WASHINGTON -- Some of the nation's largest corporations could produce healthy earnings gains in the coming weeks -- not just from improved operating results, but because of heftier contributions by their pension funds to their bottom lines.
Among them are AT&T Corp., E.I. du Pont de Nemours and Co., Ford Motor Co. and IBM Corp.
Ma Bell could see its pre-tax earnings improve by around $800 million, or $200 million a quarter, thanks to its pension fund's contributions; DuPont could see a gain in the vicinity of $500 million this year, or $125 million a quarter; and Ford could rake in upward of $100 million a year, or $25 million a quarter, according to Pensions & Investments' analysis of the companies' latest financial reports.
Moreover, IBM's 2000 pre-tax earnings could grow by as much as $200 million.
AT&T earned 4% of its pre-tax earnings in 1999 from its pension fund; DuPont earned 9.7%; and IBM, 5.4%.
Ford, which incurred a pension expense last year, could receive financial help from its pension fund in 2000.
General Electric Co., which earned 8.9% of its pre-tax earnings last year from its pension fund, already bested analysts' estimates when it reported its first-quarter earnings late last week.
And, General Motors Corp., which reported its first-quarter earnings April 13, could start logging pension income this year, as opposed to pension expense. The company has pumped billions of dollars into its pension fund since the late 1980s to get rid of its huge unfunded liability.
Accounting rules require companies to report their pension liabilities or surpluses in their annual financial statements, and to book the cost of providing pensions in the most recent financial year in their income statements.
But instead of incurring pension costs, many large companies are generating pension income, which flows through to operating income.
The earnings gains are attributable to stellar investment returns on pension assets and to the rise in long-term interest rates last fall. That increase caused most plan sponsors to bump up, by as much as 100 to 150 basis points, the rates they use to calculate the present value of their future pension obligations.
"The significant outperformance of pension plan assets has continued to deliver a real benefit for those employers that sponsor a defined benefit pension plan. This year's crop of numbers just amplifies that," said Adam Reese, a consulting actuary in the Arlington, Va., office of Towers Perrin.
Mr. Reese, who analyzed the latest financial statements of the companies that comprise the Dow Jones industrial average, found 11 of the 25 companies that sponsor defined benefit plans reported pension income in 1999. (That excludes certain one-time costs for early retirement programs and divestitures.)
The companies are AT&T, Boeing Co., Caterpillar Inc., DuPont, Eastman Kodak Co., GE, Honeywell Inc., IBM, International Paper Co., Philip Morris Cos. Inc. and SBC Communications Inc.
The group reported pension income totaling $1.1 billion in 1999, a vast improvement over the pension expense of $2.3 billion a year earlier.
For the 11 companies, pension assets grew to $457 billion in 1999, from $411 billion in 1998, even after paying out more than $26 billion in benefits. And their pension liabilities decreased to $356 billion, from $375 billion a year earlier, primarily as a result of the interest rate hike last year.
Thanks to the strong stock market, the group's median or midpoint return on assets was 19%, double the expected return.
Consequently, the pension surplus, or the excess of assets over liabilities, grew to $101 billion for the group in 1999, a 180.6% leap from the $36 billion in pension surplus it reported a year earlier.
Accounting for income
Even though accounting rules let companies take their pension income or expense into account in their operating income, most securities analysts discount the pension earnings as unsustainable.
Some, such as Patricia McConnell, an accounting expert at Bear Stearns & Co. Inc., New York, believe companies should be required to treat pension income the same way they treat earnings on investments or from the sale of businesses -- as a windfall.
Of the three key components of pension cost -- the cost of benefits earned by workers during the year, the interest expense on the deferred pension liabilities and the expected return on pension investments -- Ms. McConnell believes companies should be allowed to include only the service cost or the cost of current benefits in calculating operating income.
Higher interest rates translate into lower pension liabilities, as well as lower pension costs, because companies need less money in their pension funds today to pay for benefits in the future. Higher interest rates also mean most companies should book higher returns on their assets.
But because many of the largest corporations already are enjoying surplus pension assets, higher interest rates also could result in more sizable pension earnings.
