
different dates of measurement, different definitions of reporting 
entity, different methodologies for determining costs of benefits, and 
different methods of measuring assets and liabilities. Table 1 
summarizes some of the differences.

Table 1: Differences in Measures of Pension Assets and Liabilities in 
Reports:

Measurement dates; 
Form 5500 Schedule B: May be any day during the plan year. Large 
companies typically use the first day of the plan year, while many 
small companies use the last day. Plan years normally run concurrently 
with the company's fiscal year; 
Corporate financial statement: The last day of the plan sponsor's 
fiscal year or, if used consistently, a date not more than 3 months 
prior to the end of the fiscal year; 
Significance: The use of different dates generally results in 
different asset and liability values as asset prices fluctuate and, 
with the passage of time, additional liabilities accrue.

Number of plans covered in report; 
Form 5500 Schedule B: One form is filed for each qualifying plan 
sponsored by a company; 
Corporate financial statement: Regardless of number of plans sponsored 
by a company, total pension assets and liabilities are generally 
reported in aggregate for all plans, including those not required to 
file a Form 5500 (e.g., plans for employees overseas); 
Significance: A company may sponsor multiple plans that have different 
benefit provisions and are funded at different levels. These potential 
differences may be masked by the aggregation of data.

Method of determining annual cost of benefits; 
Form 5500 Schedule B: ERISA allows companies to choose one of six 
different methods; 
Corporate financial statement: Accounting standards mandate a single 
method of measuring the annual cost of benefits earned. This method is 
one of the six allowed in Form 5500; 
Significance: Methods for spreading out the cost of benefits over the 
working life of employees may differ, resulting in different measures 
of cost and obligations each year.

Method of calculating asset and liability values; 
Form 5500 Schedule B: Assets are valued on an actuarial basis, and 
liabilities are reported two ways: (1) actuarial liability, calculated 
using an interest rate selected by the plan actuary, and (2) current 
liability, based on an interest rate prescribed by law.[A]; 
Corporate financial statement: Assets are reported at their fair value 
and liabilities are calculated using an interest rate that is typically 
equal to the rate for long- term investment in corporate bonds - this 
rate is typically different from the interest rates used in Form 5500.
[B]; 
Significance: Actuarial asset values represent average asset values 
over some time period while fair values reflect asset values at a 
specific time. Using different interest rates to calculate present 
values of plan liabilities will yield different results. 

Source: GAO analysis.

[A] In calculating current liability for purposes of the funding rules, 
the Internal Revenue Code requires plans to use an interest rate from 
within a permissible range of rates. See 26 U.S.C. 412(b)(5)(B). Plan 
sponsors may select a rate within 90 to 105 percent of the weighted 
average interest rate on 30-year Treasury bond securities during the 4-
year period ending on the last day before the beginning of the plan 
year. The top of the permissible range was increased to 120 percent of 
the weighted average rate for 2002 and 2003. The Department of the 
Treasury does not currently issue 30-year securities. As of March 2002, 
the IRS publishes the average yield on the 30-year Treasury bond 
maturing in February 2031 as a substitute.

[B] The interest rate used to calculate pension liabilities in 
corporate financial statements should reflect the rate at which the 
benefits could be effectively settled by purchasing a group annuity for 
plan participants. The interest rates used to determine the current 
prices of annuity contracts and the rates of return on high-quality 
long-term corporate bonds should be considered in developing this 
discount rate assumption.

[End of table]

These differences in asset and liability measurements can result in 
significantly divergent results for the Form 5500 and the corporate 
financial statements. As an example, table 2 shows the different asset 
and liability values presented in a plan's Form 5500 filing and in the 
plan sponsor's corporate financial statements for a Fortune 500 company 
in 1999-2001 and the resulting effects on the reported pension funding 
ratios (pension assets divided by pension liabilities).

Table 2: Comparison of Pension Assets with Liabilities for a Fortune 
500 Company:

Year: 1999; 
Form 5500 Schedule B: Actuarial asset value: $18.081; 
Form 5500 Schedule B: Actuarial liability: $11.822; 
Form 5500 Schedule B: Actuarial asset value: $18.081; 
Form 5500 Schedule B: Current liability: $13.883; 
Corporate financial statement: Fair value of company’s pension assets: 
$21.861; 
Corporate financial statement: Projected benefit obligation: $17.719.

Year: Funding ratio; 
Form 5500 Schedule B: Actuarial asset value: 152.9 percent; 
Form 5500 Schedule B: Actuarial asset value: 130.2 percent; 
Corporate financial statement: Fair value of company’s pension assets: 
123.4 percent; 

Year: 2000; 
Form 5500 Schedule B: Actuarial asset value: $18.505; 
Form 5500 Schedule B: Actuarial liability: $11.008; 
Form 5500 Schedule B: Actuarial asset value: $18.505; 
Form 5500 Schedule B: Current liability: $13.862; 
Corporate financial statement: Fair value of company’s pension assets: 
$20.314; 
Corporate financial statement: Projected benefit obligation: $17.763.

Year: Funding ratio; 
Form 5500 Schedule B: Actuarial asset value: 168.1 percent; 
Form 5500 Schedule B: Actuarial asset value: 133.5 percent; 
Corporate financial statement: Fair value of company’s pension assets: 
114.4 percent; 


Year: 2001; 
Form 5500 Schedule B: Actuarial asset value: $17.324; 
Form 5500 Schedule B: Actuarial liability: $11.151; 
Form 5500 Schedule B: Actuarial asset value: $17.324; 
Form 5500 Schedule B: Current liability: $14.159; 
Corporate financial statement: Fair value of company’s pension assets: 
$17.923; 
Corporate financial statement: Projected benefit obligation: $18.769.

Year: Funding ratio; 
Form 5500 Schedule B: Actuarial asset value: 155.4 percent; 
Form 5500 Schedule B: Actuarial asset value: 122.4 percent; 
Corporate financial statement: Fair value of company’s pension assets: 
95.5 percent; 
 
Source: GAO analysis.

Note: Asset and liability values are in billions of dollars. Funding 
ratios in italics are calculated by dividing assets by liabilities.

[End of table]

One reason for the significant differences in measures of assets and 
liabilities between the Form 5500 and corporate financial statement 
filings in table 2 is that the company sponsors more than one pension 
plan. When companies sponsor multiple pension plans, the details of 
specific plans are generally aggregated in corporate financial 
statements to show their net effect on the plan sponsor and are not 
intended to provide details about the funding of each plan. Thus, the 
pension information of a sponsor with both underfunded and overfunded 
plans may show little or no funding deficiencies, although the 
consequences to participants in the underfunded plans could be quite 
severe in the event of plan termination.

Form 5500 Reports and Corporate Financial Statements Use Expected Rates 
of Return Differently:

One of the most confusing aspects of these two information sources is 
their difference with regard to the expected rate of return on pension 
assets. The expected rate of return is the anticipated long-term 
average investment return on pension assets. The Form 5500 Schedule B 
and the corporate financial statements both use an expected rate of 
return in calculating financial information about pension plans. In 
this regard, the expected rate of return is one of many assumptions, 
such as inflation and mortality rates, that affect a key pension 
reporting measure. In theory, the expected rates of return reported in 
each source should be similar because the assumption is derived from 
similar, or even the very same, assets. However, between these two 
sources there are differences in the rate's purpose, selection, and 
method of application that may, in fact, contribute to differences 
between the assumed rates of return used in the two sources. Key 
differences in expected rates of return between the reports are shown 
in table 3.

Table 3: Use of Expected Rate of Return in Form 5500 Schedule B and 
Corporate Financial Statements:

Purpose of expected rate of return; 
Form 5500 Schedule B: To calculate pension funding; 
Corporate financial statement: To calculate pension expense.[A].

How is the rate applied? 
Form 5500 Schedule B: Serves as the interest rate used to measure the 
present value of plan liabilities; 
Corporate financial statement: Multiplied by the "market-related" value 
of pension assets to obtain a dollar value for the expected return on 
pension assets for the year.[B].

To which plan/plans does the rate apply? 
Form 5500 Schedule B: For each individual pension plan a rate of return 
is selected. For companies with multiple plans, the rate may differ 
from plan to plan because of different plan provisions and investments; 
Corporate financial statement: A rate is determined for each plan. 
However, only a single weighted-average rate is reported, regardless of 
the number of plans.

Who selects rate? 
Form 5500 Schedule B: Plan actuary, in consultation with company 
management; 
Corporate financial statement: Company management. 

Source: GAO analysis.

[A] Pension expense refers to net periodic pension cost or net periodic 
pension expense, which is a calculated value. We heretofore refer to 
net periodic pension cost or net periodic pension expense as pension 
expense.

