Market taking toll on pension income
COMPANIES AT RISK OF PROFIT DRAIN
By Mark Schwanhausser
Mercury News
Scores of America's biggest companies are sitting on an accounting time bomb created by stock-market losses in their pension funds.
Some observers -- including politicians, investment managers and Wall Street analysts -- are blaming the looming crisis on accounting rules that let companies overestimate their pension income to pump up corporate profits.
These rules essentially allow companies to report paper profits from their pension fund investments based on what they expect to make in the stock market over the long run -- even if their pensions lose money in a given year. In other words, some corporations are reporting pension income that didn't materialize.
Without such questionable pension income, for instance, General Motors, SBC Communications, International Business Machines, Lockheed Martin, PG&E, United Airlines, Safeway and scores of others would have reported lower profits, or deeper losses, in 2001.
``It is an accounting gimmick that has to be cleansed out,'' said California Controller Kathleen Connell, who is calling for the rules to be re-evaluated, if not rejected. ``The shareholder has a right to know how fragile the income stream is for many of these corporations.''
The alarm comes when many American workers and retirees are worrying that their defined-benefit pension plans could be at risk if stock market losses continue and recession-stressed companies terminate their plans. But experts generally say there's no crisis yet. Although the number of underfunded pensions has jumped, most corporate pensions have enough money and time to rebuild surpluses when the market revives.
In a worst-case scenario, if a company goes bankrupt or can't cover its pension obligations, the federal Pension Benefit Guaranty Corp. steps in. But that's likely to be necessary for only a few companies.
``The forest is probably looking OK,'' said Brian Matthews, a managing principal for Payden & Rygel, an investment management company in Los Angeles. ``Tree by tree, there will be some sicker than others. You'll have to pay attention to that as an investor.''
Meanwhile, criticism of such accounting ledger-demain is mushrooming. Rep. George Miller, D-Martinez, has called for hearings on Capitol Hill. Famed investor Warren Buffett is pressuring companies to slash the ``extreme'' investment assumptions they use to predict pension income. And last week, Standard & Poor's joined the long list of Wall Street firms warning investors of the potential risks.
Few investors worried about pensions during bullish times because double-digit stock-market returns often produced comfy surpluses. Now, however, the nation is enduring what may be the worst period in pension history. Low interest rates are forcing companies to set aside more for their workers' retirements at the same time that the stock market has gouged away much of the surpluses they stockpiled before the bubble burst.
In just two years, 50 of the nation's biggest companies have lost more than 90 percent of their combined pension surpluses. More than half of those companies are running deficits -- and nine are at least $1 billion in the hole -- according to Milliman USA, a Houston pension-consulting firm.
The problem of underfunded pensions is far more widespread, according to Standard & Poor's. Halfway through the year, the average funding ratio for pensions at 624 non-financial companies had slipped to 94 percent. Just six months earlier, the average company was fully funded at 100 percent.
That means scores of corporate titans soon will need to stoke their sagging pension funds with cash -- a tactic that could crimp corporate earnings and stock prices indefinitely. Since GM announced in July that it would pump in $2.2 billion to narrow its pension gap, for example, its stock has sputtered, hitting a 52-week low Tuesday of $38.16.
Experts say investors probably are seeing only the tip of the iceberg. Because there is a long lag before companies must disclose pension data, it's hard for investors to project how much cash companies must set aside to cover growing pension liabilities.
Countless investors could be surprised when Fortune 500 companies finally acknowledge problems. ``Keep an eye out as we break past the end of the year,'' warned Adrien LaBombarde, who helped write Milliman's pension study. Pension problems ``will be 10 times bigger at the end of the year, when the financial statements start showing this.''
Ironically, many corporations actually projected higher returns on pension-fund investments even as stock-market losses were deepening. The average assumption rose to 9.39 percent in 2001, according to Milliman, with GM, IBM and Bank of America assuming 10 percent.
In reality, the Standard & Poor's 500 index skidded nearly 11 percent.
There is logic to these accounting rules. By allowing companies to stick with long-term rates of return, investors arguably get a clearer picture of a company's core operations.
Still, critics charge that inflating pension assumptions can pump up the bottom line artificially. For example, projecting a 9.5 percent return in 2001 allowed SBC Communications to add nearly $1.5 billion in pension income to its bottom line -- boosting profit 20 percent, Milliman said. It didn't matter that SBC's pension fund actually lost $2.8 billion.
``Too many corporations are still showing actuarial assumptions north of 8.5 percent,'' said Connell, who is pressuring California's giant pension funds, CalPERS and CalSTRs, to assume about a 7 percent return rather than current projections of 8.25 and 8 percent, respectively. ``There's just no way that number will be achieved.''
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Contact Mark Schwanhausser at (408) 920-5543 or mschwanhausser@ sjmercury.com. |
