Many Unhappy Returns

Many troubled industrial companies with threadbare pension funds and heavy employee retirement obligations have been doing a clever dance with the numbers. When falling interest rates began battering their funds' investment returns in 1990, they insisted that little had changed. They maintained the same rosy return assumptions they used during the double-digit 1980s. With the recession raging, that enabled companies to save money by skimping on payments into their pension funds.

Now the dance is over. On May 13, General Motors Corp. reduced its fixed-income return assumption for accounting purposes by a full point from 8.6%. The lower expected returns mean GM likely must widen its unfunded pension liability by $5 billion, or 36%. GM, like a lot of strife-ridden giants, is under pressure from federal pension regulators to catch up.

GM is far from alone. Tenneco Inc., whose pension plan is in the hole by $103 million, says it decreased its return assumptions from 9.2% to 8.9% over the past year. "But we haven't figured out yet what that means in terms of changing our liabilities," says Charles H. Hopkins Jr., Tenneco's director of benefits finance.

"PART OF THE GAME." Optimistic return assumptions have long been an artful labor relations tool for struggling industrial behemoths. In contract dickering with the United Auto Workers over the years, for instance, GM poor-mouthed its financial situation and argued that resources were better devoted to restoring the auto maker's market position than to larding the retirement fund, pension consultants say. GM balmed the union by highlighting the pension fund's stellar investment returns: an average 14.4% annually over the last 10 years, heavily propped up by the 1980s bull market. "Saying Wall Street will take care of UAW members was part of the game," says David Langer, a New York-based pension actuary.

Problems began developing in the mid-1980s. Although long-term interest rates began falling in 1988, pension managers continued to assume ever-higher rates of return on investments (chart). The trend became glaringly apparent when the Federal Reserve yanked rates down radically to combat the recession--and the bellwether long bond's yield fell below pension funds' projected rates of return. True, pension funds don't depend solely on interest from fixed-income investments. Stocks make up a good half of the average pension portfolio. But stock market returns haven't been very generous in recent years, either. While current worries over inflation have lifted interest rates somewhat, few expect that to last long.

In acknowledging the impact of lower returns, GM last year booked a $2 billion charge against equity. Changed actuarial assumptions were partly to blame: The company belatedly conceded that workers were retiring earlier. In its May 13 announcement, GM admitted that, if rates stay low for the rest of this year, the unfunded liability will leap by more than one-third, to $19 billion. That will result in another hit to equity of $1.8 billion in 1993. All this is on top of a $21 billion whack that GM's net worth took in 1992 from new rules issued by the Financial Accounting Standards Board that required companies to write off future retiree health benefits. Admits a GM executive: "The extra asset performance [of the 1980s] was covering up the problem that was brewing" with the humongous unfunded pension liability. Overall returns--stocks, bonds, and other investments-- have been running at a 10% clip for the past six months, but it's far from clear that GM can sustain that.

Thus far, few other corporations with underfunded corporate pension plans have reported what impact the expected lower returns will have on them. Companies eventually must disclose changes in their investment return assumptions, as well as material pension changes that affect the balance sheet.

Some companies may try to tough it out, at least for the time being. NWA Inc., the parent of Northwest Airlines Inc., which has $200 million in unfunded liabilities, has maintained its expected rate of return steady at 10.5%--a lot higher than many analysts think it can sustain. The company didn't return phone calls requesting comment.

But it seems certain that most companies with large, underfunded plans will have to follow GM's lead. "Steel, automative, rubber, and airlines will get hit hard," says Jerry Y. Carnegie, a partner with Hewitt Associates, an employee benefits consultant. Bethlehem Steel Corp., for instance, has a $1 billion unfunded liability, which is likely to be a drain on its earnings.

To be sure, corporations aren't the only organizations playing around with pension difficulties. Hard-pressed state and local governments have also pumped up their expected retirement-fund investment returns so they could reduce their pension contributions.

NO CONFESSIONS. Last year, New Jersey helped bridge its budget shortfall by changing its method of accounting, which enabled it to boost expected returns from 7% to 8.75%. The upshot: New Jersey and its municipalities reduced contributions from $900 million to $600 million. The New York City Employees' Retirement System made a similar move when it raised its investment performance assumption in 1990 by pegging future inflation at 4.5%, a rate many economists believe is too high. That enabled the Big Apple to shunt $120 million toward its ever-clamorous workers' pay hikes.

No one likes to concede he's stealing from tomorrow to keep going today. For years, GM and its underfunding brethren have calmed worrywarts by, quite rightly, pointing out that their pension obligations will come due only gradually over coming decades and therefore are manageable. And indeed, GM has promised it will fill the hole in its pension promises by decade's end, when presumably its profitability will be restored. Other underfunders have made similar vows. Their legions of workers and retirees had better hope they're good for it.

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