Pension Folly: How Losses Become Profits
The New York Times
April 26, 2002
FLOYD NORRIS
I n the land of executive
compensation, there is nothing like
being paid for profits that you can be
sure will be counted, even if they do
not exist. Why take chances with real
earnings?
Last year, Verizon Communications
reported net income of $389 million
after taking losses for a variety of
things, among them investments in
Metromedia Fiber Network, a company
whose shares have plunged from a
peak of more than $50 to less than 5 cents. Top officers' bonuses were reduced but
not eliminated.
Things could have been even worse for Verizon and its bosses. The net would have
been negative, save for $1.8 billion in income the company was able to report from
its pension plans.
The only trouble is that Verizon's pension plan was really swimming in red ink. Dig
through the company's annual report, and you will find that the pension funds
had a negative return on investment last year, dropping $3.1 billion. And that is
before considering the costs of pension benefits.
So how did billions in losses turn into nearly $2 billion in profits? Verizon assumed
that its pension plans would earn profits of 9.25 percent last year, and it reported
income as if that assumption were true, something it was able to do under the
current ridiculous accounting rules. Its earnings would have been even better had
it assumed a 9.5 percent return, as General Electric did, or a 10 percent return, as
I.B.M. did. In fact, both those companies lost money in their pension plans last
year, as did most big companies.
A study by Milliman USA, a benefits consulting firm, found that in 2001 the
reported results of 50 large companies included $54.4 billion of profits from
pension fund investments. In fact, the pension funds lost $35.8 billion from
investments last year.
The losses are buried in annual report disclosures that few can understand. Harvey
L. Pitt, the chairman of the Securities and Exchange Commission, has promised to
make annual reports more understandable. This would be a good place to start.
Even better would be a new accounting rule requiring actual results to be used.
The theory of the current rule is that over time, all this will
balance out - that pension income will be understated in
the good years, as it was for most companies in the late
1990's, and overstated in the bad ones. But what has
resulted is highly misleading.
Shareholders have started to become upset, particularly
because many companies include the phantom income in
determining whether executives qualify for performance
bonuses. At Verizon's annual meeting this week, a
proposal to bar the consideration of pension income from
bonus calculations was supported by 43 percent of the
shares.
Fred Salerno, Verizon's chief financial officer, says there is
no way to know how much the pension income
contributed to the bonuses because a different formula
would have been used if it had been excluded. He notes
that the company knew the approximate pension income
it would report last year when it set the formula.
Executives might do better in the future if they stopped
considering reported pension income when bonuses are
calculated, simply because pension income is headed
lower. The complicated pension rules will force companies
to report poorer results this year because last year's
reality was so bad. And John Ehrhardt, a principal at
Milliman, says that auditors in the post- Enron era may
force companies to reduce their optimistic assumptions.
Investors would do well to study the pension disclosures in this year's crop of
annual reports. They show that many plans that seemed to be overfinanced a
couple of years ago no longer are. Pensions are going to go back to costing
companies money - both in reality and, soon, even in their published financial
statements.
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