SEC Faults Pension Reporting, Wants More `Reality'
Washington, March 6 (Bloomberg) -- U.S. Securities and Exchange Commission officials say they're concerned that companies are obscuring their pension losses in federal filings and giving investors incomplete information.
``There was a general lack of informative transparent disclosure,'' says Carol Stacey, chief accountant of the SEC's division of corporation finance. She says she reviewed more than 500 annual reports for 2001 with her staff. ``We strongly encourage companies to remedy this in future filings.''
Companies in the Standard & Poor's 500 Index lost more than $200 billion in the past two years in pension investments without clearly disclosing those losses in SEC filings, according to studies by investment banks Credit Suisse First Boston and UBS Warburg LLC.
Over the past five months, 12 companies, including General Motors Corp. and International Business Machines Corp., said they had reduced shareholder equity by $40 billion to account for pension deficits.
SEC Commissioner Harvey Goldschmid says he's concerned about the quality of information on pension funds reaching investors. He says companies are burying their pension information in complex footnotes, and not clearly explaining the losses and their effect on earnings in the Management Discussion and Analysis section of annual reports.
``Pension disclosures must reflect financial reality and be as transparent as possible,'' says Goldschmid.
Over the next several weeks, as thousands of U.S. corporations file annual reports for 2002, Stacey says the SEC will watch to see if companies do a better job of informing investors about pension obligations.
Lowering Expectations
In recognition of declining pension returns, more than 80 companies, including Caterpillar Inc., Lockheed Corp. and Verizon Communications Inc., have said in the past three months they will lower their expected rate of return in pension investments by about 1/3 of a percentage point this year to an average of 8.7 percent, according to Kevin Wagner, retirement practice director for Watson Wyatt Worldwide, a pension consulting firm.
The full magnitude of pension fund losses hasn't shown up on balance sheets because accounting rules allow companies to use estimated pension investment gains, rather than calculate actual losses, a review of company filings shows. The rules have allowed companies to legally report billions of dollars in gains while their pension funds are actually losing billions.
By not adequately addressing pension fund issues now, companies will be forced to cut back on future spending and hiring because they'll have to put more money into their pension funds later, says Watson Wyatt's Wagner.
Earnings Overstated
``We're talking to companies about cutting capital expenditures and hiring in order to have sufficient cash to fund pension deficits,'' Wagner says. ``These cuts will cause a definite ding in the U.S. economy.''
If actual pension liabilities had been counted in financial statements, aggregate earnings for the S&P 500 would have been 69 percent lower than the companies reported for 2001, or $68.7 billion rather than $219 billion, CSFB found in a research study on pension accounting published in September.
Three hundred and sixty of the S&P 500 companies have defined benefit pension plans. Such plans provide annual lifetime payments to workers after they retire.
The Financial Accounting Standards Board, which sets U.S. accounting rules, says that in preparing income statements, companies should include estimated gains instead of actual gains or losses from pension fund investments in order to ``smooth out'' year-to-year swings in the stock market.
Rule Explained
Tim Lucas, project manager of the FASB team that wrote the rule called FAS 87 in 1985, says the board reasoned that since studies show that stocks appreciate over the long term, and can be volatile in the short term, it makes sense to use a smoothing technique.
The stock-market boom of the late 1990s and the decline that began in March 2000 led to multibillion-dollar disparities between what companies reported in estimated pension income and what their actual returns were, a review of filings shows.
The Standard & Poor's 500 Index has fallen 40 percent in the past three years. It was up 99 percent for the three-period before that. The Index rose by 102 percent over the past 10 years.
In December 2001, billionaire investor Warren Buffett cautioned companies to lower their annual pension income estimates to 6.5 percent, as he did with his Berkshire Hathaway Inc. His cautions have largely been ignored, according to a review of S&P 500 company filings.
General Motors
General Motors, the world's largest automaker, reduced its U.S. pension plan's expected rate of return to 9 percent in 2003 from 10 percent last year. GM actually lost 7 percent in its pension investment in 2002, says spokesman Jerry Dubrowski.
``We've got a hole on the pension side due to the weak equity markets three years in a row,'' Chief Executive Rick Wagoner said in a meeting with analysts on Jan. 9.
On Jan. 16, GM said it had contributed $4.8 billion to its U.S. pension plans last year. The company said then it would need to set aside as much as $15.5 billion over five years to meet its $76 billion retiree obligations. GM says it reduced shareholder equity, or the company's net worth, by $13.6 billion, or 69 percent, because of last year's pension losses.
United Technologies Corp., which lowered its estimated rate of return to 9.2 percent in 2002 from 9.6 percent in 2001, will lower its 2003 rate to 8.5 percent, CEO George David said on a Jan. 16 conference call.
The company said in a press release the same day that it contributed $1.5 billion in stock and cash to its pension fund over the past 14 months. In addition, the company said shareholder equity was reduced by $1.6 billion because of pension losses.
Baxter International
Some companies say they'll maintain rates of return as high as 10 percent.
Baxter International Inc., a medical development company, lowered its expected rate of return to 10 percent for 2003, from 11 percent in 2002 and 2001, CFO Brian Anderson said on an Oct. 17 conference call. Baxter's pension fund lost 19 percent, or $351 million in 2001, according to a footnote in its annual report. The actual return for 2002 hasn't yet been disclosed.
SEC Commissioner Cynthia Glassman says that companies aren't cutting their expected rates enough.
