from bloomberg (more on the US bull market pyramid game):
Pension Gains Used to Pad Profits
By Loren Steffy
(Published in September issue of Bloomberg Markets magazine.)
Irving, Texas, Aug. 23 (Bloomberg) -- Workers who gathered at the former GTE Corp. headquarters near Dallas in early July were celebrating the company's $75-billion acquisition by Bell Atlantic Corp.
They ate 50 sheet cakes and watched the raising of a flag bearing the combined company's new, red and black, V-shaped logo, celebrating the new corporate name: Verizon Communications. Verizon is now the biggest U.S. local phone company.
It has another distinction: It inflates its earnings more than any other U.S. company by using gains from its employee pension fund.
Neither of the predecessor phone companies has advertised these gains, which are discovered only by digging deeply into annual reports. In March, Bell Atlantic's showed that its pension fund accounted for $846 million, or about 13 percent, of its 1999 pretax income. At GTE, the gains were even bigger: $1.08 billion, almost 17 percent of its pretax income for the year. The number was listed on page 63 of GTE's annual report, in the footnotes to its financial statements.
Ballooned by rising stock prices in recent years, pension funds have become a significant -- though misleading -- source of reported corporate earnings.
``It's magic money,'' says Robert Monks, a principal at Lens Investment Management and a former federal official who administered the Employee Retirement Income Security Act of 1974, the principal law governing pensions. ``This fiction of earnings is being built into the expectations of a number of companies. If the stock market were to go down dramatically and the surpluses were to disappear, the impact of reported earnings would be very dramatic and very adverse.''
Locked Up
In practice, companies can't use this money. It's earmarked for employees after they retire, and surpluses could be captured by the companies only if they took the unusual action of closing the funds. Still, corporations count investment gains from pensions just as they do earnings from operations, which they can use.
Among those with the biggest pension income in 1999 were General Electric Co. ($1.38 billion), SBC Communications Inc. ($844 million), and Lucent Technologies Inc. ($614 million).
Almost one-quarter of the companies whose shares are included in the Standard & Poor's 500 Index reported gains from pensions last year, according to a Bloomberg survey of company annual reports filed with the U.S. Securities and Exchange Commission. Of those, 42 reported that pension income boosted pretax earnings by more than 5 percent.
Hocus-Pocus
``You're taking something that's an expense and turning it into a contribution to the bottom line,'' says Wayne Shaw, an accounting professor with the Cox School of Business at Southern Methodist University in Dallas. ``It's just wiping out one of your costs because the stock market happened to go up.''
Lowering expenses, though, frees up more income for other investments such as new technology, says Verizon spokesman David Frail.
Just as pension income can make company earnings look bigger, it can make losses look smaller. PG&E Corp., a San Francisco-based utility, reported a pension benefit of $252 million last year, which helped trim its pretax loss to $440 million. Packaging company Pactiv Corp. reported a pretax loss of $159 million after booking pension income of $86 million.
Accounting experts say companies should break out pension gains more clearly so that shareholders don't confuse them with operating profit. ``It's highly misleading to think that a company is fundamentally healthy because it has a lot of earnings that are coming from its pension plan,'' says Neil Stein, a law professor at the University of Alabama who specializes in pension issues.
By the Book
Companies say they're only following the rules of the Financial Accounting Standards Board, the independent group that sets reporting standards for U.S. corporations. What's more, they say, the information is there for any investors interested enough to look. ``The information is disclosed, and people can do the math,'' Verizon's Frail says.
The question of whether companies are adequately disclosing their pension gains has caught the attention of the SEC. In December, the agency sent a letter to the American Institute of Certified Public Accountants. The SEC wanted accountants to urge companies with large pension profits to more fully discuss the impact in the management discussion section of their annual reports, rather than simply listing it in footnotes.
``We thought this could be an issue for a lot of companies,'' says Scott Taub of the SEC's Office of the Chief Accountant. However, the agency stopped short of forcing a change. ``The footnotes on pensions are really pretty detailed,'' Taub says. ``If an investor was looking for the information, they would be able to find it.'' For that reason, FASB spokeswoman Deborah Harrington says, the board has no plans to review its pension accounting rules.
Don't Touch It
Under the current rules, adopted in 1985, companies whose investment returns on pension assets exceed the plan's costs can book the difference as a profit. While surplus pension earnings theoretically belong to the companies and their shareholders -- employees' benefits having been covered -- there's little chance earnings will be tapped to increase cash flow.
Taking money out smacks of past corporate raiders like Ronald Perelman and Charles Hurwitz, who took surpluses from pension funds to pay for their takeovers of Revlon Inc. and Pacific Lumber Co., respectively.
In any case, if times go bad and the stock market slumps, the surpluses will come in handy. As recently asthe mid-1980s, many pension funds didn't have enough money to cover anticipated benefits. The U.S. government's Pension Benefit Guaranty Corp. then produced a list of the 50 companies with the largest unfunded pension liabilities. PBGC, a watchdog created in the 1970s to safeguard employee retirement funds, stopped publishing its list in 1995.
Kmart Corp., which was on the last list, had a pension expense of $80 million in 1994. Last year the discount store chain reported $68 million in pension income. At least five other companies that had underfunded pensions in 1995 reported pension income last year.
Ready Cash
Many companies have found another way pension funds can boost earnings -- and in this case, it is money they can use in their day-to-day businesses.
They are slashing their pension costs by shifting from the traditional defined-benefit pension plan to a cash balance plan. In defined-benefit plans, workers typically gained most of their benefits in the last five years before retirement. Cash balance plans base retirement earnings over a longer period, usually reducing benefits.
International Business Machines Corp., the world's biggest computer maker, drew the ire of many of its workers when it switched to a cash balance pension plan in July 1999, predicting it would save $200 million a year in pension expense. At the company's annual meeting in April, 28 percent of IBM shareholders voted to repeal the cash balance plan. The vote garnered enough support to ensure it will appear on IBM's proxy again next year.
Claims that cash balance plans discriminate against older workers already have drawn Senate hearings and reviews by the Internal Revenue Service. The IRS oversees pension plans because the plans offer tax benefits to companies that make contributions on behalf of employees.
IBM says its purpose in shifting to a cash balance plan was to increase its compensation for current employees, which would help it find and keep good workers in a tight job market. ``We're trying to put more money into these programs that will make us more competitive,'' IBM spokeswoman Jana Weatherbee says.
The computer company isn't alone. Of the 10 biggest gains from pension income among S&P 500 companies last year, half were in cash balance plans. Pension plans clearly are a means for increasing profits these days -- even if some of the gains aren't what they seem. |
