Financial Stability of Funding a Pension
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Lockheed Martin Corporation, an advanced technology company, was formed in March 1995 with the merger of two of the worlds premier technology companies, Lockheed Corporation and Martin Marietta Corporation. Headquartered in Bethesda, Maryland, Lockheed Martin employs about 130,000 people worldwide and is principally engaged in the research, design, development, manufacture and integration of advanced technology systems, products and services.
A pension plan is an arrangement whereby an employer provides benefits to employees after they retire for services they provided while they were working. The company or employer is the organization sponsoring the pension plan. It incurs the cost and makes contributions to the pension fund. The fund or plan is the entity that receives the contributions from the employers, administers the pension assets, and makes the benefit payments to the pension recipients. Most companies analyze their pension plans during the fourth quarter. These calculations are done annually, and significant changes may prompt companies to issue earnings guidance before reporting their year-end results in January.
Companies may offer two types of pension plans: a defined contribution plan or a defined benefit plan. In a defined contribution (or profit-sharing) plan, the employer does not guarantee the plans future performance — the future value of benefits paid to employees is unknown. The employer makes contractual fixed payments (or a specified portion of net income, if it is a variable profit-sharing plan), but the employee assumes the risk for investment performance. Accounting for defined contribution plans is a simple and straightforward process; however defined benefit plans, involve many complicated calculations to determine the benefits provided.
Defined benefit plans requires employers to supply specific cash flows, such as a fixed amount or an amount related to the employees final salary (a career average may be used). Unlike defined contribution plans, the employer takes on the investment risk for meeting contractual pension benefits, creating more complex accounting in order to value this liability. In defined benefit plans, employers must estimate future pension obligations to determine the necessary contributions.
To determine whether a plan is overfunded or underfunded, companies must forecast expected rates of returns on the pension fund assets, future salary levels (including turnover, mortality, quit rates, retirement dates, and salary increases), and the discount rate used to compare the present value of future obligations to the current pension plan amount. All of these variables are subject to managements judgment and, as a result, pension accounting can dramatically affect reported earnings.
We will look at Lockheed Martin Corporations pension plan and post retirement benefits. We will discuss the types of plans, the impact of the on financial statements, how they are disclosed, and the impact the market plays on the company.
Lockheed Martin covers most of its employees under defined benefit pension plans, as well as certain health care and life insurance benefits to eligible retirees. The expense or income recorded for these employee benefit plans can have either a positive or negative effect on earnings. Lockheed Martin uses Statement of Financial Accounting Standards (FAS) 87 – Employers Accounting for Pensions which requires them to record income and expenses using actuarial valuations, which are susceptible to fluctuation, due to changes in key economic indicators. To estimate pension expense or income for the upcoming fiscal year, the discount rate, the expected long-term rate of return on plan assets and the rate of increase in future compensation levels are the assumptions used.
The Corporation makes trust contributions established for the payment of future benefits to the Corporations eligible retirees and their dependents. Lockheed Martin Investment Management Company (LMIMCO), a wholly owned subsidiary of the Corporation has the fiduciary responsibility to make decisions regarding investment of the defined pension plan assets and retiree medical and life insurance plans.
LMIMCO has been tasked with the investment goal of minimizing the net present value of expected funding contributions and to meet or exceed the assumed rate of return for long term plan funding. LMIMCO has in place strategies and polices that govern plan assets. These policies and strategies include the usage of external investment managers and the maintenance of sufficient liquidity to meet benefit obligations as they become due. These policies require that asset allocations of defined benefit pension plans maintained within the following ranges:
Investment Groups
Asset Allocation Ranges
Equity securities
35-70%
Non-US equity securities
0-25%
Debt securities
10-60%
0-35%
Other
0-15%
The Corporation adheres to the U.S. Government Costs Accounting Standards (CAS) and Internal Revenue Code rules in determining funding requirements for its pension plans, and the extent to which pension costs can be allocated to and recoverable from US Government contracts. Funded amounts are recovered through the pricing of the various products and services on US Government contracts and recognized in net sales. The projected 2005 funding requirements are expected to increase, in addition to additional funding that may be required by Internal Revenue Code rules. Any additional amounts paid under CAS rules will be considered prepayments and recorded on the balance sheet and recoverable in future periods.
As previously mentioned, Lockheed Martin initially only had a post-retirement benefit plans. The defined contribution plans and retiree medical and life insurance plans are not shown on the balance sheet until the 2002 financial statements. Also note that is 2002 Lockheed established an accrued pension account that was