The Financial Accounting Standards Board (FASB) issued a (final) FASB Staff Position (FSP) amending FASB Statement No. 132(R) (Employers’ Disclosures about Pensions and Other Postretirement Benefits). FSP FAS 132(R)-1 provides new rules for financial statement disclosures about defined benefit plan assets, requiring, among other things, detailed disclosure of the categories of plan assets, concentrations of risk and methodologies used to value investments.

Disclosure Objectives
Fundamental to the new FSP disclosure rules is a set of “overall objectives.” Reading between the lines, the overall objectives function both as an explanation for certain requirements in the FSP and as a way of clarifying uncertainties that may arise about the detail of disclosure required in any given situation. Those objectives are to provide users of financial statements with an understanding of:
• How investment allocation decisions are made, including the factors that are pertinent to
  an understanding of investment policies and strategies
• The major categories of plan assets
• The inputs and valuation techniques used to measure the fair value of plan assets
• The effect of fair value measurements using significant unobservable inputs (Level 3) on   changes in plan assets for the period
• Significant concentrations of risk within plan assets”

Disclosure Element 1
Statement of Investment Policies and Strategies
In keeping with these overall objectives, the first element of disclosure required by the FSP is, in effect, a statement by the sponsor of its overall objectives in investing plan assets:

“An employer shall disclose a narrative description of investment policies and strategies, including target allocation percentages or range of percentages considering the major categories of plan assets disclosed … and other factors that are pertinent to an understanding of those policies and strategies such as investment goals, risk management practices, permitted and prohibited investments including the use of derivatives, diversification, and the relationship between plan assets and benefit obligations.”

This language is substantially the same as was included in FAS 132(R), issued in 2003.

Disclosure Element 2
Categories of Plan Assets
The second disclosure element is: “the fair value of each major category of plan assets.”

“Examples of major categories include, but are not limited to, the following: cash and cash equivalents; equity securities (segregated by industry type, company size, or investment objective); debt securities issued by national, state, and local governments; corporate debt securities; asset-backed securities; structured debt; derivatives on a gross basis (segregated by type of underlying risk in the contract, for example, interest rate contracts, foreign exchange contracts, equity contracts, commodity contracts, credit contracts, and other contracts); investment funds (segregated by type of fund); and real estate.”

In considering the issue of how to categorize plan assets, FASB ran into an obvious problem—that no list of categories would be adequate, and that in some cases micro-categorization would prove unproductive. So the FSP goes on to state that, generally, “asset categories shall be based on the nature and risks of assets in an employer’s plan(s).” This suggests the use of asset categories, for any given sponsor’s plan, that effectively meet the “overall objectives.”

Disclosures with Respect to Investment Funds
Investment funds—mutual funds, separate accounts, hedge funds, etc.—present a special categorization problem. FASB considered and rejected requiring sponsors to “look through” investment funds and categorize the funds’ assets. Instead, the FSP requires that “For investment funds disclosed as major categories … a description of the significant investment strategies of those funds shall be provided.”

Explanation of Expected Long-Term Rate-of-Return-on-Assets Assumption
The final FSP modified the following requirement under FAS 132(R) by adding the last sentence:
“An employer shall disclose a narrative description of the basis used to determine the overall expected long-term rate-of-return-on-assets assumption, such as the general approach used, the extent to which the overall rate-of-return-on-assets assumption was based on historical returns, the extent to which adjustments were made to those historical returns in order to reflect expectations of future returns, and how those adjustments were determined. The description should consider the major categories of assets described above, as appropriate.”

Disclosure Element 3
Fair Value Measurement Inputs
The third disclosure element is, in effect, the application of FAS 157 (Fair Value Measurements) rules—requiring disclosure about asset valuation inputs—to a DB plan sponsored by the company. In this regard, sponsors must disclose for each major asset category:

“The level within the [FAS 157] fair value hierarchy in which the fair value measurements in their entirety fall, segregating fair value measurements using quoted prices in active markets for identical assets or liabilities (Level 1), significant other observable inputs (Level 2), and significant unobservable inputs (Level 3). [And,] information about the valuation technique(s) and inputs used to measure fair value and a discussion of changes in valuation techniques and inputs, if any, during the period.”

Disclosure Element 4
The Effect of Fair Value Measurements Using Significant Unobservable Inputs (Level 3) on Changes in Plan Assets for the Period

The FSP identifies as a separate, fourth disclosure element information about the effect of Level 3 inputs on changes in plan assets during the measurement period, as follows:

“For fair value measurements of plan assets using significant unobservable inputs (Level 3), a reconciliation of the beginning and ending balances, separately presenting changes during the period attributable to the following:
1. Actual return on plan assets (as defined in Statements 87 and 106), separately identifying the amount related to assets still held at the reporting date and the amount related to assets sold during the period
2. Purchases, sales, and settlements … net
3. Transfers in and/or out of Level 3 (for example, transfers due to changes in the observability of significant inputs)”
Despite comments that this “Level 3 reconciliation” would be overly burdensome, and against staff recommendation, the Board retained this requirement in the final FSP. Clearly there is concern at FASB (and within the accounting profession generally and at the Department of Labor) about issues presented by the valuation of hard to value assets. As the FSP states, “the Board indicated that the Level 3 reconciliation would enable users of financial statements to segregate the effect of fair value measurements of plan assets that are inherently subjective and enhance users’ ability to assess the quality of total plan assets and comprehensive income, albeit indirectly.” We would expect further efforts by FASB to “get a handle” on the valuation of these sorts of assets.

Disclosure Element 5
Concentrations of Risk
The fifth disclosure element is information about concentrations of risk. As originally proposed, the FSP “would have required an employer to disclose the nature and amount of a concentration of risk arising within or across categories of plan assets. Examples of concentrations of risk included, but were not limited to, significant investments in a single entity, industry, country, commodity, or investment fund.” For instance, REITs, direct real estate holdings and any real estate assets in an investment fund would have correlated risks. In response to comments that such an exercise would be overly burdensome, the final FSP, tying back to the overall objectives, simply requires that:

“An employer shall provide users of financial statements with an understanding of significant concentrations of risk in plan assets. This objective should be considered by employers in providing detailed disclosures about plan assets.”

Effective Date
The FSP is effective for fiscal years ending after December 15, 2009, although earlier application is permitted.
Upon initial application, the FSP’s provisions do not need to be applied to earlier periods that are presented for comparative purposes. However, plans with Level 3 assets will need to separately identify the value of these assets at the end of 2008 for purposes of preparing the reconciliation of these assets required at the end of 2009.

Conclusion
The new rules will significantly increase required financial statement disclosures with respect to DB plan assets. While there are some new requirements that are very specific, the new rules are organized around the general disclosure objectives described at the beginning of the FSP, with the idea that reporting entities should develop disclosures (e.g., with respect to categories and concentrations of risk), with those overall objectives in view.

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