Pension Deficits Could Cost Firms Billions
By Albert B. Crenshaw
Washington Post Staff Writer
Thursday, April 17, 2003; Page E02
Three years of plunging stock prices and rising benefit liabilities have thrown many of the largest pension plans in corporate America deeply into deficit -- a situation that will siphon away billions of dollars in cash and reported earnings in the next few years unless the market rebounds sharply.
That's the picture painted by a survey released yesterday, covering 100 of the largest corporate pension plans, by Milliman USA, a benefits consulting firm. It is based on figures included in companies' annual reports.
The plans, run by such giants of industry as General Motors Corp., International Business Machines Corp., Boeing Co. and AT&T Corp., have been hit by "a perfect storm" of declining asset values and declining interest rates, said John W. Ehrhardt, an actuary with Milliman. Lower interest rates caused liabilities to rise because of the way their value is calculated, and falling stock prices reduced the assets available to pay them.
The report shows that collectively these companies' pension plans went from a funding surplus of $183 billion at the end of 2000 to a deficit of $157 billion at the end of 2002. Together their assets dropped from 124.5 percent of their liabilities to 82.4 percent.
The largest deficit it found, $25.4 billion, was at General Motors, which last year contributed $5.1 billion to shore up its plan. Others with large deficits included Ford Motor Co. with $15.6 billion, Exxon Mobil Corp. with $11.3 billion, IBM with $6.4 billion and Delta Air Lines with $4.9 billion.
Some of the most underfunded on a percentage basis were Procter & Gamble Co., where assets equaled 44.8 percent of liabilities; ConocoPhillips Co., 49.3 percent; and Exxon Mobil, 50 percent.
Milliman did not call the deficits it found a threat to the system, but its experts said they are enough to put a squeeze on profits and cash flow at many companies this year.
For much of the 1990s, pension funds at many of these companies produced hefty investment returns that companies were allowed under accounting rules to include in their earnings. They cannot actually take the cash out, but can record a negative pension "expense" that adds to the bottom line.
The report comes at a time of increasing focus on pensions and pension accounting. Employers are seeking ways to minimize plan costs, including legislation to change requirements for calculating certain liabilities to make it easier for them to comply with funding requirements.
Also, there is growing debate about the assumptions used when pension-fund investment returns are included in companies' profit statements. The Securities and Exchange Commission has raised questions about firms' optimistic return assumptions that turned pension plans into profit centers for some companies in the 1990s.
And underfunded pension plans in certain industries, notably steel and airlines, have raised questions about the ability of the government's pension insurance agency, the Pension Benefit Guaranty Corp., to meet its obligations in future years.
The report referred to defined-benefit pensions, in which benefits are based on a formula, often involving pay and years of service, and the employer bears the investment risk.
"We were in the unusual position during the '90s -- and many companies are still there -- that you didn't have an expense, you had a credit coming out of the pension expense calculation," Ehrhardt said.
"That has just about been eliminated," he said, adding that he is "very confident" that for these companies in 2003, the pension income, which was $3.3 billion in 2002, "is going to be more than reversed, down to easily a $3 [billion] to $5 or more billion charge."
It is already happening for some companies, he noted. For example, Bank of America went from $38 million in pension income in 2000 to a $140 million cost in 2002.
Pension plans are allowed to make assumptions about their future earnings and plug those numbers into its earnings. Those assumptions have been unrealistically high in recent years, with many companies continuing to use 10 percent as the market produced negative returns.
Now companies are cutting those assumptions -- more than half have already done so -- so that the average for this group was 8.92 percent for 2002, down from 9.36. When those reduced percentages are applied to shrunken asset bases, the effect is a sharp reduction in the pension-return figures that are taken into the company's profit-loss calculations.
