June 15, 1999
Overfunded Pension Plans
Fatten Companies' Earnings
By ELLEN E. SCHULTZ
Staff Reporter of THE WALL STREET JOURNAL
Shareholders of General Electric Co. were pleased to see it turn in another
banner year in 1998, with strong contributions to earnings from many
different parts of the company. That includes one part they might not have
thought of: its pension plan.
Of GE's 1998 pretax profit of $13.8 billion, its pension plan provided
more than $1 billion.
Pension plans as a boon to the bottom line?
Those same pension plans that used to be a
financial burden for many companies, and
were so often underfunded? Yes, and not just at GE but at many other big
American companies, too.
Chalk up one more minor miracle for the amazing 1990s bull market.
Like many pension plans, GE's has grown fat as the stock market in which
it is heavily invested has rolled on. It is overfunded, far in surplus. GE
couldn't withdraw this surplus without paying a stiff excise tax, enacted in
1990 to put a stop to the pension raids of the 1980s.
Large pension surpluses can generate 'pension credits' that flow to the
companies' income statements, boosting earnings. These are the U.S.
companies with the largest pension surpluses. Figures are for fiscal 1998,
U S West-a
a-Cash balance or similar hybrid plan, by year-end.
b-Company did not take a pension credit in 1998, but used $2 billion in surplus for
Source: company filings
But thanks to an accounting rule that is little known to either shareholders
or analysts, and that was written for a very different era, there is a way to
gain from the pension surplus. The rule provides that if investment returns
on pension assets exceed the pension plans' current costs, a company can
report the excess as a credit on its income statement. Voila: higher
It's happening at a lot of companies, and the amounts are substantial.
Atlantic Corp.'s pension plan produced a $627 million pretax credit for the
company's 1998 income statement. GTE Corp. reaped a $473 million
pretax credit. Caterpillar Inc. scored a $183 million credit.
At Northrop Grumman Corp., 40% of first-quarter pretax profit was
attributable to the overfunding of the pension plan. USX-US Steel Group
would have reported a first-quarter loss except for its overfunded
One might think that for employees, the overfunding of plans would be
good news; there would be at least a chance that the company would
improve their benefits. But in fact, the incentives for companies are quite
different. If a small pension surplus is a boon to the bottom line, a bigger
surplus is an even bigger boon.
And one way to make the surplus bigger is to reduce benefits.
Indeed, while no company ever cites profits as a reason for a pension
switch, many companies with overfunded pension plans are changing their
plans, frequently with the result that future benefits become less generous.
Next month, for instance, International Business Machines Corp. will
convert its overfunded pension plan to a variety that will provide lesser
benefits for many older workers -- and that will render the plan even more
"It's important to know that we're not making this change to save money,"
IBM told employees on a Web site. But after IBM makes the change, the
pension credit the company records on its income statement is expected to
jump by $200 million, to roughly $654 million for 1999.
Genesis in '80s
How did this party get started? The roots lie in an accounting rule change,
which took effect for large employers in 1987 and smaller companies a
little later. The Financial Accounting Standards Board was concerned that
corporations weren't reporting their pension obligations in a uniform way. It
required companies to start recognizing them on their income statements by
recording a liability. With much grumbling, companies complied.
But soon, the unexpected happened. The stock market started moving
relentlessly upward. And the pension funds' managers shifted more of their
assets into stocks, raising the share from less than half to about 60% today.
Assets in the plans mushroomed.
Liabilities didn't keep pace. Many companies were shrinking both their
work forces and their pension benefits. The result was the birth of some
gargantuan pension-plan surpluses. The 10 U.S. corporate pension plans
with the largest surpluses have combined surpluses of more than $100
The pension-fund surpluses are proving valuable to companies in other
ways. For one thing, they can be spent on employee-related costs that
companies otherwise would have to pay from cash flow, such as disability
benefits, certain profit-sharing contributions or part of the cost of top
executives' benefits. DuPont Co., for instance, uses about $250 million a
year of its pension-fund surpluses to pay for retiree health costs.
