But not all companies are waiting patiently for the go-ahead to increase assets. Many are also attacking the issue from the liability side of the balance sheet and simply reducing benefits. Many major corporations--including IBM, Ameritech, Duke Energy, Kmart, and Lucent, to name just a few--have implemented pension cuts in recent years. In some cases, the changes have been in the form of subtle modifications to the compensation and benefits formulas, such as a reduction in the rate at which benefits are accrued. Increasingly, however, employers' efforts to boost pension plan surpluses-- and corporate earnings--have been far less subtle, consisting of the outright elimination of specific benefits, such as early retirement subsidies.
Historically, companies cut benefits when business is bad. But these are prosperous times, and most pension plans are fully funded, if not overfunded. "[FAS 87] has given companies the ability to realize the economic value of pension plan assets without actually going through a reversion," says Richard P. Hinz, director of the Office of Policy and Research at the Pension and Welfare Benefits Administration. As a result, he says, pension plans are now effectively a profit center.
Could it Backfire?
All of this maneuvering has provided considerable short-term benefits to companies. But many experts fear that corporations' increasing reliance on growth in pension plan surpluses will backfire over the long term.
Sooner or later, the stock market will stop performing as spectacularly as it has in recent years. At that time, says Sondhi, "not only are companies going to have to make pension contributions, [but] they will no longer be able to recognize the credit." In this scenario, pension plans easily could become a cost center again. "[They are], after all, a cost of doing business," says Sondhi. "Right now, [they're] not showing up as a cost of doing business because [they're] shielded by a confluence of events--the market's performance and changes in assumptions."
A change in the current environment, say analysts, may also reveal subpar growth in income from certain companies' primary businesses. "Pension plan returns are far in excess of the return on assets of their sponsors," says Ciesielski, noting that according to his estimates, 32 of the 87 S&P 100 firms with defined benefit pension plans had pension plan returns in excess of their operating returns in 1999.
Still, Gaston Kent, vice president of investor relations at Northrop Grumman, maintains that as long as firms adequately disclose their pension income, pension fund accounting should not be an issue. "Every shareholder that I talk to is fully aware of it," he says. "And there are also some fairly significant noncash expenses."
While many analysts believe that companies should be required to treat pension income the same way they treat earnings on investment--as nonoperating income--no one expects any changes in the accounting rules anytime soon. While the Financial Accounting Standards Board acknowledges the validity of some of the recent criticisms about pension accounting, it currently has no agenda item scheduled to address the issue. "There is obviously a lot going on in a pension plan," says Jim Kroeker, a FASB fellow. "But it seems that all of the necessary information is available in the footnotes to the financial statements."
The SEC, however, is trying to get pension surplus information out of the footnotes and into the spotlight. Although the commission does not plan to organize a task force or propose new rules on the issue, it is "sensitive to the disclosure of pension fund details," says a senior official. Most recently, in December chief accountant Lynn Turner sent an audit risk alert letter to the American Institute of Certified Public Accountants, letting accountants know that any gains or losses on pension fund investments that are "reasonably likely to have a material impact on financial condition, liquidity, or results of operations of the company" should be included in the management discussion portion of a company's filings. Changes in types of plans must also be discussed, the letter said.
The Other Shoe
The continuing desire of corporations to maintain pension surpluses, say some observers, is the force behind the recent spate of cash- balance plan conversions. An estimated 500 defined benefit pension plans in the United States have been converted to such plans in recent years.
By definition, a cash- balance plan conversion does not have to mean lower benefits for employees and retirees. "There are valid reasons for switching to a cash- balance plan," notes Turpin of the American Academy of Actuaries. In theory, it can be structured to provide employees and retirees with long-term retirement benefits equivalent to those in the old defined benefit plan, while also meeting the portability needs of today's workforce.
In practice, however, the conversion generally produces significant reductions in the employers' total pension liabilities by reducing benefits for many employees. Last year, for example, when IBM converted to such a plan, one of the company's engineers calculated that he would lose $212,000 when he retired in 10 years after 30 years of service. "The purpose of IBM's cash-balance plan conversion was to slash obligations to employees, increase the pension plan surplus, increase the company's operating income, and drive up its stock prices," says James Marc Leas, an advisory engineer and patent lawyer at IBM's Burlington, Vermont, semiconductor fabrication plant.
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