September 25, 2000

Jonathan G. Katz
Securities and Exchange Commission
450 Fifth Street, NW
Washington, DC 20549-0609

Dear Sir:

Buck Consultants, Inc., a leading international employee benefits and human resources consulting firm, would like to submit the following comments concerning the SEC's July 12, 2000 proposed amendments to the rules regarding auditor independence. We commend the SEC's proposals that are aimed at safeguarding the integrity of public companies' financial statements by ensuring the independence of those entrusted to audit their financial records.

We are limiting our comments to the area of greatest relevance to our own business, that is, the provision by auditors of actuarial and related services to and for the employee benefit plans of their clients. In brief, our view is that:


As evidenced by the annual reports of SEC registrants, the cost of pensions, postretirement and other postemployment benefits is material to the earnings of many publicly-held companies. Recently published articles have highlighted the fact that among many large publicly-held companies, a significant percentage of net income is attributable to net periodic pension cost (income).

For example, an article in the June 15, 1999 issue of the Wall Street Journal noted that more than $1 billion of GE's pre-tax profit of $13.4 billion was attributable to its pension plan. GE, like other big American companies, has invested large sums of pension assets in the stock market which has produced plan surpluses. These companies are following generally accepted accounting rules which provide that if investment returns on pension assets exceed the pension plan's current costs, a company may report the excess as a credit on its income statement. This article also noted that Bell Atlantic Corporation's pension plan produced a $627 million pre-tax credit for the company's 1998 income statement and that GTE Corporation and Caterpillar, Inc., reaped pre-tax credits of $473 million and $183 million respectively, from their pension plans. In fact, this has become so common a scenario that, according to a Bloomberg survey of SEC annual reports, 25% of S&P 500 companies reported net income from pensions in 1999. Of this group, 42% reported that pension income boosted pre-tax earnings by more than 5%.

Determination of Actuarial Costs

The Financial Accounting Standards Board has provided guidance on the determination of net periodic pension cost (or income where the plan is funded in excess of its obligations) and other postretirement and postemployment benefit costs in these standards:

Under FAS 87, companies that sponsor pension plans report pension liabilities or surpluses in the footnotes to their financial statements, and book the cost of providing pensions in their income statements. In today's strong economic environment, many large companies are not incurring pension costs. Instead, pension funds are generating income, which flows through to operating income. This is a result of the dramatic increase in pension assets that has led to increased earnings on these assets, which offset pension costs and, in some instances, generates a net income.

The determination of costs under any of these standards requires the services of a qualified actuary who uses computer models, actuarial techniques and actuarial assumptions. Actuarial assumptions include a discount rate, an expected long-term rate of return on plan assets (if any), and assumptions as to future employee mortality, turnover and ages at retirement. In the case of postretirement medical expenses, an assumption must also be made about inflation in future medical costs (the "trend rate").

The selection of assumptions in valuing these obligations is the responsibility of management, but typically involves consultation with a qualified actuary. In the case of a funded pension plan, the plan is required by federal law to retain an Enrolled Actuary who determines, among other things, the minimum required contribution and the funded status of the plan. Since the Enrolled Actuary is already familiar with the plan, management normally chooses to consult with him or her on the actuarial assumptions used to determine entries in the financial statements.

Effect of Actuarial Assumptions on Financial Statements

Relatively small changes in actuarial assumptions can result in large changes in reportable numbers.

For example, we have reviewed the 1999 10-K report of Lucent Technologies Inc. The 10-K shows pension income of $614M and postretirement benefit expense of $368M, compared to net income of $4,766M. Clearly, for Lucent, these benefits are material to the financial statements.

Lucent reports that it assumed that pension plan assets would earn 9% in the fiscal year ending in 1999. If it had assumed 8% instead, we have estimated that the expected return on plan assets would have declined by about $328M, and net periodic pension cost would have increased by the same amount, or about 6% of reported net income.

With regard to other postretirement benefits, Lucent reports that an increase of 1% in its assumed health care cost trend rate would have increased the accumulated postretirement benefit obligation (APBO) by $371M, from $8,604M to $8,975M. It also would have increased the aggregate service and interest cost components of postretirement benefit cost by $23M, from $617M to $640M.

The sensitivity of financial results to the choice of assumptions has important implications for auditor independence. A small change in a critical actuarial assumption can have a dramatic effect on pension or other postretirement expense, as our brief review of Lucent suggests. A change of 1% in the discount rate for a well-funded plan can easily change net periodic pension cost by 10% or more.

"Turn-Key" Models

We do not believe that a "turn-key" model which the auditor would run while management provided only key assumptions and significant data could possibly be set up in a manner that would provide the appropriate guidance to the client while satisfying the standards for auditor independence.

Management could presumably choose a discount rate, for example, from a limited range of acceptable rates. However, without competent actuarial advice, it would not be in a position to select demographic assumptions, some of which (e.g., retirement ages) can have significant financial effects. Someone must select the assumptions. A computer model is a tool for use by a qualified actuary; it does not substitute for actuarial judgment as to technique and assumptions. For the same reason that our laws require a qualified actuary to certify insurance company reserves or pension funding adequacy, so do we believe that actuarial values in financial statements should, at least, involve the judgment of a qualified actuary.

On the other hand, we do not object to an auditing firm selling or leasing computer software that will be used by qualified actuaries who are retained by management and are independent of the firm's auditor.

Auditor Independence

A question in the proposed rules asks whether the provision of certain actuarial services by actuaries working for a CPA firm (e.g., determining key actuarial assumptions, calculation of actuarial reserves, preparing pension plan reports) would compromise the independence of the CPA firm. We believe it would.

The industry standards (as outlined in Section 1000.35 of the SECPS reference manual) clearly prohibit a CPA firm from rendering actuarially-oriented services involving the determination of policy reserves and related accounts to its audit clients unless such clients use their own actuaries to provide management with the primary actuarial capabilities.

This standard, which is applicable to insurance companies, should be expanded to include actuarial pension and other postretirement benefit calculations. Policy reserves are clearly significant to the financial statements of an insurance company. As discussed above, pension and other postretirement benefit plans can also have a significant impact on the financial statements of many publicly-held firms and should cause similar concern for auditor independence.


For the above-mentioned reasons, we believe that if auditing firms wish to continue to offer nonaudit services to the public entities they audit, they should be required to reorganize their services into separate operating entities without common ownership (as some have already done) to guarantee the independence of their auditors.

The importance of our capital markets demands that auditors be truly independent of their audit clients. For the reasons given, we believe that auditors should not be providing actuarial services in relation to the benefit plans of their audit clients and we hope that the SEC will adopt and enforce this position.

Very truly yours,


Joseph A. LoCicero
Chief Executive Officer