ARMONK, N.Y. -- Big Blue's pension income grew hugely in 1999, not because of purported savings from the retrofitting of its traditional pension plan into a cash balance plan, but because of hefty returns from pension fund assets.
IBM Corp.'s pension income grew to $638 million at the end of 1999, up $184 million from the $454 million it had earned the previous year.
The company had anticipated earning $3.5 billion on its pension assets last year, a $340 million jump from 1998 projections.
And that $340 million increase -- the single biggest factor in the company's jump in pension income last year -- dwarfs the $200 million in savings the company projected last May it would realize by moving most of its employees to the cash balance plan.
In fact, the company ended up saving somewhat less, and those savings were redirected into expanding the company's stock option program for non-executives, a company spokesman said.
A company's pension cost includes the cost of benefits earned by employees during the year, or service cost, as well as interest on the deferred pension liability. Those costs are offset, however, by the expected returns on pension assets, as well as a recognition of some of the earlier gains the company may have recorded due to changes in actuarial assumptions.
Financial Accounting Standard 87, the accounting rule for pensions, requires companies to use their assumed rate of return, instead of actual returns, in computing their pension cost or earnings.
At the same time, the higher return was offset by an increase in liabilities because of a decline in interest rates and the cash balance conversion. Lower interest rates mean companies need more money in their pension funds today to pay for pension benefits in the future. Conversely, higher interest rates result in lower pension liabilities, and lower pension costs.
But while a year-end change in interest rates affects liabilities immediately, it doesn't affect a company's pension costs (or pension income) until the following year. Thus, the company's use of higher interest rates in 1999 had an immediate impact on its 1999 pension liabilities but will not show up in its pension costs until this year.
IBM's pension income contributed 5.4% of the company's pre-tax earnings of $11.8 billion last year, up from 5% of pre-tax profits in 1998.
The company would have reported even higher pension income in 1999 had it not more than doubled the number of employees who could choose to stay in the traditional pension plan.
In fact, it appears the company incurred costs to the tune of $5 million to $10 million in the second half of the year because of the company's conversion to the cash balance plan, based on an analysis of the company's 1999 financial reports. A company spokesman could not explain this cost, which shows up in IBM's pension liability as related to "amendments."
It converted to a cash balance plan in July, but in September agreed to let more middle-aged workers stay in the old plan after thousands of employees, fearing cuts in their pension benefits, complained to lawmakers.
Employee anger at the company's ostensible savings resulting from pension cuts for many middle-aged workers was funneled into a shareholder proposal that asked the computer giant to give all employees the choice of staying in its traditional pension plan, and receiving full retiree health care benefits. The shareholder resolution garnered 28.4% of the total votes cast at the company's annual meeting last month, far more than the dissident shareholders had expected.
"There was speculation that companies were going to cash balance pension plans because of savings in pension expense. It just isn't so," said an actuary who declined to be identified.
IBM simultaneously overhauled its retiree health care plan and realized savings of about $20 million last year alone as a result, according to a company spokesman.
A company's pension expense is the cost of providing pensions for the year. It is added onto the pension liability the firm has reported up to that point. Thus, the firm's 1998 year-end pension liability of $34.4 billion was the starting point for its 1999 pension cost.
IBM's service cost went up to $566 million in 1999, from $532 million in 1998, largely because it used a lower interest rate -- 6.5% from 7% -- to value its liabilities than it had the previous year. The company's service cost would have gone up far more had the company not converted to a cash balance pension plan, a spokesman explained.
Because IBM assumed lower interest rates, the interest component of its pension cost also went up correspondingly, to $2.4 billion in 1999. But pension costs were offset by the $3.5 billion the company expected to earn on its pension assets, as well as an amortization of earlier gains.
Because IBM anticipated earning far more than it anticipated spending on pensions last year, it was able to record pension income or a pension credit of $638 million last year.
In fact, IBM earned $6.4 billion on its pension assets last year, or a healthy 15.8%, well above the $3.5 billion, or 9.5%, it had anticipated earning.
The company also shaved off $2.8 billion from its pension liability during 1999, primarily because it assumed higher interest rates when calculating the present value of its future liabilities. It assumed an interest rate of 7.75% to value its pension liabilities last year, instead of 6.75% the previous year.
The computer giant's pension income should continue to grow even larger this year, thanks in part to its upward revision in its discount rate at the end of 1999. Moreover, because accounting rules allow companies to spread out their pension returns over several years, the returns earned on pension assets last year as well as earlier years will show up in the pension cost for this year.
At the end of 1999, however, the company also assumed its workers' salaries would rise at the rate of 6% a year, instead of the 5% a year it had assumed previously. Because salary-related increases mean the company will have to pay greater pension benefits, its pension income in 2000 will grow less than it would have if it had assumed no change in the salary increase.
Even so, IBM's 2000 pre-tax earnings could grow by at least $200 million, or $50 million a quarter, based on an analysis of its disclosures of pension liabilities and assets in its 1999 financial statements.