And some experts think the expectations remain too high. Investor Warren Buffett has said that he thinks 6.5 percent is closer to reality.
washingtonpost.com
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Many Corporate Pension Funds Assumed Outsize Gains
By MARY WILLIAMS WALSH
NYTimes.com
The first comprehensive examination of the pension funds of the nation's biggest corporations shows that nearly half made assumptions about their investment returns for 2002 that would be deemed too aggressive by federal regulators, starting this year.
Of the 100 companies examined, 45 used an annual rate of return of more than 9 percent, the proposed standard for this year. Eight of the companies assumed that their pension funds would have returns of 10 percent or more. In fact, though, almost all the pension funds examined lost money last year.
The companies that used the highest estimates included Northwest Airlines, General Motors and Honeywell International.
The optimistic assumptions about returns on fund investments translated into billions of dollars for corporate America's collective bottom line in 2002, according to the study, by the actuarial firm of Milliman USA.
During the stock market boom, when pension funds were growing steadily each year, these assumptions did not prompt much concern. Because such funds invest for the long term, and may experience short-term fluctuations, an assumed rate of return provides a way to smooth out the impact on the company's financial performance.
"I've had more questions on the assumed rate of return in the last six months than I had for 15 years before that," said John W. Ehrhardt, a consulting actuary and principal of Milliman and author of the new study. "The auditors are looking at this much more closely. Nobody, in the post- Enron environment, wants to have any questions asked about their financial statements."
The Milliman survey showed that America's biggest companies last year assumed an average rate of return of 8.92 percent for their pension investments. Mr. Ehrhardt said many companies are lowering their assumptions for 2003.
"I wouldn't be surprised to see an average of 8.5 percent," he said, adding that he considered that rate "reasonable," given long-term investment trends.
Accounting rules do not offer companies detailed instructions for picking each year's rate, but the rates should reflect the long-term investment performance of the types of assets in their pension funds.
Berkshire Hathaway, which has been widely praised for its realistic pension accounting techniques, used an assumed rate of return of just 6.5 percent, the second lowest of the 100 companies surveyed. Only Merrill Lynch was lower, at 6 percent.
Milliman's study also shed light on how quickly corporate pension plans shrank as financial markets soured. Milliman surveyed the 100 largest American companies that offer traditional, defined-benefit pensions to their workers. It found that these companies together enjoyed a substantial pension surplus in 2000, but by the end of last year, they were only 82 percent funded, on a collective basis.
A company's pension funding ratio indicates the extent to which current assets will cover projected future payments to retirees.
The study used data taken from the companies' 2002 financial reports, which calculate pension activity with methods intended to show general trends to investors. These calculations differ from those used to show employees and retirees whether their companies were setting aside enough to pay their pensions.
Mr. Ehrhardt said the pension deficits underscored by the survey were not a sign of any impending pension defaults by the companies. "I don't think this is a benefits-security issue yet," he said.
Rather, he said, the study offered strong evidence that growing numbers of companies would have to make substantial cash contributions to their pension funds in the coming months. He said these expected contributions should not cause consternation among investors, except for companies that were not generating enough cash to cover the mandatory payments.
"A pension plan is a very good benefit," he remarked, "and companies should expect to have to pay for it."
Mr. Ehrhardt also said that as companies bring their assumed rates of return in line with the realities of the securities markets, corporate bottom lines are likely to be reduced, because some of the illusory profits that accounting rules permit will melt away.
Noting that the average rate used by the 100 companies was 8.92 percent, on that basis the pension funds gave those companies a collective income increase of $3.3 billion. Had the companies used an average rate of 7.92 percent instead, he said, they would have wiped out that increase and reduced their collective pretax earnings by a further $5.7 billion.
Though 10 percent returns now seem far-fetched after three poor years of stock market performance, eight of the largest corporations used such assumptions, while posting investment losses in their funds ranging from 2.9 percent to 13.5 percent, according to Mr. Ehrhardt.
