The Following Article
contains a strong summary of how Corporations can use Pensions to their own
benefit. While SBC is not alone, they have played some of these games with the
EPR retirees and others.
Bruce Beckman
VP-AASBCR, Inc.
By ELLEN E. SCHULTZ
Staff Reporter of THE
Employers love to
complain about benefits plans -- ailing pensions, rising health-care costs and
burdensome retirees.
But for all the
bellyaching, there's another side to this story: Employers have been among the
biggest beneficiaries of benefits plans.
The plans are a
source of income, as well as cash for various expenses, and they can be used as
alimony in downsizings and bargaining chips with unions. Even when the plans
don't provide big payoffs, they're often much cheaper than they look, thanks to
tax deductions and subsidies.
Of course, some of
these options can be risky if companies are too aggressive. In recent years,
many employers have been tempted to manage their benefits plans for short-term
rewards at the expense of long-term goals, leading to underfunded
pensions, investigations by the Securities and Exchange Commission and even a
few lawsuits.
Here's a look at 10
of the biggest ways benefits plans benefit employers, or cost less than
companies let on.
1.
Pension Piggy Banks
Although recent
headlines make it sound as though pension plans are an endangered species,
roughly two-thirds of the companies in Standard & Poor's 500-stock index
have them. And the assets in those plans can help employers cover some steep
costs.
For one thing,
employers can withdraw pension assets to pay the bills of benefit consultants,
administrators, lawyers and investment managers involved with the pension plan.
For example, in 2002, the latest figures available, International Business
Machines Corp. paid consulting
firm Watson Wyatt Worldwide $13.7 million, primarily for administration of its
pension plan; the next highest fee associated with the plan was $7.9 million to
J.P. Morgan Chase & Co., the plan's trustee. IBM also paid itself more than
$5.9 million for human-resources administration and investment management
related to the pension.
Companies can also
tap surplus pension-plan funds to pay for retiree medical expenses. Lucent
Technologies Inc. withdrew $1.9 billion from its pension plan for this
purpose in recent years. Others that have made these transfers: Allegheny
Technologies Inc., DuPont Co., Marathon Oil Corp., Qwest
Communications International Inc. and U.S. Steel Corp.
Now many employers
are backing legislation that will further ease their ability to tap the assets.
The danger: If companies draw too heavily on pension assets, the plans may end
up underfunded. This happened during the market slide
from early 2000 to late 2002: Many employers that had heavily withdrawn surplus
assets didn't have a cushion to fall back on. At the end of 1999, 264 of the
366 companies with pensions in the S&P 500 had a pension surplus; by the
end of 2003, only 51 did.
But this is turning
around. Although pensions in the S&P 500 were collectively underfunded by 13% in 2003, they will be overfunded by 2% in 2006, thanks both to rising interest
rates and market returns, according to Bear Stearns.
2.
Inducements for Downsizing
In tight labor
markets, attractive benefits can make it easier to hire people. But benefits
also make it easier to get high-cost people to leave. Older workers are more
likely to retire if they have a pension, life insurance and health coverage to
support them.
In the downsizing
waves of the 1990s, employers found a fresh way to entice older, longer-service
workers to leave early: lump-sum pension payments, in lieu of a monthly check
in retirement. To many, the prospect of obtaining a large wad of cash was too
tempting to pass up.
The hidden benefit
to employers: Lump sums are often cheaper than monthly pensions. When the
employer converts the future payments into a present-value cash amount, it can
leave out the value of "early retirement subsidies." These are
pension enhancements that typically kick in at age 55, and bulk up the pension;
they're intended to encourage older workers to leave before they reach normal
retirement age.
For certain
employees, typically those in their late 40s through late 50s, the lump sums
can be worth 20% to 50% less than normal pensions. Companies also save on
administrative costs and don't have to pay premiums for the departed employees
to the Pension Benefit Guaranty Corp., the government-sponsored
pension-insurance agency.
It's a perfectly
legal tactic -- if it's adequately disclosed. Employers are forbidden by law to
cut a pension that has already been earned, but they are allowed to give
employees a choice between the full-value pension annuity and a lump sum worth
less. If the employees then choose the lower-value option -- essentially
choosing to cut their own pensions -- then the anti-cutback rule hasn't been
violated. Few employees realize that lump sums are often worth less, though
employers are supposed to tell them what the relative values of the pension
options are.
Providing lump sums
doesn't necessarily lead to underfunding. Although a
big chunk of money leaves the pension plan, the liability for the departing
workers falls to zero. But there may be a problem if a company hasn't been
adequately funding the pension all along: In these situations, the assets in
the pension don't have time to earn returns to make up the shortfall.
3.
