The bad news is in.
Pension fund liabilities outstripped pension assets by a record 45% between December 1999 and September 2001, according to a new report by Ryan Labs Inc. For the nine months ended Sept. 30, pension liabilities outpaced assets by 16.6%, and since Dec. 31, 1998, pension assets have barely kept pace with liabilities.
Ronald J. Ryan, presidentof New York-based Ryan Labs, and other experts place the blame on the steep decline in 30-year Treasury bond rates, the prescribed rate for calculating annual pension liabilities and contributions, as well as for determining insurance premiums to the Pension Benefit Guaranty Corp.
Moreover, because annual pension liabilities are based on the four-year weighted average interest rate on the benchmark Treasury security, the full impact won't hit home until 2003, many experts warn.
Adding to plan sponsors' woes is the poor performance of pension assets because of the downdraft in the stock market since March 2000. If the stock market doesn't cooperate this year, pension funds not only will risk seeing their liabilities soar, but also could see their pension assets shrink further.
This means some pension funds that had just enough assets to cover their current liabilities could face a gaping hole, necessitating pension fund contributions and higher insurance premiums to the PBGC. Employers must pay a higher PBGC premium if their pension assets fall below 85% of the present value of their current liability.
"Those plans that were already underfunded or the ones that were so overfunded that they still won't make any contributions won't be affected at all, but the ones at the margin will be greatly affected," said Mark Beilke, director of employee benefits research at Milliman USA, Vienna, Va.
Many of the nation's largest corporations that had become accustomed to beefing up their bottom line with income from their pension funds are going to face a drag on earnings. And because of the way the accounting rules work, companies could see their reported earnings hit for many years, Mr. Ryan said.
Michael Peskin, principal in the global pensions group at Morgan Stanley Dean Witter & Co., New York, warned investors are going to put increasing pressure on companies to report current pension liabilities in their annual financial statements, and report how much they expect to contribute to their pension funds in the current fiscal year. Under existing rules, they are not required to disclose this obligation.
Already, John Devine, chief financial officer of General Motors Corp., New York, has warned investors he expects the company's pension plan for hourly employees to report a $9.1 billion shortfall in 2001 because pension assets lost 5.7% last year instead of hitting the 10% target rate of return. As a result, the automaker expects to take a $1.37-per-share hit to its pre-tax earnings in 2003, when it anticipates contributing about $2 billion to the pension plan to avoid paying higher insurance PBGC premiums, he said. The pension plan had a $1.7 billion surplus on its books at the end of 2000.
Other plans may follow
Other companies could follow.
According to data the companies submitted for Pensions & Investments' survey of the nation's largest pension funds, American Airlines Inc. contributed $163 million to its pension fund for the most recent plan year, compared with $93 million the previous year; Merck & Co. Inc. contributed $209 million vs. $153 million a year earlier; United Airlines contributed $230 million compared with $200 million; and Lockheed Martin Corp. contributed $56 million, up from $12 million.
But because actuarial valuations of pension plans for 2001 will not be completed until the summer, and federal pension law permits plan sponsors to contribute until nearly nine months after the end of the year, many companies don't yet know how much more they will have to contribute for 2001.
"Our contributions are probably going to be going up." said William F. Quinn, president of AMR Investment Services Inc. Fort Worth, Texas, which oversees American's pension fund.He blamed the shortfall the benchmark T-bond's interest rate decline; the end of the bull market; higher benefits in new labor contracts; and the addition of employees from TWA (which merged with American) who will be eligible for pension coverage this year.
Because of the shortfall in its pension fund (10% or so), the airline expects to continue paying a higher insurance premium to the PBGC, he said.
Actuaries and others representing employers are lobbying furiously for a change in the law that would permit plan sponsors to use an interest rate tied to high-quality corporate bonds or another benchmark instead of long-term Treasury securities. But some experts, including Mr. Ryan, warn the fundamental problem is the mismatch between pension liabilities and pension assets.
FAS 87 effects
Compounding that problem is Financial Accounting Standard 87. The accounting rule allows companies to spread out, over 15 years, the difference between the assumed rate of return and the actual return on pension assets, and lets companies use their assumed actuarial rate of return instead of their actual return on pension assets in computing their annual pension expense or income. FAS 87 also lets companies spread out the difference between the total return on pension assets and the change in liabilities.
Instead of viewing pension liabilities as long-term obligations and investing pension assets in stocks to pay for those liabilities, plan sponsors should recognize them as short-term liabilities, measured each year, upon which annual contributions are based. If sponsors accepted that pension liabilities are annual obligations and therefore like fixed-income securities, they would invest more in bonds than stocks, Mr. Ryan and some other experts suggested.
"People think the pension game is a long-term ballgame - not true. It's an annual ballgame. If you screw up in any way, you might have earnings drag, higher contributions, PBGC variable premiums to pay and volatility in (corporate) earnings," Mr. Ryan said.