Pension funds may dip into profits

NEW YORK -- Even if the economy manages to bounce back, don't expect corporate profits to soar. Not if underfunded pensions keep crimping the bottom line.

When Wall Street was going up and up, companies shifted more of their pension funds into stocks and watched their assets grow.

But the plunging stock market has sent their holdings tumbling, and now they will have to contribute big money to cover their costs.

That's sure to knock down earnings for at least the immediate future, in some cases taking millions of dollars out of profits.

"Earnings won't be able to come back so fast, if only for the problem with pensions," said Frederic M. Stiner, chairman of the accounting, taxation and law department at Long Island University in Brooklyn, New York.

The pension crunch only affects companies with defined benefit plans, or those that promise future pension payments to their employees. About 360 of the 500 companies in the Standard & Poor's 500 stock index offer them.

401(k)s unaffected

Unaffected are companies' defined contribution plans, such as 401(k)s. In these plans, employees pitch in part of their salary each month, with the company sometimes making a matching contribution at the same time.

During the stock market boom, soaring share prices resulted in a big boost to pension assets, with growth far outpacing expenses. Accounting rules let companies add that extra income to their earnings, spaced out over a 15-year period. They could then put that surplus to other uses.

The pension surplus in 1999 was $252 billion, the highest level in more than a decade, according to a recent study on pensions from UBS Warburg.

But that drastically changed over the last three years, with UBS Warburg now estimating a current pension deficit of $126 billion.

Two factors are to blame for the steep and swift tumble.

Stock markets have seen a selloff since early 2000, with the S&P losing nearly half its value and other market indexes tumbling, too. During this period, many companies had estimated that the equity investments of their pension plans would rise by about 11 percent to 12 percent, said David Bianco, who heads UBS Warburg's U.S. Valuation and Accounting Group.

On top of that, declining interest rates have resulted in lower discount rates, which are used to estimate how much money is required today to meet the pension obligations over an employee's lifetime. The lower the discount rate, the greater amount of money the company needs to contribute to its pension fund.

"It's a double whammy with the lower discount rates and the volatile stock market," said Clyde Stickney, a professor of management at the Tuck School of Business at Dartmouth College.

When pension plans are underfunded by at least 10 percent of their obligations, companies have to fill the void. And the cash contributions have to come from somewhere, whether they're taken out of money that was supposed to be allocated to stepping up operations, buying back stock or paying down debt.

Pressed for cash

So even when the economic recovery really kicks in, many companies may still very well be pressed for cash, and that will likely mean lower profits.

A recent study by Credit Suisse First Boston estimates that companies in the S&P 500 with defined benefit plans will have assets to cover only 79 percent of their liabilities by the year's end.

The number of companies with underfunded plans jumped to 240 at the end of 2001, the highest level in the last 10 years, and that is expected to jump to 325 companies by the end of this year, CSFB said.

CSFB expects 30 companies within the S&P 500 to have plans that are 25 percent underfunded. Five sectors -- autos, auto components, oil and gas, pharmaceuticals and airlines -- account for largest percentage of underfunded plans, CSFB said. Some companies already have revealed how the pension crisis will hurt earnings. Ford Motor Co. estimated its plan was underfunded by $3.2 billion as of June 30, due to a 6.7 percent loss on its investments. And if that negative rate of return continues through the end of this year, it expects its pension expense to increase by $125 million in 2003.

S&P's credit rating services downgraded General Motors Corp.'s long-term corporate credit ratings because of questions about the automaker's pension liabilities, which reached $9 billion at the end of last year.

The New York Times Co. has already contributed $65 million to its pension fund this year and expects to add about $76 million more by year's end. United Technologies said it has contributed $500 million to its plan, while IBM said that it would have to contribute $1.5 billion a year for the next five years to cover the shortfall in its pension funds.

"In defined benefit plans, the company is the one bearing the risk of the market, and when the market goes, they bear the brunt of the losses," said Mary Ellen Carter, assistant professor of accounting at The Wharton School at University of Pennsylvania.

The only way for companies to climb out of this pension mess is to have the stock market come back with a vengeance, and for that rally to be sustained for a long period of time. No one is betting on that just yet.

Rachel Beck is the national business columnist for The Associated Press. Write to her at rbeck@ap.org