Low-Cost Retiree Health Coverage
About 66% of
companies in the S&P 500 provide retirees with health benefits, which
typically continue coverage until age 65, when Medicare kicks in. After that,
employers may provide a supplement to Medicare to pay some of the costs of
prescription drugs, which haven't been covered by the government program.
These benefits
aren't as costly as many people think. In fact, when used to encourage early
retirement in a downsizing, the benefits don't raise a company's health-care
costs at all.
The employer is
simply continuing to pay to cover the employee who has retired; the actual cost
hasn't changed. And since the company is downsizing, the employee either won't
be replaced -- meaning no new health-care costs -- or he or she will be
replaced by a less-expensive worker.
Meanwhile, employers
can protect themselves from health-care inflation for the retirees. More than
half of companies establish annual limits on what they'll pay per retiree, and
once the limit is hit; all the additional costs are passed to the retirees. In
fact, rising prices can benefit employers because retirees who can't afford the
rising premiums drop the coverage. The employer can also then reduce the
liability it has projected for the retiree, which boosts income.
4.
Savings from Medicare
The new Medicare prescription-drug
act will further reduce employers' cost for Medicare-eligible retirees.
Starting next year, the
Under accounting
rules, employers can estimate what this reimbursement will be worth to them
over the lives of the retirees, and can deduct it from their liabilities. These
one-time reductions in liabilities generate accounting gains that boost earnings.
General Motors Corp. estimated that the Medicare
prescription-drug plan cut its liability for retiree health care by 6%, to $63
billion at the end of 2003. Other companies with large reported reductions in
liabilities include $1.3 billion at Verizon
Communications Inc., $600 million at Lucent,
$575 million at BellSouth Corp., $415 million at AMR Corp. and
$280 million at UAL Corp.
Meanwhile, employers
don't pay taxes on the subsidy they receive, thanks to another provision of the
new Medicare law. And the law doesn't require employers to keep benefits
constant. So employers could eventually shift all the cost of coverage to
retirees, and still qualify for the subsidy payments, according to the federal
Centers for Medicare and Medicaid Services.
5. Cheaper
Than Salaries
One of the oldest
reasons companies have offered benefits is that they're cheaper than salaries.
After World War II, cash-strapped employers promised pensions and health care
in retirement in lieu of higher current salaries. The arrangements were
particularly lucrative for utilities, which could pass the costs along in their
rates, and defense contractors, which could build them into their government
contracts, along with other compensation. In recent years, the automobile and
telecom industries, among others, have leaned heavily on this strategy.
Benefits also give
companies flexibility when negotiating with unions: They're a way of offering
increased compensation without increasing wages.
The
drawback? Some
companies promise benefits down the road but don't adequately fund them. The
consequences of passing the buck to future management and shareholders have
been quite clear in recent years, as companies, including U.S. Airways, Kaiser
Aluminum Corp. and Bethlehem Steel Corp., have dumped their pensions on the
Pension Benefit Guaranty Corp. In response, the PBGC is asking Congress to
impose tighter funding requirements and higher premiums on employers. Some
employers say that if forced to pay more, they'd rather freeze their pensions,
which means no one's pension would grow any further. If that happens, the
losers, as usual, will be the employees.
6.
Benefits Plans as Profit Centers
In the 1990s,
pension plans became over funded, thanks to years of double-digit stock-market
returns and falling liabilities from rising interest rates, downsizing and
benefits cuts.
One result was that
many companies had more money than they needed to pay all the obligations, even
if every retiree lived to be 103, and didn't have to contribute a dime to their
pension for years.
Another result was
that the plans generated income. The reduction in liabilities plus the returns
on the assets erased the current expense of the pension, and produced a
negative expense -- in other words, income. This income may be a paper gain,
but it's added to operating income right along with income from the sale of
widgets and services.
Pension plans pumped
billions of dollars into earnings until the market slide. But even though many
pensions lost money for several years, pension income is still a significant
contributor to earnings at many companies. At the end of 2003, 45 corporations
reported pension income, including BellSouth, whose $486 million in pension
income accounted for 7.9% of operating income. IBM had $571 million in pension
income, which accounted for 5.1% of its operating income; General Electric
Co. had $1 billion, or about 5.3% of operating income, according to figures
compiled by R.G. Associates Inc., an institutional research group in
Retiree health plans
can also generate income when liabilities shrink rather than grow. Sears,
Roebuck & Co.'s retiree medical plan has added $383 million to earnings
since 1997, thanks in large part to cuts in benefits and cost-shifting to
retirees.
Meanwhile, about
one-third of large companies set aside money for retiree health benefits in a
trust. This means that the expected return on those assets gets added to the
income calculation -- making it more likely that the benefits plan will boost
the company's earnings. Procter & Gamble Inc.'s $2.8 billion retiree
health trust added $141 million to income in 2004, and more than $1.9 billion
since 1994.