[B] Market-related value is either the fair value of pension assets or 
an average value of pension assets over a period not exceeding 5 years.

[End of table]

In Form 5500 Schedule B, the expected rate of return is used to 
calculate pension funding--that is, the measurements of pension assets 
and liabilities, which determine whether, and in fact, what amount the 
company needs to contribute to its pension plan to meet the statutory 
minimum funding requirements.[Footnote 15] The expected rate of return 
is usually derived from the pension plan's investment experience and 
assumptions about long-term rates of return on the different classes of 
assets held by the plan.[Footnote 16] Actuaries calculate a present 
value of plan liabilities using the expected rate of return, which is 
called the valuation liability interest rate on the Form 5500 Schedule 
B. If plan liabilities exceed assets, the resulting difference is used, 
in part, to determine the amount the company may have to contribute to 
the pension plan for that year. The amount of contributions required 
under the minimum funding rules of the Internal Revenue Code is 
generally the amount needed to fund benefits earned during that year 
plus that year's portion of other liabilities that are amortized over a 
period of years.[Footnote 17] Amendments to ERISA in 1987 and 1994 made 
significant changes to the funding rules, including the establishment 
of a deficit reduction contribution requirement if plan funding is 
inadequate.[Footnote 18] The 1987 amendments to ERISA established the 
current liability measure, which is based on a mandated interest rate 
rather than a rate selected at the discretion of the plan actuary.

For financial statements, the expected rate of return is used to 
calculate the annual expected investment return on pension assets, 
which factors into the measurement of pension expense. Pension expense 
represents the company's cost of benefits for the year and generally 
includes (1) service cost--benefits earned by plan participants for a 
period of service; (2) interest cost--increases in the benefit 
obligation because of the passage of time;[Footnote 19] (3) expected 
returns on pension assets, which offset some or all of the net benefit 
costs; (4) amortization of prior service cost resulting from plan 
amendments; and (5) amortization of gains or losses, if any, that may 
result from changes in assumptions or actual experience that differs 
from assumptions. To calculate a dollar amount for the expected return, 
the expected rate of return is multiplied by the value of pension 
assets.[Footnote 20] This expected return is used instead of the actual 
return on pension assets in the calculation of pension expense, which 
has the effect of smoothing out the volatility of investment returns 
from year to year. Furthermore, if the expected return on plan assets 
is high enough, a company may report a negative pension expense--or 
pension income.

Form 5500 reports and, until recently, corporate financial statements 
have not provided specific information about how expected rates of 
return are selected.[Footnote 21] Actuaries told us that they estimate 
rates of return on the basis of several economic forecasting measures 
and also take into account how asset allocations may change in the 
future based on the demographics of plan participants. In contrast, 
financial analysts and actuaries told us that many companies select 
their expected rates of return on the basis of their pension asset 
returns in past years.[Footnote 22] However, in December 2002 a 
Securities and Exchange Commission staff member publicly stated that 
the SEC would likely review expected rates of return higher than 9 
percent if the rate was not clearly justified in the company's 
financial statement. The SEC determined the 9 percent rate on the basis 
of studies on the historical returns on large-company domestic stocks 
and corporate bonds between 1926 and the first three quarters of 2002. 
According to actuaries and financial analysts we spoke with, this 
statement by the SEC has been a primary factor in the selection of 
lower rates of return in 2002.

Figure 1 shows the average expected rates of return reported for 1993 
to 2002 by the companies and their pension plans in our sample.

Figure 1: Comparison of Average Expected Rates of Return Reported in 
Form 5500 Schedule B and Corporate Financial Statements for a Sample of 
Fortune 500 Companies:

[See PDF for image]

Note: Companies in this sample were all listed in the 2003 Fortune 500. 
Data from Form 5500 reports for 2002 were not fully available at the 
time of this analysis. PBGC analysis of its entire Form 5500 dataset 
shows that the average expected rate of return for plans with at least 
10,000 participants ranged from 8.371 percent in 1994 to 8.473 percent 
in 2001 before falling to 8.408 percent in 2002 for the 80 percent of 
plans with data available. The number of observations per year for 
corporate financial statements and Form 5500 ranged from 63 to 89 and 
61 to 84, respectively. See appendix I for further description of the 
methodology.

[End of figure]

Both Reports Provide Complementary Pension Information but Do Not Fully 
Satisfy Users:

Both the Form 5500 Schedule B and corporate financial statements have 
limitations in the extent to which their required information meets 
certain needs of regulators, plan participants, and some investors. The 
Form 5500 takes considerable time for companies to prepare and for 
federal agencies to process, so it is not available to pension plan 
participants and others on a timely basis. The required asset and 
liability measures in the Form 5500 Schedule B are used by regulators 
to monitor compliance with statutory funding requirements. However, 
these funding measures are not intended to indicate whether plans have 
sufficient assets to cover all benefit obligations in the event of plan 
termination. In addition to using the Form 5500, regulators can also 
use corporate financial statements to try to determine whether a plan 
sponsor will be able to meet its obligations to its pension plans. 
However, some investors have concerns about whether corporate financial 
statements accurately reflect the effect of pensions on plan sponsors. 
According to financial analysts we spoke with, the pension information 
in corporate financial statements is also limited because it has not, 
until recently, included key disclosures, and the methodology used to 
calculate pension expense does not reflect the potential impact of 
actual investment returns on a company's future cash flows and 
profitability. However, others argue that the current accounting for 
pension expense is appropriate for reflecting the long-term nature of 
pension obligations and their effect on the plan sponsor.

Form 5500 Information Is Untimely but Statutory Reporting Requirements 
Limit Opportunities to Improve Timeliness:

Information in the Form 5500 is plan-specific and identifies the value 
of assets a plan must have to comply with ERISA funding requirements. 
However, this information is at least 1 to 2 years old by the time it 
is fully available, making it an unreliable tool for determining a 
plan's current financial condition. The value of plan assets can 
significantly change over this period of time, and the value of plan 
liabilities may also change because of changes in interest rates, plan 
amendments, layoffs, early retirements, and other factors. For plans 
that experience a rapid deterioration in their financial condition, the 
funding measures required in Form 5500 may not reveal the true extent 
of a plan's financial distress to plan participants and the cognizant 
federal agencies.

The Form 5500 Schedule B information is not timely for three main 
reasons. First, the plan's assets and liabilities can be measured at 
the beginning of the plan fiscal year instead of the end of the year, 
resulting in information that is over a year old when the Form 5500 is 
filed. In 2001, of the 61 companies in our sample with both Form 5500 
and corporate financial statement data, at least 48 used the beginning 
of the plan sponsor's fiscal year for the plan's measurement 
date.[Footnote 23] Second, ERISA allows plan sponsors 210 days, plus a 
2˝ month extension, from the end of the plan fiscal year to file their 
Form 5500. According to PBGC officials and actuaries we spoke with, 
most plans file at the extension deadline, almost 10 months after the 
end of the fiscal year, and almost 2 years from the measurement date if 
it is the beginning of the fiscal year. Third, according to Department 
of Labor officials, it has taken an average of 6˝ months to process 
Form 5500 filings, though actuaries and PBGC officials told us that 
recently, some processing has been completed within 1 to 2 months of 
receiving the forms. Even with this improvement in processing time, 
most large companies' 2003 pension data in Form 5500 will be based on 
valuations as of January 1, 2003, and will not be available to the 
public until January 2005.[Footnote 24]

There are several difficulties in making the filing of Form 5500 
reports more timely. According to actuaries we spoke with, collecting 
and preparing the necessary information is time-consuming and resource-
intensive for plan sponsors. Large companies' human resource data are 
often not well organized for this purpose, according to two pension 
experts we spoke with. Common problems include merging information from 
different databases, dealing with retiree data that may not be 
computerized, and identifying vested participants who have left the 
company.[Footnote 25] The data collection and analysis becomes much 
more complicated when companies go through mergers, acquisitions, or 
divestitures. According to one senior pension actuary we spoke with, 
data preparation efforts can consume as much as 75 percent of the time 
involved in preparing the Form 5500 filing. Other issues include 
scheduling the work of auditors and actuaries who must review and work 
with the information once it has been assembled.