``I think in the current environment at some firms they may be too high,'' says Glassman, without referring to any particular company. ``It's important that companies can justify the rates they are using, and take into account both the good times and the bad that we've been experiencing over the last ten years.''
Raised Eyebrows
Alan Beller, director of the SEC's division of corporation finance, questions the rates set by companies. ``There are some numbers out there that have caused us to raise our eyebrows and ask companies to justify them,'' he says.
Peter Bernstein, an economist and president of New-York based Peter L. Bernstein Inc., a pensions consulting firm, says those estimated rates of return just don't add up. ``I don't think there's anything in history to justify these numbers,'' Bernstein says.
Bernstein says it's wrong to expect U.S. stock indexes to return as much as 7 percent annually in the future. He says dividend yields are at historically low levels of under 2 percent, and price-to-earnings ratios are high, now averaging 29 for the S&P 500, compared with 9.2 in 1980.
``We can learn a lot from looking back, but extrapolating the past into the future is very dangerous,'' says Bernstein.
Reconsider Rules
A report by Goldman, Sachs & Co. last week said that a portfolio of investments held 60 percent in stocks and 40 percent in bonds probably would return about 6 percent a year over the long term.
Accounting rules for pension income need to be reconsidered, SEC Commissioner Glassman says. An economist who joined the commission last year from the accounting firm of Ernst & Young, Glassman is part of a growing group of financial experts who suggest rewriting FAS 87.
``I think it's time to take a fresh look at that rule, and see if there's a better way of reporting the pension fund results,'' Glassman says.
SEC Commissioner Goldschmidt agrees. ``In the long run, FASB and the SEC must seriously review the accounting principles in this area,'' he says.
Lucas, the former FASB research director who headed the team that wrote FAS 87, says companies should disclose pension information each quarter, rather than once a year. ``More information on how the plans are performing and how they're managed is important,'' he says. ``Pension plans are an integral part of the company.''
Actuaries Caution
Ethan Kra, chief actuary of the U.S. retirement practice at Marsh & McLennan Cos.' Mercer Human Resources Consulting, the world's largest actuarial firm, says U.S. companies have been told by their actuaries that pension funds probably won't earn 8.5 percent to 9 percent in the future.
``We've run the models,'' Kra says. The most likely return in the long run would be 6.5 to 7.5 percent, he says.
In the stock market boom of the late 1990s, most pension funds earned more than the average 9 percent estimate, Kra says. That allowed companies to avoid making contributions to their pension plans for several years, he says.
``Chief financial officers have gotten into the habit of thinking it's a free lunch,'' he says. ``Wake up and smell the reality. Pension plans cost money. That realization is painful.''
There's more than one incentive for companies not to lower the expected rates of return on their pension funds, says Ron Ryan, president of New York-based Ryan Labs Inc., a pension plan consultant. When companies use higher expected returns, their pension costs are lower and their reported earnings are higher, Ryan says.
Fully Funded
IBM, for example, using an estimated rate of 10 percent, reported assumed pension gains totaling $12.2 billion for 2000 and 2001 in its SEC filings, following FASB rules. IBM's annual reports showed in footnotes that the world's largest computer maker actually lost $2.8 billion in its pension fund for those two years -- a disparity of $15 billion.
On Dec. 31, IBM said it put $3.95 billion in cash and stock into its U.S. pension fund to make it fully funded. In addition, pension losses reduced IBM shareholder equity by $3 billion, says company spokesman Joe Stunkard.
Another concern is the rapid growth of future pension obligations, which must be funded by pension assets, says Ryan. The recent decline of interest rates to historic lows has enlarged these obligations, he says.
Actuaries estimate the size of those future obligations in current-day dollars by selecting an interest rate -- called the discount rate -- to adjust for future inflation and the cost of money. Because of the decline in long-term interest rates, the present value of future pension obligations has soared, Wagner says.
Artificial Shrinking
Ryan estimates the average discount rate used by S&P 500 companies is 6.5 percent, and says it should be 5.5, based on long- term interest rates. He says the higher discount rate understates pension liabilities by about 15 percent, or about $150 billion for S&P 500 companies with pension plans.
``The year 2002 was the worst year in pension history,'' Ryan says. He estimates pension assets fell 11 percent, as pension liabilities increased 19 percent.
The SEC's Beller says some companies are artificially shrinking the size of their pension obligations by using an inflated discount rate. That can make a pension deficit seem smaller than it really is.
``We've found some numbers in terms of discount rates that strike us as surprisingly high,'' Beller says. ``We're somewhat skeptical about them, and we've asked companies to justify them.'' He says agency policy prohibits him from naming specific companies.
Even the extended bull market of the 1990's wasn't sufficient to keep pension plan assets in line with their growing liabilities.
Kra, the pension actuary, says that some companies that now have under-funded pension funds had large surpluses three years ago. By exiting the stock market and investing in bonds or annuities then, they could have settled all their pension obligations, he says.
He says by moving funds from stock investments, companies would have had to lower estimated annual returns below 8 percent, and company earnings would have been lower as a result. ``People get addicted to things,'' he says. ``Some get addicted to heroin and cocaine. They got addicted to pension earnings.''
The SEC's Stacey says companies must work harder to clearly inform investors of pension issues.
``We had to do a lot of digging to find out what companies are doing and why,'' she says of last year's annual reports. This year, she says, investors shouldn't have to use a shovel to uncover what companies are saying in their annual reports. |
