Underfunded Pension Plans May Threaten Shareholders More than Employees
Jul. 20--Because of the stock market's long swoon, a growing number of U.S. companies are finding their pension plans no longer have enough money to ensure full benefits for future retirees.
That may sound scary for employees. But in truth, for companies with underfunded pension plans, including corporate titans like General Motors and Ford Motor Co., the situation is more a potential problem for their stockholders than for their workers.
That's because Uncle Sam holds companies to some pretty tough rules on how much funding their pension plans must have. For example, the government forces companies to use realistic assumptions when they calculate the cost of providing retirement benefits decades into the future.
And since federal authorities guarantee pension plans much as they insure bank deposits, regulators are also strict about ensuring corporations keep enough money in the kitty to make good on their retirement obligations.
Hence, it's unlikely Baby Boomers working for companies with defined-benefit pension plans will get short shrift when it's time to collect years from now. But it's becoming increasingly probable that corporate earnings will face increasing pressure as companies are forced to dip into their cash holdings to remedy shortfalls in pension plans.
When Washington-based human-resources consulting concern Watson Wyatt Worldwide surveyed 500 U.S. companies in 2000, 82 percent said they had plans funded at 100 percent or more. As of Jan. 1, 2002, said Watson Wyatt researcher Ken Steiner, "we estimate that 82 percent had dropped to 37 percent."
And "the market's dropped a lot more since then," he said.
The pension-funding issue is most prominent among older manufacturing companies with a unionized workforce.
Although a majority of U.S. companies have turned toward less-costly retirement plans in which workers contribute to a 401(k) fund that the employee controls, many manufacturers still have defined-benefit plans in which employees receive a guaranteed sum for as long as they live.
Those pension costs, which grow increasingly onerous as more workers retire and begin drawing from the pension fund, are sometimes referred to as "legacy costs." As the stock market goes into free-fall, the value of the equities held in the pension plans keeps declining, putting more pressure on companies to ante up.
Although the regulations regarding pension-plan accounting are complex, the underlying calculus is simple, Steiner said.
Over the long run, the cost of a pension plan for employers is "equal to the benefits paid out minus the investment return." And when investment returns dwindle, as they have been doing for more than 18 months now, eventually "you either have to increase your contribution or cut back on benefits."
Last week, for example, GM reported that during the second quarter it had put $3.2 billion into its underfunded pension plan. Although GM officials have sought to downplay the potential financial impact of the plan's funding, the state of the automaker's $67 billion pension plan "is indeed something to be concerned about," said UBS Warburg analyst Saul Rubin.
Although GM has said it expects to inject an additional $9 billion in cash or stock into the fund by 2007, Rubin said the company's estimate may prove to be too low.
According to Sean McAlinden, economist for the Center for Auto Research in Ann Arbor, Mich., GM has 2.5 retirees for every active worker, compared with 1.2 retirees per active worker at Ford. "Of every GM vehicle sold," he said, "$2,500 covers the cost of meeting the company's pension costs."
Like other auto companies, GM has stepped up its early-retirement program in order to cut labor costs--a move that swells the ranks of retirees to whom GM's pension plan must mail a monthly check.
At Ford, pension-fund assets declined by 6.7 percent through the year's first half, resulting in an underfunding of $3.2 billion. The company says it doesn't expect to have to inject cash into the fund until 2006, but investors remain wary. Ford's pension problems, compared with those hanging over GM, are "minor, for now," said Rubin.
"I think all of corporate America is going to be facing this issue," in the future, Ford Chairman and Chief Executive William Ford Jr. said last week.
Normally, underfunding poses little threat to current retirees because the money would not run out until many years into the future. And because the market's up and down moves even out over time, federal rules allow a company's pension fund to go into deficit for a while.
Recently, in fact, Congress temporarily granted employers more slack in that respect out of concern that companies would be forced to divert into their pension funds cash that could otherwise be used to create jobs.
Because of that relief, many companies will be spared from having to put extra funds into their plans this year, said Watson Wyatt's Steiner. But "if the stock market remains where it is, I think we'll see significant contribution increases in 2003." Although there are too many variables to make a precise estimate, he said, "we're talking in the billions of dollars."
In the embattled U.S. steel industry, where retirees vastly outnumber active workers, swelling pension costs have made it difficult for domestic producers to compete with offshore rivals that don't have to shoulder such burdens. The industry is seeking, without much success, to have the government take those legacy costs off its hands.
For the Big 3 automakers and other manufacturers, the situation is less dire, but unfavorable trends have been building for some time. Because of the long bull market of the 1990s, however, the pension-funding issue hasn't loomed large until recently.
As the stock market surged higher, so did the value of the stocks and bonds held by pension plans. Some companies, long accustomed to putting in an annual contribution to keep the plan's funding up to snuff, found their plans to be overfunded. That means the value of the fund's investments had grown faster than the company's obligations; because of that happy phenomenon, many companies didn't have to make any contributions for several years.
Topping off an underfunded pension plan hurts company profits because it soaks up cash flow that could otherwise be used to pay debt or buy new equipment. But some companies got even more mileage out of their plans' investing success: In the late 1990s, pension-fund holdings grew so lush that companies could properly account for excess fund profits as part of their earnings.
Since the market's boom went bust, however, those days of a pension-generated profit enhancement are long gone.
At auto-components maker BorgWarner Inc., "our benefit plans are still overfunded" thanks to earlier gains, a spokeswoman said. But with the stock market's rapid decline, she conceded, these days "the amount of overfunding is very much decreased."
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© 2002, Chicago Tribune. Distributed by Knight Ridder/Tribune Business News.
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