Once the forms are completed and submitted to the Department of Labor, 
speeding up the processing also has complications. While the process is 
significantly faster now than it used to be, it depends on paper rather 
than electronic filing and is slowed because the Form 5500 is also used 
for defined contribution and welfare benefit plans. Only about 32,000 
of the more than 1 million Form 5500 filings pertain to PBGC-insured 
defined benefit plans, and the filings for defined benefit plans are 
not readily identifiable in order to receive priority when the 
Department of Labor processes these forms. Additionally, if errors in 
the Form 5500 filing are identified, the filing is returned to the plan 
sponsor with a 30-day deadline for making corrections and refiling. If 
errors are not properly corrected in the first response, the 
administrator is notified and given an additional 30 days to correct 
the amended filing.

ERISA Does Not Require Reporting of Plan Termination Funding in Form 
5500:

A second limitation in Form 5500 is that it is not required to furnish 
information about the ability of a plan to meet its obligations to 
participants if it were to be terminated.[Footnote 26] Compliance with 
ERISA funding rules, as reported in Form 5500, is often based on the 
plan's current liability, which is the sum of all liabilities to 
employees and their beneficiaries under the plan. In theory, keeping a 
pension plan funded up to its current liability will ensure that the 
plan has assets to meet its benefit obligations to plan participants as 
long as the plan sponsor remains in business. However, if a plan is 
suddenly terminated because of its sponsor's financial distress, the 
plan liabilities are likely to increase and plan assets are less likely 
to cover the cost of all benefit obligations. Therefore, Form 5500 
information often does not accurately indicate the ability of the plan 
to meet its benefit obligations to plan participants in the event that 
the plan sponsor goes bankrupt. A different measure, called the 
termination liability, comes closer to expressing the pension plan's 
cost of discharging the promised benefits to participants in a distress 
termination. The termination liability, which is usually higher than 
current liability, reflects the cost to a company of paying an insurer 
to assume its pension obligations were the plan to be 
terminated.[Footnote 27] PBGC has found no simple relationship between 
measures of current and termination liability, and therefore a fixed 
set of factors cannot be applied to the plan's current liability 
funding level (or its components) to estimate termination liability. 
For plans whose vested benefits are underfunded by at least $50 
million, PBGC receives a termination liability measure in a separate 
filing called a Section 4010 filing (named after the ERISA section that 
requires companies to submit such reports). However, this information 
is available only to PBGC and by law may not be publicly disclosed.

The differences in the two types of liability measures are substantial 
enough that a plan can appear in reasonable condition under the current 
liability measure that serves as the basis for the minimum funding 
standard, but not have sufficient resources to settle plan termination 
liabilities. For example, Bethlehem Steel's pension plan was 97 percent 
funded on a current liability basis in its 1999 Form 5500 filing. 
However, when the plan was terminated, in December 2002, it was funded 
at only 45 percent on a termination liability basis.[Footnote 28] Plan 
terminations often result from a plan's sponsor entering bankruptcy, 
which, according to PBGC officials, cannot usually be predicted more 
than a few months in advance. Some of the reasons that a plan can have 
a reasonable ratio of assets to liabilities under the current liability 
measure but a less than adequate ratio under the termination liability 
include:

* Different retirement ages. When companies shut down, many long-time 
employees retire and begin collecting pension benefits at an earlier 
age.

* Different discount rates. Termination liability discount rates have 
usually been lower than for current liability in recent years, making 
the present value of termination liability larger.

* Different plan provisions. Terminations may coincide with factory 
shutdowns, which often trigger provisions that increase retirement 
benefits.

Corporate Financial Statement Information Can Supplement Form 5500 
Data:

While the information about pensions in corporate financial statements 
does not serve the same purpose as the information in Form 5500, it can 
also be useful to the PBGC. This information is useful in two primary 
ways:

* Its overall measures of the company's financial condition provide 
indications about the company's ability to meet its pension 
obligations. According to PBGC officials, most large plans that were 
terminated by PBGC were sponsored by companies whose debt was rated 
below investment grade for a number of years prior to plan 
termination.[Footnote 29] Though plan asset-to-liability ratios are not 
dependent on the health of the plan sponsor, participants in 
underfunded pension plans at financially distressed companies face the 
risk that the plan sponsor will lack the cash resources to meet the 
ERISA funding requirements. In contrast, a company in a strong 
financial position is much more likely to be able to make up funding 
shortfalls.

* It provides the timeliest public data about pension plans, which may 
be useful if the company sponsors only one pension plan. Within 60 to 
90 days from the end of their fiscal years, publicly traded companies 
must file their financial statements, which provide data based on 
measurements on the last day of a company's fiscal year.[Footnote 30]

Pension Accounting Disclosures and Methods Have Been Subjects of 
Debate:

Some primary users of corporate financial statements have expressed 
concerns about the extent to which these reports show how pension plans 
affect a company's profitability, cash flow, and financial position. 
This information is particularly important for companies with large 
pension plans because the greater the value of a company's pension 
assets relative to the company's market value, the more sensitive its 
cash flows and profits will be to changes in pension asset values. 
According to analysis by Standard and Poor's (S&P), a leading corporate 
debt rating agency, defined benefit pension plans significantly affect 
the earnings of about half of the companies in the S&P 500 index. As 
conveyed to us by financial analysts, investors' concerns about 
financial reporting on pensions have been twofold: First, financial 
statements have heretofore lacked adequate disclosures about how 
pension plans affect the sponsoring companies' cash flow and overall 
risk. Second, some investors believe that current standards for 
measuring pension expense do not adequately recognize the financial 
condition of pension plans and distort measures of company earnings. 
However, others argue that these standards provide a more appropriate 
accounting of a company's annual pension costs over the long term.

Disclosure concerns, to date, have been of two main types:

* First, according to financial analysts we spoke with, it has been 
difficult to reasonably estimate a pension plan's claims on a company's 
cash resources in the coming year and near future. Contributions are 
determined primarily by ERISA funding requirements, but the plan 
funding status reported in the Form 5500 is not current enough to be 
used by financial analysts and investors. Large required contributions 
to pension plans can reduce the cash available to companies to apply to 
shareholder dividends or invest in their business so that profits may 
continue to grow. For industries in which investors are concerned 
primarily with a company's cash flow, estimates of such future 
contributions would be critically important, but have been unavailable 
to date.[Footnote 31]

* Second, to date it has been difficult to accurately evaluate the risk 
that pension investments pose to the plan sponsor. The allocation of 
pension assets can pose additional risk to the company's cash flow and 
profitability, especially for companies with very large pension plans. 
Investments in more volatile assets, such as equities, are likely to 
create a wider range of potential cash contributions for the company in 
the future, as companies may need to make contributions to meet 
statutory funding requirements following negative returns on pension 
assets.

In addition to raising these disclosure concerns, some financial 
analysts and investors have also expressed opposition to current 
accounting standards for measuring pension expense, while others 
support these standards.[Footnote 32] Pension expense is included in 
the calculation of corporate earnings, which investors use to track a 
company's performance, in comparison both with other firms and with a 
company's own past performance. In order to reduce the potential 
volatile effect of pension plans on their sponsors' earnings, the 
accounting standards call for three main smoothing mechanisms to 
calculate pension expense: (1) expected return is used instead of 
actual return on pension assets, (2) the expected return may be based 
on an average value of pension assets rather than their current fair 
value,[Footnote 33] and (3) differences between actual experience and 
assumptions are recognized systematically and gradually over many years 
rather than immediately when they arise. Therefore, when the expected 
return on pension assets significantly differs from the actual return, 
this difference does not immediately affect a company's reported 
pension cost or earnings.

As actual experience differs from assumptions on such things as 
expected rates of return, inflation rates, and plan participant 
mortality rates, the differences are added to or subtracted from an 
account for unrecognized gains or losses.[Footnote 34] When 
unrecognized gains or losses exceed 10 percent of either the market-
related value of pension assets or the projected benefit obligation, 
whichever is greater, the company must factor a fraction of the excess 
unrecognized gain or loss (difference between the total gain or loss 
and the 10 percent threshold) into its calculation of pension 
expense.[Footnote 35] For example, a company may experience 3 years of 
unusually high gains on its pension assets, and at the end of year 3, 
the cumulative difference between expected and actual returns on 
pension assets surpasses the minimum threshold for recognition of the 
difference. The company must record part of its unrecognized cumulative 
gain in its calculation of pension expense, thereby decreasing the 
pension expense for the year.

Although actual and expected rates of return may differ sharply in any 
given year, or even over 2 to 3 years, the variance between them should 
decrease over the longer term, provided that expected rates of return 
are reasonably accurate. Table 4 shows the results of our comparison of 
expected and actual rates of return for 52 companies from our sample of 
Fortune 500 companies that had data available over the 9 years from 
1994 through 2002. During this period the average expected rate of 
return used in the financial statements was 9.29 percent, while the 
average actual rate of return was 7.56 percent and ranged from a low of 
-8.85 percent to a high of 22.36 percent in any given year.