The company with the biggest discrepancy between its assumed rate of return on pension assets and its real return was Northwest Airlines. Northwest assumed its pension assets had a 10.5 percent gain last year, but the funds actually lost 13.5 percent on investments.
Starting this year, federal regulators have said that they will audit the financial statements of any companies that use rate-of-return assumptions greater than 9 percent for their pension funds. Any company unable to persuade the auditors that a higher rate is valid will be required to restate earnings.
Northwest has already said that it will use an assumed rate of 9.5 percent for its pension investments in 2003. A spokesman, William Mellon, said the airline decided to use the rate "after consultation with outside experts and consideration of historic rates of return."
"We are comfortable with a 9.5 percent rate of return," Mr. Mellon added.
General Motors, which has America's largest corporate pension fund, also used an assumed rate of return of 10 percent last year and will use 9 percent in 2003.
"We feel that that's an appropriate rate of return, based on our track record as of the last 15 years," a General Motors spokesman, Jerry Dubrowski, said.
nytimes.com
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Pension shortfalls drain firms' cash
By Christine Dugas, USA TODAY
Posted 4/16/2003 10:00 PM Updated 4/17/2003 2:55 AM
The unrelenting bear market forced top-tier U.S. companies to pour cash into their sagging pension plans last year, and the financial pain will only worsen if stocks don't stage a lasting rebound soon.
In 2002, 100 of the largest corporations with pension plans contributed $34 billion to their underfunded pensions — more than a threefold increase over 2001, according to a study out Wednesday by pension consultants Milliman USA.
Pension contributions this year are expected to double, says John Ehrhardt, a consulting actuary for Milliman. And it is not something that can be put off until the end of the year: The large pension shortfalls at many companies will trigger rules requiring them to start making quarterly payments this week, he says.
That means companies, already squeezed by the sluggish economy, will have less cash to spend in other areas, such as investing in their businesses or giving raises to workers.
Top contributors
Pension fund contributions in 2002 (in billions):
General Motors
$5.16
IBM
$4.19
Citigroup
$1.24
ConocoPhillips
$1.19
J.P. Morgan Chase
$1.15
Altria
$1.10
3M
$1.09
Johnson & Johnson
$1.07
United Technologies
$1.06
ExxonMobil
$0.97
Source: Milliman USA
Not all of the companies making big pension contributions last year did so under duress. "We think many of them were voluntary," says David Zion, a pension accounting expert at Credit Suisse First Boston, who recently completed an analysis of companies in the Standard & Poor's 500 that have pension plans.
Companies make voluntary contributions for a number of reasons, Zion says, such as obtaining tax benefits, improving the health of the plan or avoiding paying a higher premium for pension plan insurance.
In addition, companies sometimes make pension contributions so they don't have to reduce their shareholders' equity, which can be required when pension shortfalls balloon. A charge to equity can cause a credit-rating downgrade or put a company in violation of its loan agreements — either of which can make it harder or more expensive to borrow.
Last year, IBM contributed $4.2 million in cash and stock to its underfunded pension plan. It didn't have to fully fund its plan all at once but chose to do so, saying that based on the strength of its cash flow and balance sheet, it wanted to put the problem behind it.
Not all companies generate enough cash flow to cover their pension contributions. They may have to issue new stock, borrow money or, in extreme cases, sell operations to generate the funds, Ehrhardt says.
Pensions become underfunded when retirement benefit obligations exceed the assets in the pension plan portfolio. During the 1990s bull market, most plans sported surpluses, which helped boost corporate earnings and meant companies avoided making pension contributions several years in a row.
"The '90s were not normal," Ehrhardt says. "Pension contributions and expense are the norm."
Three years of declining stock market returns and low interest rates have eliminated most surpluses. Only 39 companies in the S&P 500 had a pension surplus last year, Zion says. General Electric, for instance, had a surplus of $4.5 billion. Overall, the pension shortfall for companies in the S&P 500 totaled $216 billion last year.
usatoday.com |