But counting
retiree-plan returns as income can lead companies to take greater chances with
those assets. In recent years, many companies have loaded up their pension
portfolios with stocks in an effort to generate more income. According to
Wilshire Associates, the percentage of pension assets invested in stocks rose
from 47% in 1990 to more than 62% as of
What's more, the
desire for more income also led some companies to use aggressive assumptions in
pension and benefits plans, which made their liabilities appear lower, perhaps,
than they actually were.
In a paper released
last year, researchers at Harvard and the Massachusetts Institute of Technology
found that companies' adoption of high-return assumptions coincided with
managements' exercising of stock options and periods leading up to
acquisitions. The research also suggested that managers increase equity
allocations in the pension plans to justify the assumptions they make about
what the assets will return.
Last fall, the
Securities and Exchange Commission began investigating the assumptions
companies use in their benefits plans, because the agency is concerned they've
been using the plans to manage earnings. The SEC asked Boeing Co., Delphi Corp., Ford
Motor Co., GM, Navistar
International Corp. and Northwest Airlines for information about how
they account for their pension and other retiree benefits, though none has been
accused of wrongdoing. (For more on pension-plan assumptions, see "How
Companies Make the Most of Pensions" below.)
7.
Payroll Savings from Pretax Plans
"Cafeteria
plans," which let employees use pretax dollars to pay for their share of
medical, dental disability and life insurance premiums, offer an appealing deal
to employers, as well.
Employees benefit
from the arrangement, because the amounts they defer aren't subject to income
tax, and are exempt from withholding for Social Security. But employers don't
have to pay their share of Social Security and Medicare taxes on that money,
either -- which comes to a combined 7.65% on salary up to $90,000. This can
save companies a bundle, and makes it cheaper to provide compensation in the
form of benefits than salary.
8.
Low-Cost Loans
One of the most
lucrative benefits plans for employers has been the ESOP, or employee stock
ownership plan.
Thanks to a tax-law
provision, ESOPs can take on debt, something no other retirement plan can do.
Companies typically have funded ESOPs by borrowing money to buy shares of their
own stock from themselves, which they contribute to the plan. Then they can
deduct both the principal and interest on the loan repayments, which can reduce
the cost of borrowing by as much as 34%.
In effect, companies
have used this technique to get a low-cost loan to make capital expenditures --
while inexpensively funding their retirement plan. Meanwhile, the employer
keeps a huge block of stock in friendly hands.
9. The
Joys of 401(k)s -- for Employers
Employees like 401(k)s because they can contribute pretax money, enjoy
tax-deferred investing and maybe get a matching contribution from their
employer.
But employers like the
savings plans, too: Their contributions are also tax-deductible, and exempt
from payroll taxes. Plus, unlike pensions -- which are funded entirely by
employer contributions -- employees provide most of the funding for 401(k)s, in the form of salary reduction. And they bear 100% of
the investment risk.
Many employers
further reduce the cost of contributing to 401(k)s and
profit-sharing retirement plans by contributing shares of their own stock,
rather than cash. The only "cost" for this is a dilution of shares.
Among large companies that have company stock as an investment in their 401(k)
plans, company stock accounted for roughly 30% of plan assets at the end of
2003, according to the Employee Benefit Research Institute, a research
organization in
10.
Deducting Dividends
Some benefits plans
can also help companies secure a big tax break. Ordinarily, companies aren't
allowed to deduct dividends they pay, but they can if the stock is held by an
ESOP or a certain type of hybrid 401(k), called a KSOP. KSOPs
are created when a company adds an ESOP feature to the 401(k). More than 900
companies have 401(k)s with this feature, including Bank of America Corp., Ford and Verizon.
To capture the deduction,
more companies in recent years have converted their 401(k)s
to KSOPs, including Abbott Laboratories Inc., which took this
step in 2001. This enabled the company to deduct the more than $72 million in
dividends it paid on the $5.1 billion of its shares in its retirement-savings
plan, which accounted for 82% of the plan's $6.2 billion in total assets.
In 2003, the
deduction for the dividends on GM's common stock held in the ESOP portion of
the employee savings plan was $53 million.
But as appealing as
it can be for employers to contribute shares of their stock to employee
retirement plans, employees can pay a high price. They are commonly locked into
their employer's stock for years, so their savings remain dangerously
undiversified. Last fall, employees of Marsh & McLennan Cos. lost
millions of dollars in savings when the giant insurance brokerage was accused
of rigging bids, and its shares plummeted.
Marsh & McLennan
now joins a growing club of companies, including Enron Corp. and WorldCom Inc.,
facing suits by employees who lost money when the value of the employer stock
in their retirement plans evaporated.
Ms. Schultz, a
Wall Street Journal news editor in New York, served as contributing editor of
this report.
Write to Ellen E. Schultz at ellen.schultz@wsj.com3