When the global recession hit in 2008, Honeywell’s pension plans felt the force. Like most companies, Honeywell incurred significant losses to the asset values of its defined benefit pension plans and the lower interest rate environment that ensued further adversely affected each plan’s funded status.

Honeywell has a number of these defined benefit pension plans, with a combined projected benefit obligation of approximately $19 billion at 31^st December 2010. During the recent recession, plan asset returns were down 29% in 2008 and discount rates dropped from 6.95% to 5.25% from 2008 to 2010 year-ends, respectively, resulting in a deterioration in the funded status of the company’s pension plans of approximately $4.1 billion under-funded at 31^st December 2009.

To improve the transparency of the business operating results, Honeywell adopted an innovative approach to pension accounting referred to as the Mark-to-Market (MTM) accounting model.

The company historically accounted for its pension plans under US Generally Accepted Accounting Principles smoothing assets over three years (versus peer average of five years) and amortising actuarial gains and losses (due to actual returns being lower than expected returns and the impact of lower interest rates on the pension obligation) over six years (versus peer average of ten to 12 years).

This accounting methodology of smoothing approximately $7.5 billion in deferred losses over relatively short periods resulted in a significant increase in projected annual non-cash pension expense from $100m in 2009 to an estimate of $800m in 2010 and $1.2 billion in 2011. The problem was that the pension plans and expense were distorting Honeywell’s reported financial results and the market’s perception of the company by masking improving operating performance as the global economy recovered.

Conversely, under MTM accounting aggregate actuarial gains and losses outside the corridor are recognised annually in the fourth quarter of each year. This meant that approximately $7.5 billion in deferred losses were no longer going to be amortised in the future, which would mean that an approximate $1 billion was saved in forecast 2011 pension expenses.

Honeywell’s comprehensive approach to pension management was important because it established a unique accounting model for pension plans that improved the transparency of the company’s operating results and has been followed by others, including Verizon and AT&T.

Honeywell also proactively initiated the execution of a smart, tax efficient funding strategy and took steps to mitigate future variability by lowering the assumed rate of return on plan assets.

“We implemented a smart funding strategy by tax efficiently utilising Honeywell stock as well as proceeds from a debt issuance ($1 billion) to proactively fund our pension plans. We took steps to mitigate the variability of future pension expense by lowering our asset return assumption from 9% to 8%, as well as began to evaluate asset mix and liability duration matching as our pension plans approach full funding,” says John Tus, Group Treasurer.