Heard Off the Street: Watch out as pension losses mount but appear as gains

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Heard Off the Street: Watch out as pension losses mount but appear as gains

By Len Boselovic

Post-Gazette, May 19, 2003

Here's one reason why millions of workers are worried about retirement: 320 members of the Standard & Poor's 500 paid out pension benefits equaling 8.5 percent of their pension plan assets last year. At the same time, they replenished those plans with contributions equaling only 4 percent of the assets in their plans.

Even in the wacky world of pension accounting, mathematical maneuvering such as this can only go on for so long.

The sobering statistic is contained in a study released last week by Wilshire Associates, an investment advisory firm. Senior managing director Stephen L. Nesbitt, the author of the report, says 2002 was the worst year ever for corporate pension plans.

Combined, the 320 plans ended the year with a $177 billion deficit, meaning they have made $177 billion in retirement promises they are not currently capable of keeping. Put another way, the plans are 83 percent funded. They contain 83 cents for every $1 in pension obligations. At the end of 2001, the plans were 104 percent funded. Only 36 of the companies -- or 11 percent -- have pension assets greater than their liabilities vs. 36 percent in 2001 and 71 percent in 2000.

The obvious culprit is the stock market, which is off about 40 percent over the last three years. The three-year skid has eroded profits the bull market of the 1990s generated for the plans, profits that meant companies didn't have to make pension fund contributions. Record low interest rates have compounded the shrinking pension fund pot. Interest rates are used to gauge pension plan liabilities. The lower the rate, the higher the liabilities.

The result: assets are decreasing, liabilities are increasing, and companies are beginning to dig into their pockets to pay for their pension promises. Wilshire says the S&P 500 companies contributed $41 billion to their pension plans last year up from just $12 billion in 2001.

"These companies have already woken up to the fact that you have to pay for pensions with real money," Nesbitt says. "That may have some implications for how companies design and provide retirement benefits in the future."

As gloomy as the situation is, the pension picture would be even bleaker were it not for accounting rules. The standards acknowledge the fact that companies pay their obligations over a long period of time, not all at once. They also reflect the fact that the meteoric rise and precipitous plunge of the stock market in recent years aren't indicative of the returns companies can expect to earn on their pension funds over a long period of time.

The Financial Accounting Standards Board, the private organization that serves as the accounting industry's lawgiver, permits companies to base their pension costs for any given year on a long-term assumption of what their pension funds will earn rather than actual returns. Following FASB's rules, the companies Wilshire looked at had a median expected return of 9 percent at the end of 2002. Nesbitt says that's slightly higher than the 8.7 percent return corporate pension plans have averaged over the last 10 years.

That doesn't sound so unreasonable until you take a closer look at the numbers. The companies in the study lost $84 billion, or 8.9 percent, on their pension investments last year. But based on their long-term assumptions, they recorded a $98 million gain.

So instead of recording pension expenses of $182 billion on their income statements last year, the companies based their 2002 earnings on the assumption that their pension plans broke even -- that their "expected" $98 million return covered benefits and other pension costs.

If a company's expected return assumption was a little more aggressive than 9 percent, the market going to hell in a handbasket wouldn't necessarily mean their pension fund couldn't be a profit center. Verizon Communications, which assumed a 9.25 percent return last year, reported earnings of $4.1 billion, including $2.5 billion from its pension plan.

"This whole pension issue has caused and continues to cause a gap between the quantity of earnings and the quality of earnings," says Nesbitt. "From a shareholder point of view, you've got to be very careful looking at these numbers."

"Careful" is an understatement. Verizon's 2002 earnings, reported in strict adherence with generally accepted accounting principles, assumed pension fund earnings of $4.9 billion. In the real world, the phone company's pension plan lost $4.7 billion.

Closer to home, U.S. Steel "expected" returns of $788 million but lost $434 million. Alcoa assumed earnings of $776 million while in reality it lost $376 million. And Weirton Steel, whose pension plan was only 52 percent funded at year end, assumed returns of $54 million when it really lost $38 million.

Nesbitt says 93 of the companies Wilshire examined managed to report pension income last year even though the group as a whole lost about 9 percent on their pension investments.

FASB announced in March it would take another look at the standards. It expects to issue a new standard in the fourth quarter. Hopefully, the new rules will satisfy workers, retirees and shareholders seeking more forthright disclosure. A less distorted version of the truth will probably increase retirement insecurities. But like a junkie trying to kick the habit, companies have to admit their numbers have problems before the problems can be solved.