Where's My Pension?
The slow-moving storm battering traditional pension plans is hitting Old Economy companies full force, making them less competitive, driving up expenses, and sucking cash that might otherwise go toward capital investment and pumping up the economy. There's no safe harbor because their assets, mostly invested in stocks, have plunged 19% since the start of 2000 while their projected obligations have surged 49%, according to research shop Ryan Labs Inc. The result: By yearend the so-called defined-benefit plans of Standard & Poor's 500-stock index companies will be underfunded by $243 billion, estimates David Zion, accounting analyst at Credit Suisse First Boston.
The problems are concentrated in old-line industrial companies that are still burdened by labor contracts made years ago. Their promises put them at a big disadvantage with foreign companies and domestic upstarts that don't have such baggage. Worst hit among major companies are those in the auto, auto components, airline, oil and gas, and pharmaceutical industries. General Motors, Ford, Delta, AMR, Goodyear, Navistar, and Cummins, for example, could each end the year with plans underfunded by more than half of their stock market value.
There's no painless cure. On Nov. 18, Delta Air Lines (DAL ) said it will convert its main defined-benefit plan to a cheaper cash-balance plan, that usually transfers market risk to retirees. Caterpillar Inc. (CAT ) is cutting both retiree health benefits and future pension entitlements of workers hired after Jan. 1, 2003. Other companies are slashing capital spending, issuing stock, or selling off businesses to replenish their funds. "We're talking to clients who are deciding what businesses to sell, what to close down, what capital expenditures not to make, and what people not to hire in order to be able to make cash contributions to their pension plans," says Kevin C. Wagner, retirement practice director at consultants Watson Wyatt Worldwide.
Naturally, companies are trying to put the best possible face on their situation, arguing that their problems will ease once the stock market picks up. After S&P downgraded Ford Motor Co. (F ) on Oct. 25, partly over pension issues, treasurer Malcolm S. Macdonald held a conference call on Nov. 14 to reassure worried analysts and investors that the problems will abate. "It is neither necessary, nor, frankly, advisable to overreact to recent volatility in equity markets," Macdonald said. In fact, the plans got some help in October when stocks and bonds moved sharply in their favor.
But it will take more than a few months of good markets to undo problems that have built up over three years. At the end of 1999, 76% of the nearly 360 S&P 500 companies with plans were overfunded. Now, 91% will likely end the year with shortfalls--and an obligation to contribute $29 billion to their plans next year, nearly double the amount they had to pony up in 2001, says CSFB's Zion.
As they ponder how to fill the void, a few companies are prepared to part with cash. Whirlpool Corp. is considering a $200 million cash contribution to its plans at yearend, largely to avoid an accounting charge that could wipe out 20% of its shareholder's equity. For others, it isn't an option. Under government rules, Northwest Airlines Corp. (NWAC ) faces a $223 million contribution by yearend. It is asking regulators to let it contribute stock of a commuter airline it wants to take public---and an extra five years to shore up its plans. "We've seen a lot of interest in funding waivers," says Watson Wyatt's Wagner. But the government is leery of granting waivers because its Pension Benefit Guaranty Corp. insures many pension benefits.
Most companies would rather fund their plans with their own stock. Government rules generally allow plans to keep 10% of their portfolios in company assets. Bearing maker Timken Co. (TKR ) is issuing 3 million shares, nearly 5% of its outstanding stock, to its plans, to save cash and pay down other debt. IBM (IBM ) is considering putting $1.5 billion of stock, about 1% of its outstanding shares, into its plans.
Although issuing stock saves cash, it is no free lunch. When truck builder Navistar International Corp. (NAV ) put 7.75 million shares of company stock into its plans on Nov. 8., it diluted its shareholders by 13%. To Navistar, that was the lesser evil. "As long as we can make the contributions with stock, we still have the money to do capital investments that we'd like," says Chief Financial Officer Robert C. Lannert. What's more, by issuing stock the company increases the equity on its balance sheet, making it look better to credit-rating services, he says. But the shares filled only half of a $350 million hole in Navistar's plans. And since the plans now have 8% of assets invested in company stock, Navistar won't be able to add much more without special permission from regulators.
The pension burdens worry Wall Street. Companies with traditional plans are having to pay more for capital because investors and credit-rating services are leery about their obligations and the Byzantine accounting and funding rules governing them. Navistar now has three retirees for each active worker. And both LTV Corp. and Bethlehem Steel Corp. have gone bankrupt under the weight of retiree benefits that competitors don't have. "You're going to see a lot more bankruptcies over this issue," says workout investor Wilbur Ross, chairman of W.L. Ross & Co.
The complex accounting and funding rules make matters worse. Many investors now distrust pension accounting because it distorts reported earnings. And, occasionally, some companies find themselves in a bizarre Catch 22--because their plans are underfunded according to generally accepted accounting principles but overfunded according to government rules. If they pump money into their plans, they risk a 10% excise tax and loss of the tax deduction on their contributions, says John Ehrhardt, consulting actuary at Milliman USA.
Such government rules discourage companies from putting more money into their plans during the good times. As a result, the underfunding situation is worse than it might have been. "The rules are not conducive to an orderly pattern of contributions over the years," says Larry Sher, principal at Buck Consultants Inc.
But the prospects for fixing them are slim. The more likely outcome is that companies with defined-benefit plans will phase them out in favor of schemes that put risk on the shoulders of workers--the very people who already feel most vulnerable.
By David Henry in New York and Michael Arndt in Chicago with David Welch in Detroit