Table 4: Average Expected and Actual Rates of Return on Pension Assets 
from 1994 to 2002 for a Sample of Fortune 500 Companies:

Year: 1994; 
Average expected rate of return (percent): 9.19; 
Average actual rate of return (percent): 0.52; 
Average difference (actual minus expected): -8.67.

Year: 1995; 
Average expected rate of return (percent): 9.26; 
Average actual rate of return (percent): 22.36; 
Average difference (actual minus expected): 13.10.

Year: 1996; 
Average expected rate of return (percent): 9.26; 
Average actual rate of return (percent): 14.21; 
Average difference (actual minus expected): 4.95.

Year: 1997; 
Average expected rate of return (percent): 9.33; 
Average actual rate of return (percent): 19.04; 
Average difference (actual minus expected): 9.71.

Year: 1998; 
Average expected rate of return (percent): 9.32; 
Average actual rate of return (percent): 12.55; 
Average difference (actual minus expected): 3.23.

Year: 1999; 
Average expected rate of return (percent): 9.35; 
Average actual rate of return (percent): 14.26; 
Average difference (actual minus expected): 4.91.

Year: 2000; 
Average expected rate of return (percent): 9.45; 
Average actual rate of return (percent): 5.07; 
Average difference (actual minus expected): -4.38.

Year: 2001; 
Average expected rate of return (percent): 9.45; 
Average actual rate of return (percent): -6.45; 
Average difference (actual minus expected): -15.90.

Year: 2002; 
Average expected rate of return (percent): 8.98; 
Average actual rate of return (percent): -8.85; 
Average difference (actual minus expected): -17.83.

Year: 1997-1999 average; 
Average expected rate of return (percent): 9.33; 
Average actual rate of return (percent): 15.25; 
Average difference (actual minus expected): 5.92.

Year: 2000-2002 average; 
Average expected rate of return (percent): 9.29; 
Average actual rate of return (percent): -3.59; 
Average difference (actual minus expected): -12.88.

Year: Nine-year average; 
Average expected rate of return (percent): 9.29; 
Average actual rate of return (percent): 7.56; 
Average difference (actual minus expected): -1.73. 

Source: GAO analysis of pension footnotes in corporate financial 
statements.

Note: The average rates of return for multiyear periods in table 4 are 
geometric means, which are used to calculate the compound average, or 
the average annual return that would yield the same total change in 
asset values over a multiyear period. 52 companies in our sample had 
data available for this entire 9-year period.

[End of table]

In comparison with the results of our analysis, a study by one 
investment bank revealed an average actual return on pension assets of 
greater than 12 percent between 1985 and 1998.[Footnote 36] Therefore, 
average actual rates of return will vary according to the time period 
being measured. For example, for the companies in our sample, the 
average actual return on pension assets was 15.25 percent from 1997 
through 1999 and -3.59 percent from 2000 through 2002.

Opponents of current methods of accounting for pension expense argue 
that the smoothing mechanisms lack transparency because reported 
pension expense (1) does not reflect the current financial condition of 
pension plans and (2) distorts measures of corporate earnings. Under 
the current methodology for calculating pension expense, the cumulative 
net effect of pension asset gains or losses may not be reflected in 
reported pension expense for a few years, if at all. While alternating 
years of gains and losses may keep reported pension expense relatively 
smooth from year to year, consecutive years of gains or losses can 
eventually result in significant changes in reported pension expense. 
Many companies that reported pension income in 2001 and 2002, while 
their pension assets were in fact decreasing in value, benefited from 
the use of the market-related value of pension assets (the average 
asset values over not more than the previous 5 years) rather than the 
lower actual value of these assets. For example, of the 97 companies in 
our sample, 26 reported net pension income in 2002, but only one of 
these companies saw an increase in the value of its pension assets. 
Conversely, it is likely that many of these companies will report net 
pension expenses in the next few years, even if their pension asset 
values rise, because their market-related values of pension assets will 
reflect, in part, the decline in the stock market between 2000 and 
2002.

In contrast, employer contributions, which are only indirectly related 
to pension expense, may better reflect the current financial condition 
of pension plans. Employer contributions to pension plans are 
determined by a complex set of factors, including the tax deductibility 
of contributions, minimum funding requirements, the employer's expected 
cash flows, and PBGC premiums. In 2002, when most large companies saw 
declines in their pension asset values, many were required to make 
contributions to their pension plans to meet the statutory funding 
requirements. The 93 Fortune 500 companies in our sample with available 
financial statement data reported aggregate contributions to pension 
plans of $10.1 billion in 2002, while their aggregate pension expense 
totaled $622.6 million. Financial analysts pay close attention to 
companies' cash contributions to pension plans because large 
contributions to plans represent resources that companies will not have 
available to use for other purposes, such as expanding their 
businesses.

Investors have also been concerned about the extent to which defined 
benefit pensions contribute to a company's total profits. According to 
one investment bank study, 150 of the 356 Fortune 500 companies with 
defined benefit plans reported net pension income (negative expense) in 
their financial statements in 2001.[Footnote 37] However, the value of 
pension assets for 313 of these companies actually declined in 2001. To 
try to address these apparent inconsistencies in the financial 
reporting on pensions, many financial analysts and investors try to 
strip out the effects of pensions to determine a "true" measure of a 
company's earnings that reflects its performance from ongoing 
operations. For example, Standard and Poor's issued a proposal in 2002 
to standardize measures of corporate earnings that excludes several 
items from the earnings calculation, including investment returns on 
pension assets.

Proponents of current pension accounting standards argue that the 
smoothing mechanisms are beneficial because (1) pension obligations are 
long-term liabilities that do not have to be funded all at once and (2) 
sponsoring pension plans and investing plan assets are not the primary 
business activities of plan sponsors. Pension obligations are normally 
paid out over a long period of time; therefore, pension assets have a 
similar time period to meet those obligations. The smoothing mechanisms 
allow plan sponsors to gradually and systematically attribute portions 
of the long-term cost of pension plans to each year. Without smoothing 
mechanisms, companies would potentially face year-to-year fluctuations 
in their reported pension expense that some investors may also consider 
misleading given that unexpected losses on pension assets in one time 
period may be offset by unexpected gains in another.

The Financial Accounting Standards Board adopted the smoothing 
mechanisms in part to reduce the volatility of reported earnings caused 
by investment returns on pension assets. Because investing pension plan 
assets is not the primary business activity of plan sponsors, FASB 
determined that earnings volatility caused by immediately recognizing 
all changes in the value of plan assets and liabilities as they occur 
would be misleading to investors. Furthermore, such volatility could 
make comparisons of earnings more difficult when looking at different 
firms, some of which may not sponsor defined benefit plans.

Changes to Pension Accounting and Regulatory Reporting Have Been 
Implemented or Proposed:

Both in this country and abroad, changes have been proposed--and in a 
few cases, implemented--to make information about defined benefit plans 
more transparent or complete. These changes relate to information 
associated with both Form 5500 and corporate financial statements. The 
administration has proposed augmenting current Form 5500 information by 
making available certain data that currently are not made public, such 
as measurements of termination liabilities. The Financial Accounting 
Standards Board has recently amended one of its accounting standards to 
require, among other things, that companies provide more information 
about the composition and market risk of their pension plan assets and 
their anticipated contributions to plans in the upcoming year. Outside 
the United States, proposals are being discussed that would move toward 
eliminating or reducing the use of smoothing mechanisms in calculating 
pension expense.

The Administration Has Proposed Making Additional Information Available 
Relating to Pension Risk:

In July 2003 the Department of the Treasury announced "The 
Administration Proposal to Improve the Accuracy and Transparency of 
Pension Information." The proposal presented four areas of change, and 
one of them would broaden the public's access to pension information 
currently available only to PBGC.[Footnote 38] The proposal would 
expand the public's access to pension information in two main ways:

* Reporting termination liability. Under the proposal, information 
about a plan's termination liability would be included in ERISA-
required summary annual reports to workers and retirees. The annual 
reports, which are based on data from the Form 5500 reports, now report 
the plan's financial condition based on the plan's current liability. 
Termination liability information is reported to PBGC by companies 
whose plans are collectively underfunded by more than $50 million.

* Public disclosure of underfunding of at least $50 million. Section 
4010 of ERISA requires companies with more than $50 million in 
aggregate plan underfunding to file annual financial and actuarial 
information with the PBGC. This information is reported separately from 
Form 5500 information and must generally be filed no later than 105 
days after the end of the company's fiscal year. PBGC uses this 
information to monitor plans that may be at greater risk of failure, 
but under current law, PBGC cannot make the information public. 
According to the administration, the information is more timely and 
better in quality than publicly available data. Under the proposal, the 
market value of assets, termination liability, and termination funding 
ratios contained in these reports would all be publicly disclosed.

