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U.S. Economy: Pension Costs Rise, Threatening to Slow Growth

Bloomberg News

June 10, 2003

Rising pension liabilities may hinder the U.S. economy by forcing companies such as Goodyear Tire & Rubber Co. to divert funds from investment and hiring, economists said.

In the past four years, the pension funds of companies in the Standard & Poor's 500 Index lost $173 billion in value as the shares in the index fell 25 percent, according to Credit Suisse First Boston. Interest rates, as measured by the Federal Reserve's key overnight bank rate, fell from 5.0% to 1.25 percent, hurting returns on plan investments and raising the companies' obligations by $289 billion. The combined $462 billion swing is equivalent to two-fifths of annual U.S. capital investment.

``Firms no longer able to rely on appreciating stock prices to bail them out of their pension obligations have been forced to divert profits, reduce capital expenditures and cut labor costs,'' said Joseph Abate, senior economist at Lehman Brothers Inc. in New York, who recently analyzed the issue for clients.

Goodyear's unfunded pension liability more than doubled to $2.2 billion during 2002. The company plans to raise contributions to its retirement funds this year by almost two-thirds, or $144 million, even as it cuts costs by eliminating brands, products and jobs. Capital spending in 2003 will drop a fifth to $360 million, reflecting limits imposed by creditors holding $3.35 billion of Goodyear debt.

Pension contributions of 320 companies in the S&P 500 quadrupled last year to $41 billion, or 5 percent of corporate profits, according to investment adviser Wilshire Associates in Santa Monica, California. The companies were trying to plug $177 billion in fund shortfalls.

Economic `Headwinds'

Lehman's Abate said such measures raise ``headwinds'' for an economy that grew at an annual rate of just 1.9 percent in the first quarter and is on track to expand 2.4 percent this year, matching growth in 2002, according to a May survey of 59 economists by Bloomberg News.

Calculating the effects across the U.S. economy is difficult, economists said, because of inconsistencies in the ways companies allocate resources among different needs such as pensions and investment. Of 360,000 pension plans in the U.S., about a sixth offer defined benefits, requiring that sufficient funds be set aside to cover expected future payouts, based on projected rates of return and actuarial assumptions. Defined contribution programs, such as 401(k) plans, aren't affected.

``The most likely to have benefit plans are large, unionized, manufacturing companies who invest a lot,'' said Don Beller, an economist at the Employee Benefits Security Administration, an arm of the Labor Department.

Drag on Investment

With manufacturing accounting for one-seventh of gross domestic product, economists say the rise in pension obligations will act as a drag on capital spending. Nonresidential fixed investment fell in the first three months this year for the ninth quarter in 10, to $1.105 trillion, 13.9 percent below the third quarter 2000 peak. That partly reflects the lowest capacity use in factories in almost 20 years.

Federal Reserve Chairman Alan Greenspan called a rebound in capital spending a ``central question'' for the economy. In testimony last month before Congress, he said such investment fuels job creation and economic growth.

Big U.S. companies ones aren't the only ones affected. A survey of 151 small and mid-sized concerns in the U.S., the U.K., Canada and the Netherlands, issued last week by SEI Investments Co. in Oaks, Pennsylvania, found that pension funding pressures have led 22 percent to cut capital spending and 11 percent to project reductions.

Obligations Widen

``We're not going to see a bump in rates, and that means pension contributions will remain high, pressuring earnings and investment,'' said Jim Morris, SEI's senior vice president for retirement solutions.

CSFB said unfunded pension obligations for companies in the S&P 500 will widen by $95 billion more this year. While the S&P 500 Index has risen 16 percent over the past three months, experts said the drop in interest rates will continue to expand the pension-fund shortfalls. Yields on the 10-year Treasury note dropped 13.5 percent in the past three months to 3.29 percent, close to a 45-year low.

``Pension plans have deteriorated through 2003, and that means less cash for companies to invest and hire,'' said David Zion, CSFB's accounting analyst in New York.

In 2000, 19 percent of American workers were covered by defined benefit plans, and 26 percent by defined contribution programs, according to the Labor Department's most recent data. In 1998, there were 56,405 defined benefit and 300,593 defined contribution plans.

Goodyear, Alcoa

Companies are tapping profits, cutting capital spending or paring labor costs to rebuild their pension funds, economists said.

Aluminum producer Alcoa Inc. and heavy equipment maker Caterpillar Inc. have also been threatened with lower credit ratings by S&P because of rising pension and medical costs. General Motors Corp. and Ford Motor Co., the world's No. 1 and No. 2 automakers, have already had their ratings cut in the past nine months for that reason.

``Assets in many of these funds have diminished in value significantly, making us more focused on them,'' said Solomon Samson, S&P's New York-based managing director for corporate ratings.

FedEx Corp., the largest overnight delivery service, is seeking as much as $190 million a year in savings by offering some workers early retirement to help contain rising pension and health- care costs that will erode profit this fiscal year.