Pension plans take a hit from slump, scrutiny

A federal agency that takes over failing pension plans faces an increased caseload.
KNIGHT RIDDER NEWSPAPERS
Last fall, the focus was on Enron Corp. and problems with 401(k) retirement plans. This year, the worries have spread to the nation's traditional pension plans.
A third year of falling stock prices and historically low interest rates is transforming defined-benefit pension plans from hidden earnings engines for corporations into black holes gulping huge sums of cash at some companies.
Financial troubles for corporate pension funds are arising at a time when investors and regulators are scrutinizing corporate books for anything that is less than crystal clear. Few things fit that bill better than pensions.
"I think the concern of the market is that there are time bombs out there," said Robert T. LeClair, an associate professor of finance at Villanova University.
Investors have not seen the worst of it, he said, "unless the market turns around and produces much higher average returns than I and most people are expecting."
Government guarantee
Widespread pension woes combined with a high corporate bankruptcy rate are putting financial stress on the Pension Benefit Guaranty Corp., a federal agency set up in 1974 to take over defined-benefit plans that have failed or are in danger of failing.
Because of PBGC, most retirees and other participants in defined-benefit pension plans can rest assured that their benefits -- at least a portion of them -- are secure even if their company goes bankrupt or the plan fails for some other reason.
PBGC took over 157 plans with about 200,000 participants in the fiscal year that ended Sept. 30, compared with 104 plans with 89,000 participants the previous year, when the agency paid more than $1 billion in benefits for the first time.
Despite the problems, it is not time to panic, said Olivia S. Mitchell, executive director of the Pension Research Council at the University of Pennsylvania's Wharton School. "Many of these pension plans have a substantial asset base and are able to continue paying benefits to existing and future retirees."
Differences in plans
The plans getting all the attention this year are defined-benefit pension plans, as opposed to the more common defined-contribution plans, such as 401(k) plans. Company sponsors of defined-benefit plans bear the risk of ensuring that retirees will receive a specified amount of money each month for the rest of their lives.
Defined-contribution plans shift the risk to the employee because sponsors guarantee only that they will put a certain amount of cash or stock into an account.
Before the passage of the federal Employee Retirement Income Security Act of 1974 -- which created PBGC -- defined-benefit pension plans were much riskier than they are now because there were no funding requirements. The law does not cover other corporate retirement benefits, such as health insurance.
The accounting rules developed to deal with the new funding requirements kept the huge assets and liabilities of pension plans off corporate balance sheets for the most part -- even though the obligation is backed by the companies' earning power.
Estimated values
There were other compromises in accounting standards released in 1985 that divorced financial reporting of pensions from economic reality -- at least in the short term.
Companies wanted to avoid having to book as profit or loss the potentially huge swings in the value of pension assets every year. To do this, assumptions are made about rates at which pension assets and pension liabilities will grow.
Because assets and liabilities do not grow at the same rate, companies are allowed to smooth out the discrepancies over a five-year period. Companies can report income even when their pension assets lose money if there were big gains in previous years.
During 2001, pension plan assets held by companies that are members of the Standard & amp; Poor's 500-stock index lost $90 billion, but pension accounting rules allowed the companies to book $104 billion of pension income during the same period, according to a recent study by Credit Suisse First Boston.
At DuPont Co., for example, pension assets lost $615 million in value last year, but the Wilmington, Del., company "earned" $374 million on the plan because its expected return of $1.9 billion exceeded expenses.
Ken Porter, DuPont's director of global benefits financial planning, said the system works because pension plans need to be managed with a time horizon of 60 years or more.
"If we were actually recording into income what actually happened year to year, we would have had $3.8 billion more income in 1999, which of course is a ludicrous result in the minds of some people," he said.
Contributions
In addition to accounting rules, managers of corporate pension funds also have to contend with complicated tax rules that determine when they are allowed and when they are required to make pension fund contributions.
The long bull market of the 1990s gave companies a nice respite from funding their pension plans. That is likely to change.
Pension plans at 325 companies in the S & amp;P 500 index may be underfunded by the end of this year, up from 240 at the end of 2001, reported Credit Suisse First Boston. The investment bank and research firm estimated that 360 of the S & amp;P 500 companies sponsor defined-benefit plans.
Plan sponsors do not have to contribute cash to pension funds until the assets fall below about 85 percent of liabilities. Complicated tax rules govern when they are allowed to make a tax-free contribution.
"Many companies are going to be required to divert cash from business operations to fund the plan," said Bob Wright, a senior retirement consultant with Mercer Human Resource Consulting in Philadelphia. Some people "think that could delay a recovery in some industries," he said.