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An onerous legacy
Financial Times
July 10, 2003 One of the most stubborn legacies of the bursting of the stock
market bubble is the growing number and size of deficits in company pension
funds. A recent study by UBS, the international bank, put the combined hole
for 500 of the biggest US companies at $239bn at the end of May. The gaps have been created by the double whammy of shrinking asset
values and rising liabilities. A potent force behind the latter problem has
been falling interest rates. By lowering the discount rate for future
liabilities, the decline has raised their present value. This is vividly illustrated in the US, where the yield on 10-year
Treasury bonds has fallen from 6.4 per cent to 3.7 per cent since January
2000. When General Motors last month issued $13.6bn in bonds to shore up its
retirement fund, it said the 0.75-1 percentage point drop in interest rates
this year had added $5.7bn-$7.6bn to the $19.3bn hole in its fund. No wonder moves are afoot from the Bush administration to raise the
discount rate by pegging it to higher-yielding corporate bonds. The
immediate effect would be to help pension funds fill their funding holes.
But it also pushes funds down the sensible route of better matching their
assets and liabilities, and this conveys a more ominous signal about the
burden of pension promises. The rub will come if, as planned, the dose of reality is stepped up
in a couple of years' time by forcing companies to tailor the discount rate
to the age profile of workforces. The older they are, the more immediate the
liability - meaning the most appropriate discount rates will be the lower
ones at the short-term end of the bond yield curve. That will push the bill
back up for older industries, such as vehicles and airlines, with huge
legacy schemes. This is only part of the uncomfortable exercise of getting real
about the cost of company pensions. In the UK, many companies have started
to apply a proposed accounting standard, FRS17, that marks asset values to
market, making deficits immediately apparent and bringing home the
volatility of funds with large equity exposures. This is an antidote both to
over-optimistic assumed returns and to the smoothing of fund valuations,
which has delayed or hidden bad news. In the US, companies have been bringing down assumed returns -
General Motors has cut from 10 to 9 per cent. But such figures still look on
the hopeful side and they continue to flatter earnings per share. All moves to bring pension fund valuations closer to reality are
welcome. Increased transparency has brought home the true nature of the
burden that companies took on with pension schemes that guaranteed a certain
level of retirement income. In effect, they managed to postpone a pile of
labour costs; in other words, they were never as profitable as they
appeared. Modern
managements are wise to continue the trend of shying away from this legacy
of paternalism. Copyright ©
2002 Global Action on Aging
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