* Since the announcement of the administration's proposal, no further 
action has been taken by either the administration or Congress to 
implement these proposals.

FASB Has Changed U.S. Pension Disclosure Standards; Other Changes Being 
Considered Abroad:

In regard to corporate financial statements, one change designed to 
address users' concerns about pension-related information has recently 
been enacted. In December 2003 FASB issued a revision to its accounting 
standard on pension disclosures.[Footnote 39] The revised standard 
incorporates all of the disclosures required by the prior standard and 
requires more informative pension disclosures.[Footnote 40] FASB added 
the new disclosures because users of financial statements, such as 
financial analysts, requested additional information that would assist 
them to evaluate, among other things, the composition and market risk 
of the pension plan's investment portfolio and the expected long-term 
rate of return used to determine net pension costs. As a result, some 
of the new disclosure requirements include listing the percentage of 
pension assets invested in major asset classes such as equity 
securities, debt securities, real estate, and other assets. Companies 
must also provide a narrative description of the basis used to 
determine the overall expected rate of return on assets assumption. The 
FASB believed that this new information would allow users to better 
understand a company's exposure to investment risk from its pension 
plans and the expected rate of return assumption. Another required 
disclosure is the employer's estimated contribution to pension plans in 
the following year. However, the revised standard does not change the 
general approach used in the financial statements of aggregating this 
information across all pension plans.

Outside the United States, other standard-setting boards have been 
addressing issues related to the use of smoothing techniques designed 
to smooth out the volatility of reported pension expense. One of these 
boards is the International Accounting Standards Board (IASB), an 
independent accounting standard-setting organization. Many countries 
require publicly traded companies to prepare their financial statements 
in accordance with IASB's financial reporting standards. IASB's current 
pension accounting standard is very similar to the current standard 
promulgated by FASB, in that both allow a smoothing mechanism to reduce 
the volatility of pension expense. However, IASB is considering a 
revision to its current standard to allow companies to calculate 
pension expense using actual investment returns instead of expected 
returns, on a voluntary basis. According to the IASB manager in charge 
of the project, the exposure draft will be issued in 2004, and a final 
standard is expected in March 2005. Separately from the IASB action, 
the United Kingdom's Accounting Standards Board has already issued its 
own accounting standard that would require companies to report the 
differences between actual and expected returns on pension assets in 
their financial statements.[Footnote 41] Full adoption of this standard 
has been delayed out of concern that the changes made by firms to 
comply with the Accounting Standards Board standard might need to be 
modified again in subsequent years to meet a potentially different IASB 
standard.

Concluding Observations:

Form 5500 reports and corporate financial statements both provide key 
pension financial data, but they serve different purposes and, as a 
result, provide significantly different information. To date, neither 
report in isolation provides sufficient information for certain users 
to fully determine the current financial condition of an individual 
pension plan or how pension obligations could affect the financial 
health of the plan sponsor. While particular concerns have been raised 
about differences between expected and actual pension asset rates of 
return reported on corporate financial statements, expected rates of 
return do not have a significant effect on the actual financial 
condition of plans.

Continued concerns about the financial condition of plans and how this 
information is disclosed have been highlighted by the administration's 
proposal to provide information about funding in the event of plan 
termination to plan participants and regulators. We have previously 
reported that an essential element of pension disclosure should include 
requiring plans to calculate liabilities on a termination basis and 
disclosing this information to all participants annually. Likewise, we 
recommended that Congress consider requiring that all participants 
receive information about plan investments and the minimum benefit 
amount that PBGC guarantees should their plan be terminated.[Footnote 
42] While such new requirements could help improve the transparency of 
pension plans' financial condition, there are other challenges to be 
addressed as well. For example, plan participants and regulators 
continue to need more timely information. However, there appear to be 
few opportunities to improve the timeliness of Form 5500 information 
under the current statutory reporting requirements. One challenge to 
improving the timeliness of this information on pensions will be to 
find a solution that does not impose undue burdens on plan sponsors. 
Resolving this challenge will prove crucial to providing policy makers, 
plan participants, and investors with more timely and transparent 
information on the financial condition of defined benefit plans.

Agency Comments:

We provided a draft of this report the Department of the Treasury, the 
Department of Labor, the Pension Benefit Guaranty Corporation, the 
Securities and Exchange Commission, and the Financial Accounting 
Standards Board. We received technical comments from each agency that 
we incorporated as appropriate.

We are sending copies of this report to the Secretary of Labor, the 
Secretary of the Treasury, the Executive Director of the Pension 
Benefit Guaranty Corporation, the Chairman of the Securities and 
Exchange Commission, the Chairman of the Financial Accounting Standards 
Board, appropriate congressional committees, and other interested 
parties. We will also make copies available to others on request. In 
addition, the report will be available at no charge on GAO's Web site 
at http://www.gao.gov.

If you have any questions concerning this report please contact me at 
(202) 512-7215 or George Scott at (202) 512-5932. Other contacts and 
acknowledgments are listed in appendix III.

Sincerely yours,

Signed by: 

Barbara D. Bovbjerg: 
Director, Education, Workforce, and Income Security Issues:

[End of section]

Appendix I: Scope and Methodology:

To explain the two sources of pension financial information, we 
interviewed federal agency officials from the Pension Benefit Guaranty 
Corporation (PBGC) and the Department of Labor (DOL). These federal 
agencies use Form 5500 information in performing their oversight and 
monitoring responsibilities. In addition, we reviewed the Form 5500 
instructions, form, and schedules to understand the information they 
provide. For the financial statements, we reviewed relevant accounting 
standards from the Financial Accounting Standards Board, which sets 
standards for financial statements, and spoke with board officials. We 
also reviewed many financial statements of large domestic companies.

Our work also included analyses of a sample of corporate financial 
statements of Fortune 500 companies and the corresponding Form 5500 
filings for those companies with available data. We chose to sample 
from the universe of publicly owned Fortune 500 companies with defined 
benefit plans because (1) the pension plans sponsored by these firms 
represent a large percentage of the total private defined benefit 
pension plan participants, assets, and liabilities in the United 
States; (2) these firms tend to have the largest defined benefit plans, 
and if these plans fail they would create the largest burdens for PBGC 
and possibly the government; and (3) most of these firms are publicly 
traded, so their corporate financial statements are publicly available.

We drew a systematic random sample of 100 of the 2003 Fortune 500 
companies with defined benefit plans, after excluding government-
sponsored entities. The sampling process accounted for the companies' 
revenues in 2002 and the distribution of expected rates of return on 
pension assets. This distribution was available in a Compustat database 
for approximately 290 of the 329 companies in the population. From the 
initial sample of 100 companies, 3 companies were removed because one 
is not publicly traded, another is European and filed its financial 
statements in euros, and the third changed its end-of-fiscal-year date 
in 2001, which made it more difficult to compare with other firms. For 
the 97 remaining companies, we obtained as much as 10 years of pension 
data from these companies' corporate financial statements using the 
Securities and Exchange Commission's Electronic Data Gathering, 
Analysis, and Retrieval System (EDGAR), depending on data availability. 
Data were available from 1993 through 2002 for 68 companies. However, 
others did not have 10 years of data available because, for example, 
they were formed, or only began to publicly trade their stock, at some 
time between 1993 and 2002. Nine companies in our sample reported more 
than one expected rate of return for their pension plans and a weighted 
average could not be determined accurately. Most of these companies 
sponsor pension plans for employees outside the United States and 
provide separate assumptions for domestic and international plans. 
These companies did not report the weighted average expected rate of 
return that was used to calculate their expected return on pension 
assets.

We also obtained the corresponding Form 5500 filings for the companies 
in our sample from PBGC for plan years 1993 through 2001.[Footnote 43] 
To identify these filings, we matched the sample of 97 Fortune 500 
companies to their pension plans on the basis of their employer 
identification number (EIN). An EIN, known as a federal tax 
identification number, is a nine-digit number that the IRS assigns to 
organizations. We developed a list of EINs reported on the companies' 
financial statements and provided this list to the PBGC. PBGC matched 
the EINs to their Form 5500 database and provided information to us. 
However, in several cases, PBGC did not find matches to our list of 
EINs, either for all 10 years or for just some of the years. Based on 
the number of companies with data available in any of the 10 years, we 
decided on a threshold of 7 years' worth of data in order to achieve a 
sample size that would allow us to compare data over most of the 10-
year period. In other words, to be included in this analysis, a company 
must have at least 7 years of Form 5500 data. One hundred and fifty 
plans had at least 7 years of Form 5500 data.[Footnote 44] The years in 
which data were missing were spread sporadically among the 10-year 
period covered in this analysis.

