John Tus, treasurer and VP; Kathleen Winters, controller and VP; and Harsh Bansal, VP, investments.

In the wake of the global recession, which battered pension plan assets, Honeywell International changed its approach to managing its defined-benefit plan. Last November, the $36 billion manufacturing and technology company broke from the pack and said that it would begin to use mark-to-market accounting for the plan, which had obligations of about $19 billion at the end of 2010.

The company also contributed to the plan to boost its funded status, lowered the asset return assumption, from 9% to 8%, and began to reassess the pension plan’s asset allocation.

Under mark-to-market accounting, Honeywell uses the fair value of the plan’s assets and recognizes the plan’s gains and losses in the year they are incurred, instead of amortizing them over a period of years. Previously it smoothed changes in the plan’s assets over three years and amortized the gains and losses over six years, an amortization period that it says compared with the 10 to 12 years used by most of its peer-group companies.

The company considered lengthening its amortization period to match that of its peers, says John Tus, Honeywell’s treasurer and vice president, but decided against it because “longer amortization periods were not deemed to be preferable accounting.”

At yearend 2009, the funded status of Honeywell’s pension plan had fallen to 78.4%, and the company projected that its non-cash pension expense would rise from $100 million in 2009 to $800 million in 2010 and $1.2 billion in 2011.

Adopting mark-to-market accounting meant that of the pension plan’s estimated $7.5 billion of deferred losses, the company recognized $5.5 billion in prior years. In the process, Honeywell reduced its forecast of its 2011 pension expense by $1 billion.

Two elements drive the mark to market, Tus says. “One element is the discount rate,” he says. “To the extent that there is a lowering of interest rates, the liability grows and that would contribute to a charge, a mark-to-market charge. Alternatively, if interest rates were to go up, you would in effect see the liability come down and you would have a gain.”

On the asset side, the company assumes an 8% rate of return, Tus says. “To the extent that the rate of return is above that, you’ll have gains and if you have returns below the 8%, you’ll have losses. It’s a combination of those two that in effect produces the mark-to-market adjustment.”

The company also made contributions to the plan, including $1.34 billion worth of Honeywell stock and $1 billion in cash raised by issuing debt, with the goal of getting its funded status up to 90% by the end of 2011.

Making the change in accounting methods took the company just a couple of months, Tus says. “We all got together, treasury, controllers, our investment group, and did the analysis and the adoption in the fourth quarter of 2010.”

The biggest challenge in changing the company’s approach to managing its pension plan was “the education process,” he adds.

“Internally, obviously, we had to take senior management through the process, and we also took the audit committee and the board of directors through the process,” Tus says. “When we decided internally, it became equally important, quite frankly, to take a quite complex and esoteric topic and present it externally to our shareowners and Wall Street.”

Honeywell says the new accounting method makes its financial results clearer to investors. The change was received favorably by investment analysts, and in the wake of Honeywell’s move, AT&T and Verizon also announced that they were shifting to mark-to-market accounting for their pension plans.