Eight of 100 companies surveyed by Pensions & Investments raised their pension funds' assumed long-term rates of return last year, despite the bear market, while only 16 lowered their assumptions.
As the stock market was delivering negative returns for the second year in a row, dropping the three-year compound annual return to -1%, SBC Communications Inc., San Antonio, Texas, raised its pension fund rate of return assumption by 100 basis points to 9.5%.
SBC raised this rate despite reporting a loss on investments of almost $3 billion in 2001. However, the plan has achieved a 10-year annualized return of more than 10% - a rationale the company felt compelled to state in the text of its annual report.
Alcoa Inc., Pittsburgh, and John Hancock Financial Services Inc., Boston, each raised its assumption by 50 basis points to 9.5%. Goodyear Tire & Rubber Co., Akron, Ohio, raised its assumption 50 basis points to 10% and Consolidated Edison Inc., New York, raised its return assumption 70 basis points to 9.2%.
Con Edison increased its assumption because it had earned returns in the midteens for several years, said Robert Stelben, vice president and treasurer. The benefit obligation increased in 2001, meanwhile, and plan assets dropped as the fund booked losses on investments for both 2001 and 2000. Still, said Mr. Stelben, "two years doesn't make a lifetime."
Biggest cut
Among the companies that reduced their rate of return assumptions, ChevronTexaco Corp., San Francisco, made the biggest cut, 120 basis points to 8.8% from 10%. AK Steel Corp., Middleton, Ohio; Weyerhaeuser Co., Federal Way, Wash.; Sprint Corp., Overland Park, Kan.; Walt Disney Co., Burbank, Calif.; and Sears, Roebuck & Co., Hoffman Estates, Ill., all reduced their return assumptions by 50 basis points.
Weyerhaeuser's cut still left its return assumption at 11%, the highest for any company examined.
ChevronTexaco adjusts its rate of return assumption quarterly because it "wants to reflect reality," said David Smay, general manager of benefit plan investments. Executives do not think 10% or 9.5% returns are realistic expectations, Mr. Smay said, and "we'll be delighted if we can get 8% (returns) on the whole portfolio."
Among the 100 largest corporate plans, the average expected rate of return was 9.3% and the median was 9.5%, P&I found. Almost a quarter of the plans examined had even more optimistic rates - between 10% and 11%. Three-quarters of the 100 plans made no change to their interest rate assumptions from 2000 to 2001.
All but five of the nation's 100 largest corporate plans had negative returns on their plan assets in 2001. Still, eight of the 10 largest plans reported pension surpluses. Forty-eight plans had obligations exceeding their assets in 2001; of these plans, only 17 were underfunded in 2000.
At Viacom Inc., New York, investments on plan assets netted $190.3 million. General Dynamics Corp., Falls Church, Va., had a return of $80 million on its pension assets, Alcoa's plan gained $65 million, and First Energy Corp., Akron, Ohio, recorded $8.1 million. And Fort Worth, Texas-based American Airlines Inc., in a year especially cruel to the major domestic airlines, earned $1 million on its pension assets.
The companies with the largest pension surpluses in dollar terms were General Electric Co., Stamford, Conn., $14.6 billion; Verizon Communications Inc., New York, $12.2 billion; and SBC, $7.7 billion. All three used a 9.5% rate of return assumption, although GE and Verizon offset this somewhat with high salary increase assumptions of 5%.
In terms of plan assets as a percentage of benefit obligations, the best funded plans were those of Kaiser Permanente, Oakland, Calif., 245%; Sandia National Laboratories, Albuquerque, N.M., 204.9%; FPL Group Inc., Juno Beach, Fla., 188.2%; and GE, 147.9%.
Unfunded liabilities
Among the plans with the largest unfunded liabilities in dollar terms were General Motors Corp., New York, with $9.1 billion; ExxonMobil Corp., Irving, Texas, $2.8 billion; UAL Corp., Chicago, $2.5 billion, Delphi Automotive Systems Corp., Troy, Mich., $2.4 billion; and Delta Air Lines Inc., Atlanta, $2.35 billion.
Arlington, Va.-based U.S. Airways Inc. had the worst funding status in terms of assets as a percentage of benefit obligation: 57.3%. It was followed by Northwest Airlines Inc., St. Paul, Minn., and ExxonMobil, both with assets equal to only 65.9% of obligations.
In a year of economic downturn and dismal market performance, to count on investment returns of 9% or higher would seem like wishful thinking - but it is not an invitation for disaster, said Adam Reese, a senior consultant in the Arlington, Va., office of the Hay Group.
Pension funds calculate their rates using "a slightly higher inflation base than we're experiencing currently," Mr. Reese said, but they are considering a long period of time. Over the last five years, he said, most plans have returned better than 9.3%. And most plans, he added, still are drawing on unrecognized gains from the boom years of 1998 and 1999 to temper last year's losses.
The market in 2001 took a toll on General Motors' funding of its defined benefit plans. The company, which had $67 billion in pension assets and used a 10% expected rate of return on plan assets in 2001, saw $4.4 billion in pension assets disappear as it reported a -5.7% return on assets.
In contrast, in 2000 the company reported pension income of $634 million and had a funding surplus.
GM made no change to its 2001 interest rate assumption, however, because during any 10-year period over the past 15 years, the plan averaged more than a 10% return on its assets, said Jerry Dubrowski, a GM spokesman.
According to several actuaries, under Financial Accounting Standard 87, companies are permitted to report the average market value of their pension assets over a maximum period of five years. Most controversially, they also are allowed to include their net pension earnings in their net corporate earnings, encouraging overly optimistic pension accounting and potentially disguising the true health of a company, the actuaries said. A higher expected rate of return on pension assets decreases the benefit cost and raises the corporate bottom line.
"FAS 87 invites corporations to set up an artificial profit production factory," said Keith Ambachtsheer, president of K.P.A. Advisory Services Ltd., Toronto. "Corporations can assume anything they want."
Larry Bader, a retired actuary, formerly of William M. Mercer Inc., New York, concurs: "If you asked an automaker to report their expected sales, would you think they would go low or high?"
Pension income
Of the companies examined, several of those using above-average return assumptions also reported pension income as a significant part of their net income. Weyerhaeuser, with its 11% expected rate of return on plan assets, reported pension income of $234 million - 66% of the net corporate income. (The average contribution of net pension income to net corporate income was 12%, P&I found.)
Verizon booked the highest pension income of the 100 funds researched, at $2.7 billion, while using a 9.3% expected rate of return on plan assets in 2001. This surplus then showed up as 692% of Verizon's net corporate income, an extreme that provoked a shareholder resolution calling for the company to exclude pension income from corporate earnings (P&I, April 15).
The average compensation increase assumption was 4.2%, P&I found. The average discount rate for obligations was 7.2%, a figure tied into long-term debt ratings.
A slight change to the discount rate has a negligible effect on pension expenses, noted Jeremy Gold, an independent New York-based actuary.
