Although the issue of pension liability recognition has been widely discussed, recognition of a net pension surplus as a corporate asset has not been considered in depth.

Many Plans Are Overfunded

Recognition of a net pension asset deserves serious consideration as an increasing number of corporations find themselves with overfunded plans. According to Pensions and Investment Age's survey of the 100 companies that sponsored the largest defined benefit plans in 1988, 95 companies had overfunded plans, using the accumulated benefit obligation as a measure of the firm's liability. Pension funds can also be very large relative to total corporate assets. Forty-four of the surveyed 100 companies had a ratio of plan assets to total corporate assets in excess of 20%. For 29% of the companies, earnings on plan assets were large enough to offset completely the periodic cost of plan sponsorship and to generate net pension income.

Although information on the fair market value of pension plan assets can be found in footnote disclosures, disclosure cannot be considered a substitute for recognition if pension assets meet recognition requirements. While some research indicates footnote disclosures are incorporated into the market's determination of stock prices, other studies have suggested individuals do not treat footnote disclosures in the same way as balance sheet items.

Asset Recognition under SFAS 87

Under SFAS 87, an employer must recognize a liability in the statement of financial position that is at least equal to the unfunded benefit obligation, although that liability can be offset by an intangible asset under some circumstances. However, an employer with an overfunded plan does not recognize an asset. In its discussion of SFAS 87, FASB stated that pension plan assets should be attributed to the employer because the employer bears the risk and rewards associated with plan performance. FASB also noted that the frequency of asset reversions were compelling evidence that excess plan assets belong to the employer. Despite a stated belief that recognition of a net plan asset for overfunded plans would be conceptually appropriate, FASB concluded that requiring recognition would be too great a change from past practice to be adopted at the present time.

The Conceptual Framework

The FASB never discussed explicitly whether surplus pension assets meet the definition of an asset given in Statement of Financial Accounting Concepts 6, even though its original proposal on employer accounting for pensions would have required asset recognition for overfunded plans. FASB focused on the separate presentation of pension assets when a plan was underfunded, rather than the issue of ownership of excess plan assets. However, there are significant differences in the degree to which a corporation can control pension plan assets needed to meet existing obligations and pension plan assets which are in excess of pension plan obligations.

Assets are defined in Concept Statement 6 as "probable future economic benefits obtained or controlled by a particular entity as a result of past transactions or events." The economic benefits to a firm of pension plan assets are not disputed. Even if a corporation had no access to plan assets for other operating purposes, favorable earnings on plan assets can reduce future contributions to the plan. The controversial issue is the degree to which pension fund assets can be controlled by the plan sponsor. Legal enforceability of the claim is not a prerequisite for a benefit to qualify as an asset if the entity has the ability to control the benefit in other ways. However, in considering corporate control of excess pension assets, attention must be given to existing legal limitations on corporate control.

The Effect of ERISA on Corporate Control of Pension Fund Assets

The statutory rights and obligations of pension plan sponsors are contained in ERISA. Under ERISA, a plan sponsor must discharge its duties with respect to the plan solely in the interest of plan participants. The IRC also requires that pension plan assets of qualified plans be used for the exclusive benefit of plan participants. As long as a pension plan is a going concern, corporate access to pension plan assets is legally restricted. However, under ERISA, surplus pension assets may revert to the employer if a pension plan is terminated, the employer can satisfy all existing obligations under the plan, and the plan allows such distributions. As FASB noted in its discussion of SFAS 87 (par. 112), the ability of a corporation to terminate a plan and legally claim excess pension fund assets provides strong support for regarding surplus pension fund assets as a corporate asset. Although the employer's right to reclaim excess pension assets has been disputed, the courts have found that reversions are consistent with the spirit of ERISA, noting that the purpose of ERISA is to protect employees to the extent of promised benefits, not to provide pension windfalls just because a plan is overfunded.

Absent a planned termination, there is some question as to the degree of control a plan sponsor has over pension assets. ERISA requires that pension plan assets be managed solely for the benefit of employees, and even in the event of a termination, corporate access to surplus pension assets has been disputed. As noted previously, a corporation cannot claim surplus pension assets unless the terms of the plan explicitly allow reversions. The Pension Benefit Guaranty Corporation (PBGC), which must approve all terminations, has taken the position that plans cannot be amended to provide reversion to the employer and will litigate when reversion clauses are added prior to termination. There have also been a number of suits attempting to block companies from using pension assets to fight takeover attempts or to recapture the surplus without sharing a portion with the employees.