Before deciding to use the Form 5500 data, we investigated its 
reliability. Prior to plan year 1999, the Internal Revenue Service was 
responsible for keypunching Form 5500 information into a database, and 
DOL officials explained that some of the data contained errors. DOL 
officials explained that since plan year 1999, Form 5500 data have been 
recorded with optical scanning devices and have been subject to edit 
and validity tests. In 1999, some Form 5500 filings were not captured 
because many plan administrators did not send forms on the correct 
paper and the scanner could not capture some information. However, DOL 
officials explained that this problem has not occurred since. We 
obtained the Form 5500 data from PBGC's Corporate Policy and Research 
Department. PBGC officials explained that as errors surface in their 
use of the Form 5500 data, corrections are made to PBGC's database. In 
the past hard copies of original Form 5500 filings were obtained for 
making corrections. Today PBGC can view electronic images of the actual 
plan filings. As PBGC receives the data on Form 5500 Schedule B, it 
screens the data for errors, particularly in the asset and liability 
fields. Information we received from pension actuaries corroborates the 
data we used from Form 5500 filings and the data on expected rates of 
return, as presented in figure 1, show consistency from year to year. 
Taking all these factors into consideration, we feel that the data we 
used were sufficiently reliable for the purpose of differentiating 
between expected rates of return reported in Form 5500 filings and 
corporate financial statements.

In obtaining financial information for the sample companies, we had to 
account for companies that had merged with another company during the 
10-year period under review. In the event of a merger between a company 
with a defined benefit pension plan and a company without a defined 
benefit plan, we selected the company with the defined benefit plan. In 
the case of a merger between two companies that both had defined 
benefit plans prior to the merger, we selected the company indicated by 
the EDGAR database as the predecessor company.

While our sample is designed to represent our population for calendar 
year 2002, it is not representative of any population in prior years. 
The makeup of the Fortune 500 changes from year to year, and our method 
of tracking the same companies across several years precludes us from 
making specific statements about any larger population prior to 2002. 
Thus, while we believe that the trends identified in our sample could 
be indicative of trends in the population of large firms with defined 
benefit plans and that this supposition is supported by other studies, 
we do not claim these trends are representative of past populations of 
Fortune 500 companies.

To explain the usefulness and limitations of the information from the 
two information sources, we interviewed expert users of pension 
information in Form 5500 reports and corporate financial statements, 
including federal officials from DOL, PBGC, and SEC; pension actuaries; 
corporate debt rating agency officials; financial analysts; and 
Financial Accounting Standards Board officials. Some experts explained 
the uses of information available in the Form 5500 reports and 
limitations of these reports. Other experts described and shared 
documentation about how they analyze financial statements to understand 
the impact of pension plans on the plan sponsors' financial statements. 
Some experts explained the need for additional pension information in 
companies' financial statements. As part of our review of pension 
information in corporate financial statements, we used several research 
reports published by different investment banks. We reviewed the 
methods used in these studies and found them to be sufficiently 
reliable for the purpose of corroborating our own data analysis and 
illustrating trends in pension accounting.

To explain the recent and proposed changes to the current information 
sources, we interviewed officials from the International Accounting 
Standards Board and the Financial Accounting Standards Board. These 
boards set standards for financial statements for international 
companies and United States companies, respectively. We also reviewed 
the recently revised accounting standards issued by the Financial 
Accounting Standards Board. We also reviewed congressional testimony 
regarding the administration's proposal for more transparency of 
pension data.

We conducted our work between January 2003 and January 2004 in 
accordance with generally accepted government auditing standards.

[End of section]

Appendix II: Expected and Actual Returns in Financial Statements:

This appendix shows two things: (1) how a company may experience an 
actual loss on its pension assets while reporting income from its 
pension plans in the same year and (2) how a change in the expected 
rate of return affects other items in the financial statement. The 
information is based on numbers taken from the corporate financial 
statement of a real company from its 2002 fiscal year.

Company X's pension assets lost $512 million in value during its fiscal 
year, yet Company X still reported pension income of $90 million. This 
apparent inconsistency is possible because the expected return on 
assets is used in place of actual returns to calculate net periodic 
pension cost.

The second column of table 5 shows the effect of changing the expected 
long-term rate of return on pension assets from 9.8 percent to 8.5 
percent. The figures affected by this change are in bold text. All of 
the changes caused by the change in the expected rate of return are 
related to measurements of Company X's pension expense and measures of 
overall profitability. The change has no impact at all on measures of 
pension assets and liabilities.

Table 5: Corporate Financial Statement Example--Elements of Pension 
Footnote and Statement of Operations for Company X for Different 
Expected Rates of Return:

Dollars in millions except earnings per share.

Change in benefit obligation:

A; 
Key pension footnote elements: Benefit obligation at beginning of 
year; 
2002: $7,382; 
2002: $7,382.

B; 
Key pension footnote elements: Service cost; 
2002: 115; 
2002: 115.

C; 
Key pension footnote elements: Interest cost; 
2002: 529; 
2002: 529.

D; 
Key pension footnote elements: Plan amendments; 
2002: 0; 
2002: 0.

E; 
Key pension footnote elements: Actuarial losses; 
2002: 395; 
2002: 395.

F; 
Key pension footnote elements: Benefits paid; 
2002: (611); 
2002: (611).

G; 
Key pension footnote elements: Benefit obligation at end of year; 
2002: $7,810; 
2002: $7,810.

Change in plan assets: 

H; 
Key pension footnote elements: Fair value of plan assets at beginning 
of year; 
2002: $7,431; 
2002: $7,431.

I; 
Key pension footnote elements: Actual return on plan assets; 
2002: (512); 
2002: (512).

J; 
Key pension footnote elements: Employer contributions; 
2002: 135; 
2002: 135.

K; 
Key pension footnote elements: Participant contributions; 
2002: 0; 
2002: 0.

L; 
Key pension footnote elements: Benefits paid; 
2002: (611); 
2002: (611).

M; 
Key pension footnote elements: Fair value of plan assets at end of 
year; 
2002: $6,443; 
2002: $6,443.

Key pension footnote elements: 

N; 
Key pension footnote elements: Expected long-term rate of return on 
plan assets; 
2002: 9.8%; 
2002: 8.5%.

O; 
Key pension footnote elements: Discount rate; 
2002: 7.0%; 
2002: 7.0%.

P; 
Key pension footnote elements: Expected rate of compensation increase; 
2002: 4.0%; 
2002: 4.0%.

Components of net periodic cost of defined benefit plans: 

Q; 
Key pension footnote elements: Service cost; 
2002: $115; 
2002: $115.

R; 
Key pension footnote elements: Interest cost; 
2002: 529; 
2002: 529.

S; 
Key pension footnote elements: Expected return on plan assets; 
2002: (783); 
2002: (679).

T; 
Key pension footnote elements: Amortization of prior service cost; 
2002: 50; 
2002: 50.

U; 
Key pension footnote elements: Amortization of net actuarial (gain) 
loss; 
2002: (1); 
2002: (1).

V; 
Key pension footnote elements: Total (benefit) cost included in results 
of operations; 
2002: $(90); 
2002: $14.

Not reported in pension footnote: 

W; 
Key pension footnote elements: Market-related value of plan assets; 
2002: $ 7,990; 
2002: $ 7,990.

X; 
Key pension footnote elements: Total sales and revenues; 
2002: $20,152; 
2002: $20,152.

Y; 
Key pension footnote elements: Total operating costs; 
2002: 18,833; 
2002: 18,947.

Z; 
Key pension footnote elements: Operating profit; 
2002: 1,319; 
2002: 1,205.

AA; 
Key pension footnote elements: Consolidated profit before taxes; 
2002: 1,114; 
2002: 1,000.

BB; 
Key pension footnote elements: Provision for income taxes; 
2002: 312; 
2002: 280.

CC; 
Key pension footnote elements: Net profit; 
2002: 802; 
2002: 720.

DD; 
Key pension footnote elements: Earnings per share; 
2002: $2.33; 
2002: $2.09.

Source: GAO analysis.

[End of table]

An explanation of the pension elements in table 5 follows in table 6.

Table 6: Definitions of Pension Footnote Items in Table 5:

Item: A; 
Definition: The projected benefit obligation is the present value of 
all future retirement benefits earned and not yet paid to date, 
including estimates of salary growth over time. Measurements of the 
projected benefit obligation are provided for both the beginning and 
the end of the year.

