Pollyanna Pensions
Elizabeth MacDonald, 05.27.02
forbes.com
Some companies are pumping up profits with optimistic pension-plan assumptions. Be wary of them.
Evidently the word is not yet out that the market peaked two years ago. For its 2001 shareholder report, Goodyear Tire & Rubber optimistically hiked its expected return on pension-plan assets from 9.5% to 10%. This during a year when its $4.8 billion pension fund, far from making money, lost $231 million. By making an optimistic assumption about what it might earn someday, Goodyear minimizes the pension cost it figures into its earnings statement today. The boost in the assumed return had the effect of shrinking Goodyear's 2001 loss before nonrecurring charges from $1.37 a share to $1.27.
Off By a Mile
These corporate pension plans were supposed to do terrifically in 2001. Then reality intruded. Instead of lush returns, they all ended up losing money.
Expected Pension
return profit* RETURN ($mil)
Company rate ($mil) projected actual
Baxter International 11% $24 $177 $-351
FleetBoston Financial 10 15 248 -107
Household International 10 38 102 -137
IBM 10 1,025 4,202 -2,405
Lehman Brothers 11 32 97 -88
Mellon Financial 10 134 181 -112
Union Pacific 10 23 213 -190
Weyerhaeuser 11 234 437 -412
*Amount credited to net income. Sources: Company filings; Milliman USA.
Even 10% wasn't good enough for Lehman Bros. Last year the investment house said its expected pension fund return was 11%. That rate was responsible for $32 million of its 2001 pretax profits, or 8 cents of its reported $4.38 earnings per share for the year. Curious that as this optimism was creeping into its P&L, its pension plan was getting killed in the market. The fund lost $88 million instead of earning the expected $97 million.
With sufficiently favorable assumptions about the future, a company can declare its pension plan overfunded and report, on its income statement, a negative cost for providing pensions. That is, it can create a paper profit from the plan, even if it did not in fact withdraw cash from the fund and could not have legally done so. The table on page 160 lists eight companies that picked up paper profits from actuarially overfunded plans.
How is it that companies can raise forecasted returns even though actual returns on pension funds are negative? Pension accounting is pretty abstruse. But here's the essence of it.
A dollar that has to be paid out to a pensioner in 2020 is a liability now. That future payout needs to be supported by enough plan assets. What to use to figure out the assets needed to cover those payments? It's accepted practice to look in a rearview mirror. Union Pacific, for one, says its pension plan averaged an 11.6% return from December 1986 to December 2001, so its 10% expected return is well in line. The S&P 500's total annualized return since 1926 is not far off at 10.6%. Other companies say their expected long-term returns are just as kosher.
UP, UP AND AWAY
Companies that hiked their expected rates of return on pension plan assets. good luck getting them.
EXPECTED RETURN
Company 2001 2000
Citigroup 9.50% 9.25%
Conoco 9.25 9.00
Goodyear Tire & Rubber 10.00 9.50
SBC Communications 9.50 8.50
Source: Milliman USA.
As for recent losses in the stock market, the accountants have an alibi here, too. A rule designed to even out fluctuations in pension assets means that it will take a while for a spill in the stock market to be fully reflected in reported pension costs. Nor is it expected that a bad year or two should alter the pension sponsor's long-term view of its prospective returns.
So the pension Pollyannas aren't violating any generally accepted accounting principles. But there are two little problems with an 11%-return assumption. One has to do with the market's boffo returns over the past decade or two. The fact remains that stock prices are still very high. The ratio of stock prices to corporate earnings is currently at least twice the ratio's long-term norm (at least if you include writeoffs in earnings). In other words, the terrific returns during the 1990s may be a harbinger of bad, not good, times to come, as P/E ratios return to earth.
The other matter is that pension funds haven't always been fully invested in stocks, says accounting expert Jack T. Ciesielski of The Analyst's Accounting Observer, a corporate accounting newsletter in Baltimore, Md. Besides just real estate and cash, they own bonds, too, and the long-term return from bonds is more like 5%, according to Ibbotson. "But from looking at the financials, it's hard for investors to figure out if expected returns are baloney, because companies don't have to disclose what their pension-plan asset mix is," says Ciesielski. |