Because companies typically spread out their better-than-expected investment returns on their pension assets over several years, they should continue to benefit from their extraordinary performance for years to come. And because Financial Accounting Standard 87, the accounting rule governing pension disclosures in financial reports, requires companies to use their assumed rates of return instead of their actual returns in computing their pension costs, companies that have used high rates of return could report higher pension income.
Changes in interest rates flow through to the income statement the following year.
Effect of returns
Companies also should see a robust decline in their pension costs in the first-quarter results because of stratospheric returns on investments.
Because most companies estimated the returns on their assets in the 9% range, but logged returns of twice that or more, they now must book a portion of those surplus gains in their income statements.
"The older the company is in terms of its work-force demographics, the more this phenomenon is going to have an impact on their reported earnings," said Keith Ambachtsheer, president of K.P.A. Advisory Services Ltd., a Toronto-based pension research and consulting firm.
AT&T, for example, reported a pension income of $422 million in 1999, a huge change from the $1.1 billion in pension expense it reported the previous year. AT&T's pension income would have been "somewhat higher" had it not been for the impact of an early retirement program, an AT&T official said.
At General Motors, the remarkable investment performance by its pension fund and the interest rate hike resulted in the company's pension plans finally becoming fully funded. In fact, the pension fund is now about 110% funded, compared with a 97.5% level in 1998.
The automaker still has a pension shortfall for federal insurance purposes as measured by the Pension Benefit Guaranty Corp. GM is planning to contribute approximately $7 billion of H-class stock to its pension fund in June to ensure the fund is then fully funded in that regard.
The company's pension liabilities shot up by $5.3 billion in 1999, following a new contract with its unionized workers, but its liabilities dropped $4.6 billion, reflecting the spinoff of its Delphi operations. The company spun off $3.4 billion in pension assets to Delphi, so its assets were not hurt as much by the spinoff.
This is reflected in the company's pension cost, which dropped, in part because of less benefits owed to workers for the year, as well as a lower interest cost on its smaller liabilities. But the biggest factor resulting in the company's lower pension cost was the hefty returns the company expected to earn on its assets.
"General Motors Investment Management Corp. did an excellent job for us and significantly outperformed our expected returns," said John Behnfieldt, director of GM's worldwide pension funding and analysis.
"In a normal year, the asset returns are usually about the same as the benefit payments, but this year returns significantly outperformed the benefit payments," Mr. Behnfieldt noted.
For GE, which earned $1.4 billion, or 8.9% of its $15,577 in pre-tax profits last year, from its pension fund alone, the impact can be quite dramatic.
The company, whose pension fund had $24.7 billion in surplus assets last year, can expect that to grow hugely this year.
Because the company bumped up the discount rate it uses for valuing its pension liabilities to 7.75% at the end of 1999, from 6.75% a year earlier, it could see a gain of as much as $300 million in its quarterly pre-tax profits this year from its pension fund alone.
Meanwhile, DuPont could rake in another $560 million in pension income this year, or $140 million in the first quarter. The company earned $41 million a quarter from its pension fund last year. It is scheduled to report its first quarter earnings April 25.
DuPont raised the discount rate it uses for valuing its pension liabilities to 7.75% at the end of 1999, from 6.5% a year earlier, and is also raising its anticipated return on its pension fund this year to 9.5% from 9%.
In its 1999 annual report, DuPont notes it expects to return double-digit growth in earnings in 2000, in part reflecting "lower pension costs due to favorable asset returns, an increase in the long-term investment return assumption and a higher discount rate."
The company, which expected to earn $1.8 billion on its pension assets last year -- the biggest factor contributing to its increase in pension income -- actually earned returns "far in excess of 9%," said Ken Porter, DuPont's chief actuary. The results of that will show up in the company's 2000 pension income.
Ford had a small pension expense last year of 2.9% of its $8.4 billion in pre-tax profits, primarily as a result of a new contract agreement with its unionized workers.
Like most other large corporations, Ford assumed a 7.75% interest rate for valuing its liabilities at the end of last year, up from 6.25% a year earlier. As a result, it can expect its benefits cost to be flat in 2000 instead of going up, or be slightly lower.
But the biggest impact on the company's pension cost should be as a result of the investment performance it has recorded in previous years. Ford expected to earn $3 billion in investment returns in 1999, but in fact earned $4.2 billion.
Company officials did not return calls seeking comment.