Item: B; 
Definition: The service cost represents the actuarial value of benefits 
earned by employees during the year. It is used to show the change in 
benefit obligation from the beginning to the end of the year and in the 
calculation of net periodic pension cost.

Item: C; 
Definition: The interest cost represents the increase in the company's 
projected benefit obligation as a result of the passage of time. The 
deferred compensation arrangement of pension plans entails a time value 
of money aspect. It is used to show the change in benefit obligation 
from the beginning to the end of the year and in the calculation of net 
periodic pension cost.

Item: D; 
Definition: Plan amendments include the initiation of new plans and 
provisions that grant increased benefits based on services rendered in 
prior periods.

Item: E; 
Definition: Actuarial losses (gains) reflect changes to any assumption 
that increase (decrease) the value of the projected benefit obligation. 
Assumptions include the discount rate, salary inflation, mortality, 
retirement age, and other factors.

Item: F; 
Definition: Benefits paid represent the amount of cash payments from 
the pension plan to retired plan participants. These payments are cash 
outflows primarily from the pension plan(s). Benefits paid reduce the 
outstanding value of total pension obligations to plan participants.

Item: G; 
Definition: See Item A.

Item: H; 
Definition: The fair value of assets is the market value of the stocks, 
bonds, real estate, and other assets held by the company's pension 
plan(s) on the measurement date. Values of pension assets are provided 
for both the beginning and the end of the company's fiscal year.

Item: I; 
Definition: The actual return on plan assets is the change in the value 
of pension assets from changes in market prices on the assets held by 
the plan(s). The actual return includes dividends and interest income. 
Company X's pension plans lost $512 million.

Item: J; 
Definition: Employer contributions are the total contributions (usually 
cash) made by the company to its pension plan(s). Employer 
contributions are not the same as the net cost to the company 
sponsoring the pension plans.

Item: K; 
Definition: Participant contributions are the total amount of cash paid 
into the pensions plan(s) by employees. The employees of Company X did 
not contribute to their defined benefit pension plans in this year.

Item: L; 
Definition: Benefits paid--this is generally the same as in Item F. 
Benefits paid reduce the value of assets held by the company's pension 
plan(s).

Item: M; 
Definition: See Item H.

Item: N; 
Definition: The expected long-term rate of return on plan assets is the 
company's assumption about the long-term average rate of return on its 
pension plan assets. The rate disclosed in the current year is used to 
calculate the expected return on plan assets (Item S) in the components 
of net periodic cost of defined benefit plans.

Item: O; 
Definition: The discount rate should reflect the interest rate on high-
quality corporate bonds. It is used to the measure the present value of 
the projected benefit obligation in the current year and will be used 
to calculate the service cost and interest cost in the following year.

Item: P; 
Definition: The expected rate of compensation increase is used to 
calculate the projected benefit obligation and service cost when 
benefits take future salary into account.

Item: Q; 
Definition: See Item B.

Item: R; 
Definition: See Item C.

Item: S; 
Definition: The expected return on plan assets is an estimate of what 
the company expects to earn from the investment of pension plan assets; 
it reduces the company's periodic pension expense and is used to keep 
this expense relatively smooth over many years. It is calculated by 
multiplying the expected rate of return (Item N) by the "market-
related" value of plan assets (Item W). The expected return is reported 
as a negative number because it reduces the overall periodic pension 
cost.

Item: T; 
Definition: The amortization of prior service cost is the periodic cost 
recognized by the company for pension benefits credited to employees 
for service prior to their enrollment in a pension plan.

Item: U; 
Definition: Amortization of net actuarial (gain) loss is used when the 
cumulative difference between actual experience and assumptions reaches 
a threshold of 10 percent of either the market- related value of total 
pension assets or obligations, whichever is greater. Company X is 
recognizing $1 million in this year for past actual gains that exceeded 
expected gains. This amortization reduces its pension cost by $1 
million for this year.

Item: V; 
Definition: The total (benefit) cost included in results of operations 
is the total of Items Q - U and may also be called the net periodic 
pension cost. It is the amount included in the company's labor costs, 
which are reported in the consolidated statement of operations (income 
statement).

Item: W; 
Definition: The market-related value of plan assets is not required to 
appear anywhere in the financial statement but is used to calculate the 
expected return on plan assets (Item S). The market- related value of 
plan assets can either be the fair market value of plan assets or an 
average value of the assets over a period not exceeding 5 years. It is 
possible to closely estimate the market- related value of plan assets 
by dividing the expected return on plan assets by the expected long-
term rate of return on plan assets. 

Source: GAO analysis.

[End of table]

A company's total operating costs include its labor costs, which 
include the net periodic pension cost. Therefore the net periodic 
pension cost is factored into the calculation of total operating costs, 
which affects operating profit, consolidated profit before taxes, the 
calculation of tax to be paid, and net profit (Items Y--CC in table 5).

Changing the expected rate of return on plan assets from 9.8 percent to 
8.5 percent has the following effects:

In the components of net periodic cost of defined benefit plans, the 
expected return on plan assets (Item S) falls from $783 million to $679 
million.[Footnote 45] This increases the total periodic pension cost by 
$114 million, which is enough to turn Company X's periodic pension 
income of $90 million into a cost of $14 million.

The increase in net periodic pension cost of $114 million increases the 
companies total operating costs (Item Y) and decreases the operating 
profit (Item Z) and consolidated profit before taxes (Item AA) by the 
same amount. Because taxable income is reduced, Company X pays less in 
corporate income tax (Item BB). Last, net profits (Item CC) decline 
from $802 million to $720 million, which for Company X's shareholders 
of approximately 344 million shares of common stock would have meant a 
drop of about 24 cents in earnings per share (Item DD).

[End of section]

Appendix III: GAO Contacts and Staff Acknowledgments:

Contacts:

George A. Scott, Assistant Director (202) 512-5932 Richard L. Harada, 
Analyst-in-Charge (206) 287-4841:

Staff Acknowledgments:

In addition to those named above, Joseph Applebaum, Kenneth Bombara, 
Richard Burkard, David Eisenstadt, Elizabeth Fan, Michael Maslowski, 
Scott McNulty, Stan Stenerson, Roger Thomas, and Shana Wallace made 
important contributions to this report.

FOOTNOTES

[1] References to pension plan asset and liability values in Form 5500 
throughout this report reflect information provided in Schedule B.

[2] A 401(k) plan generally allows participants to make contributions 
that are not taxed until the funds are used. Earnings on these 
contributions likewise accumulate tax-free until the funds are used. 

[3] Private Pension Plan Bulletin: Abstract of 1998 Form 5500 Annual 
Reports, U.S. Department of Labor Pension and Welfare Benefits 
Administration, Number 11 (Washington, D.C.: Winter 2001-2002).

[4] In contrast, under a defined contribution plan, the employee bears 
the investment risk. Hybrid plans, such as cash balance plans, are 
defined benefit plans, which combine some of the characteristics of 
defined contribution plans. The characteristics of these various types 
of plans are explained more fully in our publication Answers to Key 
Questions about Private Pension Plans, GAO-02-745SP (Washington, D.C.: 
September 2002), pp. 22-24. 

[5] PBGC receives no direct federal tax dollars to support this 
insurance program; rather it is funded by premiums paid by the 
corporate sponsors of defined benefit plans insured by PBGC. The 
program receives the assets of terminated underfunded plans and any of 
the sponsor's assets that PBGC recovers during bankruptcy proceedings. 
PBGC finances the unfunded liabilities of terminated plans with (1) 
premiums paid by plan sponsors and (2) income earned from the 
investment of program assets. 

[6] On January 15, 2004, PBGC released its fiscal year 2003 financial 
results and reported a current deficit of $11.2 billion for the single-
employer insurance program.

[7] See U.S. General Accounting Office, Pension Benefit Guaranty 
Corporation Single-Employer Insurance Program: Long-Term 
Vulnerabilities Warrant "High-Risk" Designation, GAO-03-1050SP 
(Washington, D.C.: July 23, 2003).

[8] ERISA sections 103 and 104 of Title I and Internal Revenue Code 
sections 6057, 6058, and 6059 provide the statutory authority for the 
filing of an annual return/report, which includes financial information 
pertaining to the plan.

[9] The Internal Revenue Service enforces standards that relate to such 
matters as how employees become eligible to participate in benefit 
plans, how they become eligible to earn rights to benefits, and how 
much, at a minimum, employers must contribute. The Department of Labor 
enforces ERISA's reporting and disclosure provisions and fiduciary 
responsibility standards, which among other things concern the type and 
extent of information provided to the federal government and plan 
participants and how pension plans are operated in the interests of 
plan participants.

