VideoThese sure seem like good times for pension plan assets. Thanks mainly to the long bull market, many corporate plans are brimming with surpluses. Sherwin- Williams Co., for example, has pension plan assets almost three times greater than its pension obligations. General Electric Co.'s pension assets of $50 billion are nearly double its liabilities. And the pension plans of Bank of New York, Westvaco, and Cincinnati Financial Corp. are also overfunded by nearly 100 percent, according to Bear, Stearns & Co.'s 1998 estimates.
And thanks to the prevailing accounting methodology, a significant portion of those surpluses are boosting corporate bottom lines. According to Bear, Stearns, 25 percent of the companies in the S&P 500 reported income from their defined benefit plans in 1998. And for 15 of those companies, including USXUS Steel, Unocal, Northrop Grumman, Westvaco, and Peoples Energy, pension income represented 10 percent or more of total 1998 operating income. In fact, says Jack Ciesielski, publisher of The Analyst's Accounting Observer, for many companies, "pension plans--in their ability to contribute to earnings--are becoming almost as significant as operating assets."
It's no surprise, then, that more and more corporations are devising new ways to preserve and expand their pension surpluses. Such efforts have included everything from lobbying for legislative changes to reducing pension benefits to, most recently, Bank of America's novel idea of channeling 401(k) monies into defined benefit plans.
But some analysts contend that using pension surpluses to boost earnings distorts financial reality. For one, the growth rates are not sustainable. "You can do these things, but only for so long," says Ashwinpaul "Tony" Sondhi, president of A.C. Sondhi & Associates, a financial advisory firm in Maplewood, New Jersey, and chairman of the Financial Accounting Policy Committee of the Association of Investment Management and Research. For another, the earnings aren't real. Because of Employee Retirement Income Security Act (ERISA) requirements, a company can't access the assets in its pension plans for purposes other than providing benefits to plan participants. "It cannot use this money to finance capital projects, to buy back stock, or to pay dividends," says Ciesielski. "It does nothing to increase or decrease cash flow."
Moreover, the mushrooming surpluses--which have to be fully disclosed only in the footnotes of a company's annual report--have raised the ire of the Securities and Exchange Commission, which is taking a hard look at broadening pension disclosure requirements. In addition, labor unions and retirees, concerned about the lengths to which companies will go to increase the surpluses, are reviving debate over the proper use of pension plan assets. Little wonder, then, that some analysts are wondering if the surpluses might be too much of a good thing.
Multiple Options
That hasn't stopped efforts to expand the surpluses, however. On Capitol Hill, the Senate is considering a bill that would repeal the limits on deductible employer contributions to pension plans. A similar version passed in the House of Representatives in July. But whether a final version will pass muster with the Clinton Administration remains to be seen.
Even without legislative change, employers are finding many ways to boost their plans' assets. That's mostly because "the accounting methodology [for pensions] is chock-full of assumptions that can be tweaked to achieve a desired result," says Ciesielski.
That methodology--Statement of Financial Accounting Standards No. 87, or FAS 87--requires companies to record surplus pension assets as a credit to pension expenses. Simultaneously, it gives companies some flexibility in making actuarial assumptions. Consequently, each year pension plan officers revise the discount rate used to value their plans' liabilities. The higher the assumed interest rate, the lower the present value of a plan's liabilities, the higher its surplus, and the higher the company's earnings. Similarly, pension plan officers revise the assumed rate of return used to estimate plan assets. "Even minute adjustments to these estimates can cause a big swing in a large pension plan's surplus," says James Turpin, vice president for pensions at the American Academy of Actuaries.
How much tweaking is actually going on, however, is subject to debate. Because of the bull market, says Ciesielski, "firms haven't had to resort to the skulduggery of tinkering with expected rate-of- return assumptions to improve earnings. The positive earnings effects are even more likely to be the result of the accounting model itself rather than its outright manipulation."
Companies have, however, become creative in keeping their plans as funded as possible. Bank of America blazed a new trail in July when it offered participants in its $4.7 billion 401(k) plan a one-time option to roll their accounts into the company's $8 billion defined benefit plan. The advantage to employees who make the switch is that they will be able to allocate the money among "virtual" mutual funds, hypothetical portfolios that track returns on the bank's in-house funds. But for Bank of America, the windfall is potentially much larger: its investment returns could be greater than the amount the company will be obligated to pay out to employees. Other companies are surely waiting to see if Bank of America runs into regulatory problems. If it doesn't, it's likely that there will be a flood of asset transfers from 401(k) programs into pension plans.
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