VALHALLA, N.Y. - Surprise, surprise. A new study shows defined benefit plans now might be cheaper than defined contribution plans for companies with overfunded plans.
The study, by Towers Perrin, the large Valhalla-based employee benefits consulting firm, found the booming stock market and low interest rates have swelled some companies' defined benefit plan coffers far beyond expectations, letting them skip making contributions for years. Yet year in and year out, many of these same companies contribute tens of millions - and even hundreds of millions - annually to their 401(k) plans.
Moreover, the overfunded status of some of these big corporate pension plans has allowed some companies to book a pension credit, instead of a pension expense, in their financial statements. That's because current accounting rules let companies include pension income as part of operating income.
The Towers Perrin study found pension income boosted the operating income of nine companies with overfunded pension plans in the Dow Jones industrial average by just less than 5% on average.
"Companies that have stayed with defined benefit plans are actually reaping the benefits of the good returns on the stock market," said Adam Reese, a consulting actuary with Towers Perrin in Arlington, Va.
By contrast, defined contribution plans are dragging down companies' earnings because most large companies match some of their employees' contributions and must contribute money to the plans each year.
And in most 401(k) plans, any benefits of good investment returns accrue to plan participants. In a defined benefit plan, investment performance is part of a plan's cash flow and when good, can offset some of the employer contribution.
The Towers Perrin study also helps to explain why some of the nation's largest corporations have revamped their pension plans, converting them into more flexible, hybrid structures such as cash balance plans - instead of jettisoning them in favor of 401(k) plans.
The study of the 28 companies in the Dow Jones industrial average that have defined benefit plans found that total defined benefit expenses for the group had fallen by almost two-thirds - to $1 billion in 1998 from $2.6 billion in 1997. (Those costs exclude special one-time costs associated with severance or early retirement programs.)
That translates into median expenses of a mere 0.3% as a percentage of corporate revenue or 1.2% of pension assets. On average, the 28 companies had pension expenses of only $40 million.
And while the cost of promised pension benefits in 1999 is $7 billion, or more than seven times the expense charged for these benefits in 1998, that increase is attributable to the drop in interest rates between 1997 and 1998. That's because the present value of accrued future benefits rises when interest rates drop.
In fact, nine of the 28 DJIA companies recorded pension income in 1998, up from only six the previous year, the Towers Perrin study notes.
Pensions & Investments identified most of those companies: Allied-Signal (which since has merged with Honeywell Inc.); Boeing Co.; Chevron Corp.; E.I. du Pont de Nemours & Co.; General Electric Co.; IBM Corp.; and International Paper Co.
"Companies are able to continue to provide significant (pension) benefits to employees and not have to incur the true cost of them because they are able to offset some of that cost by returns," Mr. Reese said.
And because accounting rules allow companies to spread out such gains over a number of years, pension costs could continue to fall for the foreseeable future, the Towers Perrin report states.
For example, International Paper logged $85 million in pension income in fiscal 1998, up from $75 million the year before, while shelling out $46 million for the defined contribution plan in 1997 and $47 million in 1998.
"The degree to which a pension department can perform above market averages or peers, it is adding value to the company's bottom line," said Robert Hunkeler, vice president and director of investments at International Paper.
But Mr. Hunkeler warned the fat returns companies have seen on their pension fund assets could evaporate if stocks take a downturn.
Meanwhile, Boeing reported defined benefit pension expenses of $65 million in 1997, but logged $121 million in pension income in its 1998 financial statements. It contributed $361 million to its defined contribution plan in 1997 and $417 million in 1998. The company's pension plan was overfunded to the tune of 112.8% of projected benefit obligations in 1998, and 128.1% in 1997, according to an analysis of its 1998 annual report.
Boeing can thank the "prolonged positive return from the market" for that, a company spokesman noted.
Boeing's pension income could go up even more in 1999 because the company switched to a cash balance plan at the beginning of this year - which would show up in its 1999 annual report next year.
Honeywell Inc., Morristown, N.J., had a $22 million pension expense in 1997, but a year later, it reported pension income of $10 million. The reason: the stock market's performance, said Edward T. Tokar, vice president of investments. He declined to say how much the company contributes to its 401(k).
IBM booked pension income of $420 million in fiscal 1997 - but paid in $236 million into its defined contribution plan that year. The company's pension income rose to $454 million in fiscal 1998, while it shelled out $258 million for its defined contribution plan.
IBM, which switched to a cash balance plan in July, could see its pension income increase even more as a result.
General Electric Co., Fairfield, Conn., reported pension income of $1 billion in 1998. That's up about one-third from the $743 million pre-tax contribution of its pension income - including $412 million savings from its early retirement program - made to its operating income in 1997. After taxes, pension income contributed $660 million in 1998 and $483 million in 1997 to the company's net income, according to a company spokesman.
GE's pension surplus jumped to 157.5% of projected benefit liabilities up from 149.7% in 1997.
"Smart investing" and an exuberant stock market helped, a GE spokesman said.