What bear market? A recent study by actuarial firm Milliman USA shows that the 20 largest companies’ defined-benefit pension plans added almost $7 billion in corporate profits to their companies’ bottom line during 2000. And they’re likely to top that number this year.
Granted, these plans didn’t beat the 2000 market. In fact, as a group, they lost almost $30 billion–25 percent of their companies’ pension surpluses. But Milliman consulting actuary John Ehrhardt estimates that 16 of the 20 plan sponsors he studied use deferral and smoothing techniques defined by FAS 87, which allow them to spread pension gains and losses over time.
The result is a pleasant hangover from the bull-market days. Back in 1999, 32 of the 87 Standard & Poor’s 100 companies with defined-benefit pension plans actually earned more from their plans than from their operations. For corporations that use smoothing, those good times are still rolling.
Companies that chose instead to recognize the fair market value of their pension assets reaped huge rewards, but face sickening earnings hits now that the market has turned. Lucent Technologies, for example, got a huge boost to earnings in 1999 when it switched to a method that more closely aligned returns with actual market value. But its annual report, due out this month, is likely to show the networking specialist is now suffering for that decision.
“Companies that used smoothing had a less drastic but still substantial increase in pension gains [when the market was good],” says Ehrhardt, “and now they are coming down to a soft landing instead of falling off a cliff.” By contrast, he says, “companies using market value are riding a roller coaster.”
Regardless of method, none of the Fortune 100 companies Ehrhardt reviewed in the preliminary study was in danger of underfunding its pensions. A bigger concern for the CFOs of those firms should be whether the long-term average expected plan return of 9.5 percent is realistic. “Unfortunately, people in this field tend to drive from the rearview mirror,” says Ethan Kra, chief actuary at William M. Mercer Inc., “and the last 20 years includes the greatest boom market in history.”
But without pressure from auditors, few companies are likely to lower their expected rate of return. For a plan with $40 billion in assets, a 2 percentage point reduction in the estimated return on assets would create an annual reduction in pension income of $800 million, says Ehrhardt. “What CFO is going to propose doing that? “
Meanwhile, many smaller companies are in danger of falling below funding levels required by the Internal Revenue Service and Pension Benefit Guaranty Corp., says Milliman consulting actuary Jeffrey Kamenir. Plan liabilities are based in part on a mandated interest rate calculated from 30-year Treasury rates, which have been falling steadily. “Really bad stock performance could be the killer on top of lower Treasury rates,” says Kamenir. As a result, he says, many companies had to make additional contributions by mid-September or change their asset method to smoothing. Like smoothing for accounting purposes, that for funding allows shortfalls to be made up over time. But beware–the IRS gives automatic approval to asset-method changes only once every five years. “The 2001 investment year is turning out to be really bad, too, so companies that exhaust their smoothing-method option this year may have to put in contributions next year,” says Kamenir.
LET THE GOOD TIMES ROLL
A sampling of companies that used smoothing.
Expected return on pension assets | Actual return on pension assets | Pension income as reported | |
Exxon Mobil | 726 | 208 | 263 |
General Motors | 7,666 | 634 | (270) |
Ford Motor | 3,281 | 979 | 188 |
General Electric | 3,754 | 1,287 | 1,744 |
Citigroup | 757 | 102 | 29 |
Enron | 75 | 41 | (10) |
IBM | 3,902 | 1,395 | 896 |
AT&T | 1,821 | 995 | 767 |
Verizon Comm | 4,686 | 1,294 | 2,328 |
Philip Morris | 799 | (350) | 290 |
Bank of America | 813 | (135) | 118 |
SBC Comm. | 3,149 | 95 | 1,145 |
Texaco | 136 | (41) | (22) |
Duke Energy | 244 | 47 | (3) |
Chevron | 418 | 110 | 125 |
American Int’l Group | 38 | 17 | (35) |
Merck | 267 | (196) | (116) |
WorldCom | 49 | 36 | 24 |
McKesson HBOC | 37 | 13 | 6 |
Conoco | 76 | (29) | (19) |
Source: Milliman Usa