[10] The Department of Labor has issued regulations exempting certain 
pension and welfare plans from the requirement to file a Form 5500 
based on size and type of plan. Welfare plans provide participants and 
their beneficiaries various nonpension benefits such as for health 
care, unemployment, disability, training programs, and legal services. 
Welfare plans are not subject to the same funding requirements as 
pension plans.

[11] For plans with fewer than 100 participants the agencies have 
developed simplified reporting requirements that do not include audited 
financial statements.

[12] The statement of earnings and comprehensive income measures 
profitability of the company by showing the income earned and expenses 
incurred during the year. Comprehensive income would include accounting 
adjustments and holding gains and losses for certain securities and 
investments. The statement of financial position provides information 
about a company's assets, liabilities, and equity and their 
relationships to one another at the end of the company's fiscal year. 
The statement of cash flows reflects a company's major sources of cash 
receipts and its major uses of cash. The statement of stockholder's 
equity reflects the company's transactions during the year related to 
capital contributions and distributions to company stockholders.

[13] FASB's mission is to establish and improve standards of financial 
accounting and reporting for the guidance and education of the public, 
including issuers, auditors, and users of financial information. FASB, 
which is part of a structure that is independent of all other business 
and professional organizations, develops broad accounting concepts, 
standards for financial reporting, and guidance on how to implement the 
standards. 

[14] ERISA Section 103(a)(4)(B).

[15] There are additional measures of pension funding required by ERISA 
and the Internal Revenue Code, but this measure of pension funding is 
the first one used to determine compliance with pension funding 
requirements.

[16] A class of assets is composed of assets that share similar 
characteristics, such as risks and expected rates of return. Examples 
include equities, corporate bonds, government bonds, and real estate. 

[17] Minimum funding rules permit certain plan liabilities, such as 
past service liabilities, to be amortized over specified time periods. 
See 26 U.S.C. 412(b)(2)(B). Past service liabilities occur when 
benefits are granted for service before the plan was established or 
when benefit increases after establishment of the plan are made 
retroactive.

[18] See the Omnibus Budget Reconciliation Act of 1987, (P.L. 100-203, 
Dec. 22, 1987) and Retirement Protection Act of 1994 (P.L. 103-465, 
Dec. 8, 1994).

[19] For each additional period of employment (for example, 1 year), 
active plan participants normally earn additional pension benefits, 
which increase a company's pension costs. Furthermore, as employees get 
closer to retirement with each passing year, the present value of the 
company's benefit obligation increases because there is less time 
available to invest pension assets and earn interest on them.

[20] Financial analysts told us that most large companies substitute a 
"market-related" value of pension assets for the reported market value 
for the purpose of this calculation. See example in appendix II.

[21] In December 2003 FASB revised its pension disclosure standard, 
Statement of Financial Accounting Standards No. 132, to require a 
narrative description of the basis used to determine the overall long-
term expected rate of return on assets assumption.

[22] For a Form 5500 filing, ERISA requires an enrolled actuary to 
certify that all assumptions used are individually reasonable and 
represent the actuary's "best estimate of anticipated experience under 
the plan." For corporate financial statements, actuaries told us that 
they provide companies an actuarial report, which states whether the 
actuary believes the rate of return assumption used by company 
management falls within a reasonable range. The company's independent 
auditor must separately evaluate the reasonableness of all significant 
assumptions.

[23] Actuaries for small pension plans told us that they normally use 
end-of-year data because it is not difficult to assemble information 
about all plan participants and their clients usually prefer to have 
contributions to the plan in synchronization with the benefits earned 
during the year.

[24] In practice, PBGC has taken steps to allow for timelier monitoring 
of those plans that may pose a financial risk to the single-employer 
pension insurance program. In 1993 PBGC established the Form 5500 
intercept program, which has speeded up the process for obtaining 
information on the largest and most underfunded plans. For about 2,100 
plans on the intercept list, the Department of Labor mails copies of 
their Form 5500 filings to PBGC before it begins to process them.

[25] A vested participant has earned the nonforfeitable right to his or 
her accrued benefit. There are certain rules that private plan sponsors 
must follow regarding the length of time that participants must work in 
order to be fully vested in their accrued benefits. Participants are 
100 percent vested in any contributions they make to a qualified plan, 
but may have to work for a certain period of time before earning a 
right to their employer's contributions.

[26] Terminating an underfunded plan is termed a distress termination 
if the plan sponsor requests the termination or an involuntary 
termination if PBGC initiates the termination. PBGC assumes 
responsibility for terminated underfunded plans and pays the pension 
obligations to plan participants up to the amount guaranteed under 
Title IV of ERISA. PBGC also makes a claim on the employer's assets in 
bankruptcy proceedings as an unsecured creditor. However, PBGC 
officials told us that the agency's claims usually amount to only a few 
cents per dollar claimed.

[27] Termination liability is calculated by using a PBGC interest 
factor, which is based on a survey of insurance companies and, along 
with a specified mortality table, reflects group annuity purchase 
rates.

[28] See U.S. General Accounting Office, Pension Benefit Guaranty 
Corporation: Single-Employer Pension Insurance Program Faces 
Significant Long-Term Risks, GAO-04-90 (Washington, D.C.: October 
2003), pp. 17-19, for further discussion of the failure of the 
Bethlehem Steel pension plan.

[29] Corporate debt rated below investment grade by the main debt 
rating agencies (Standard & Poor's, Moody's, Fitch Ratings) pays a 
higher interest rate to bondholders and is more expensive for companies 
than if their debt is rated investment grade. A below-investment-grade 
rating indicates a significant risk that the company will not be able 
to repay its debt to bondholders. This risk is usually derived from a 
combination of a company's profitability, cash flow, total debt, and 
other factors that are reported in corporate financial statements.

[30] In 2002, the SEC adopted accelerated filing dates for 10-K reports 
for companies with a market capitalization of at least $75 million. 
Under these rules these companies must file their 10-K reports within 
75 days for fiscal years ending on or after December 15, 2003, and 
within 60 days for fiscal years ending on or after December 15, 2004.

[31] In December 2003 FASB revised its pension disclosure standard (FAS 
132) to require disclosure of the employer's best estimate of 
contributions expected to be paid during the next fiscal year. In 
addition, companies must disclose each major category of pension plan 
assets.

[32] See appendix II for an example of how pension expense is 
calculated in a corporate financial statement.

[33] Statement of Financial Accounting Standards No. 87, Employers' 
Accounting for Pensions, requires companies to determine the expected 
return on plan assets based on the expected long-term rate of return on 
plan assets and the market-related value of plan assets. The market-
related value of plan assets is defined as "either fair value or a 
calculated value that recognizes changes in fair value in a systematic 
and rational manner over not more than five years."

[34] The unrecognized gains or losses account appears in the pension 
footnote to the corporate financial statement but is not recognized on 
the plan sponsor's balance sheet.

[35] The excess amount is amortized over the average remaining working 
years of active plan participants or average remaining life expectancy 
of retired plan participants if all or most participants are inactive.

[36] Goldman Sachs, Global Economics Weekly, "US: Pension Costs--
Another Hit to Cash Flow," November 13, 2002.

[37] Credit Suisse First Boston, The Magic of Pension Accounting, 
September 27, 2002.

[38] The four areas to improve pension security for Americans were (1) 
the accuracy of the pension liability discount rate, (2) the 
transparency of pension plan information, (3) safeguards against 
pension underfunding, and (4) comprehensive funding reforms.

[39] See Statement of Financial Accounting Standards No. 132 (revised 
2003), Employers' Disclosures about Pensions and Other Postretirement 
Benefits.

[40] In GAO's response to the FASB's exposure draft for new pension 
disclosures, we supported the initiative to enhance disclosures for 
pension and other postretirement benefits. We believe that improved 
transparency in plan funding and funded status, investment strategies, 
and market risk could reduce the risks to the federal government's 
pension insurance programs and promote the retirement security of 
workers and retirees.

[41] The United Kingdom's Accounting Standards Board issued Financial 
Reporting Standard 17, Retirement Benefits, in November 2000, and it 
was amended in 2002.

[42] See GAO-04-90.

[43] Because of the filing requirements of Form 5500, no data were 
available for 2002 during the course of our study.

[44] Some of the 97 companies in our sample sponsor more than one 
pension plan.

[45] The expected return on plan assets of $679 million was calculated 
by multiplying the market-related value of plan assets (Item W) by the 
new expected long-term rate of return on plan assets (Item N) of 8.5 
percent.

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