In addition to court challenges to reversions, there have been attempts in Congress to prevent companies from claiming pension surpluses. Opponents of reversion argue that reversions are "unfair" to workers because benefits at termination are less than what workers would receive if the plan were continued. Opponents also argue that pension law requires plans be established with the intention that they remain permanent. Although Congress has not blocked reversions, there have been a number of recent legislative attempts to restrict corporate access to pension plan assets and to increase labor's control over pension funds.

There is currently a great deal of uncertainty about a corporation's direct control over a pension surplus, but excess pension fund assets could provide economic benefits to the corporation while being managed in the interest of employees. For example, there has been a suggestion that companies be allowed to use excess pension funds to finance other postemployment benefits without terminating plans (not currently allowed under ERISA). However, attributing pension assets to the corporation on the balance sheet could be a sensitive political issue, given workers often expressed view that pension funds are deferred wages and therefore their property.

Financial Theory

Financial theory offers two competing views as to whether a pension plan surplus can be considered a corporate asset. The integration hypothesis views the assets of the plan as inseparable from the assets of the firm. In contrast, the separation hypothesis views plan assets as separate from the corporation.

Under the integration hypothesis, the pension fund is considered a corporate asset and the obligation to pay the benefits is a corporate liability. The view is consistent with ERISA, which makes a plan sponsor liable for vested benefits. Benefits are independent of pension plan performance, and all corporate assets, not just plan assets, are security for promised benefits.

Financial Slack Needed

Consistent with the integration hypothesis, a pension surplus has also been argued to serve as financial slack." Financial slack is unused debt capacity or liquid assets such as cash or marketable securities that a firm can turn to rather than resorting to external financing during a downturn. Although liquid assets are more accessible than a pension surplus, there are tax advantages to accumulating financial slack, in a pension fund because earnings on pension assets are tax-free and contributions are usually tax deductible.

Assets Belong to the Beneficiaries

The separation hypothesis views the pension fund as separate from the corporation. Under this perspective, funding and investment decisions are made to serve the needs of the plan beneficiaries, not the corporation. The separation hypothesis also draws support from ERISA, which made explicit that pensions funds are legal entities and placed restrictions on a firm's control over pension assets.

What Do The Securities Markets Think?

Overall, financial theory presents two conflicting views as to whether a pension surplus should be considered a corporate asset. Market-based research has found support for the integration hypothesis, especially with respect to a net pension liability. However, one study results suggest that the market does not regard a net pension asset as a corporate asset prior to reversion. Therefore, from the perspective of corporate finance, the question of pension surplus ownership has not been resolved.

Measurement

Regardless of whether an item meets the definition of an asset, recognition depends on determination of a relevant attribute to measure. Measurability does not appear to be a problem with regard to recognition of pension plan assets. The FASB determined that the fair value of fund assets was the relevant attribute for determining the minimum liability under SFAS 87. The fair value of the plan assets (whether equity or debt securities, real estate, or other investments) is defined as current market price for investment for which an active market exists. Current market values of pension plan assets are widely reported in the financial press as well as disclosed in corporate financial reports. Recognition of pension assets using current market values, however, would increase inconsistency in current reporting. The same equity securities held in noncurrent investment portfolios are valued at the lower of cost or market, which excludes recognition of price appreciation above historical cost. There is no apparent justification for concluding current market value is the relevant attribute for pension plan assets and lower of cost or market is relevant for other corporate holdings of equity securities. Logically, recognition of pension plan assets should be accompanied by reconsideration of SFAS 12. Therefore, although pension plan assets can be measured, recognition in financial statements has wider implications.

Conclusion

The FASB's position is that a pension surplus meets the criteria for asset recognition. However, in the absence of an approved termination and reversion, the control a corporation has over the pension surplus is questionable. Absent a termination, ERISA requires pension plan assets be managed in the interest of plan participants, not corporate shareholders, and empirical studies on the stock price reaction to pension plan reversions suggest that the market does not regard a corporation's access to pension assets as a "sure thing."

The FASB needs to examine thoroughly the nature of the corporate benefits from, and claims to, excess pension assets.