And companies can use the money in overfunded pension plans to pay for
staff "downsizings," as AT&T Corp. did last year. When 15,300 of its
managers accepted a buyout package, AT&T used $2 billion of
pension-plan surpluses to pay for the packages. An added tax break kicks
in when this happens: The money is exempt from Social Security and
Medicare payroll tax, saving employers and employees about 7.65% each.
"For years, people saw the pension as this bucket of money you can't
touch," says Thomas Henritze, director of benefits accounting at US West
Inc., which had $101 million in pension credits in 1998, and, in addition,
was able to use $55 million in pension surplus to pay for retiree medical
costs. "Companies are looking to not leave the asset dormant, but use it to
deliver better returns for the company."
For certain companies, such as those deep in debt or involved in
acquisitions, the 1980s strategy of terminating a pension plan and mining its
assets can still be alluring, partly because they can dodge a lot of the excise
tax. However, most companies now are content to let the pension-plan
surpluses pile up.
Indeed, so valuable are large, overfunded pension plans to companies that
employer groups are lobbying for ways to get more money into them.
Current law doesn't let companies deduct contributions to pension plans
once the level of assets reaches 150% of the plans' liabilities, with the result
that many corporations are on a contribution holiday. GE hasn't
contributed to its pension plan since 1987 (although employees are
required to contribute; they put in $112 million last year).
Employers have already successfully lobbied to get the ceiling gradually
raised in coming years, and Wednesday the House Ways and Means
Committee is expected to consider a proposal to raise it still further.
Another bill would pave the way for companies to contribute more to their
pension plans on behalf of high-paid employees; currently, such
contributions aren't deductible on salaries beyond $160,000 a year.
Adding Employee Money
Employers also are looking for ways to feed more employee money into
already-overstuffed pension plans. That even includes employees' 401(k)
money, such as happened when NationsBank and BankAmerica merged.
At BankAmerica's invitation, NationsBank employees transferred $1.4
billion of their 401(k) money into the BankAmerica pension plan. That
nearly tripled the pension plan's surplus, to $1.3 billion. The transfer helped
produce a pension credit for the merged company, called Bank of America
Corp., says Chuck Loring, a senior vice president. "To the extent that we
have pension income instead of pension costs, it improves our earnings," he
Still, the more common way to beef up pension assets is to reduce
benefits. GE, it should be noted, hasn't done so; in fact, prodded by its
unions, it has sometimes improved pension benefits. But many companies
are converting their pension plans to what are called cash-balance plans,
which can reduce benefits for older employees who otherwise would have
seen their pension credits build up rapidly in their last working years. In
cash-balance plans, each employee has a theoretical pension balance, to
which the company makes an annual donation and which the company
treats as growing by a fixed percentage each year.
And by cutting that fixed percentage, some companies with cash-balance
plans further cut pension liabilities. For instance, AT&T will slash to 4%
from 7% the gain it credits annually to employees' pension balances,
starting after 2001.
Switching to cash-balance plans has fattened many pension-plan surpluses.
Of the 12 pension plans with the largest surpluses, 10 are
cash-balance-type plans or will be by year end. It is such a switch that is
expected to bestow the extra $200 million in credits on IBM's income
statement this year.
In the past, moves that reduced pension benefits often were resisted by
executives, because they didn't want their own pensions cut. But now, they
have so-called top-hat plans that make up the difference. For example,
proxy statements show that after Banc One Corp. and Dana Corp.
converted to cash-balance plans, supplemental executive retirement plans
were revised to make sure top managers got the better benefit available in
the old system.
In addition, since executive compensation increasingly is tied to corporate
earnings targets, pension surpluses that boost a company's bottom line can
boost what top managers earn, too.
Pension-plan overfunding has not, however, prompted companies to give
more benefit increases to retirees -- quite the reverse. In the early 1980s,
60% of large companies provided regular cost-of-living increases for
pensioned retirees; today, with the plans in better financial shape, fewer
than 4% do. GE last did so in 1996.
At GE's April shareholders' meeting in Cleveland, Chairman John F.
Welch autographed annual reports for pleased investors. "You've made me
rich," one woman told him. But about 100 retirees made a plea for an
increase in their pensions, noting that GE's $43 billion pension plan
currently is overfunded by $15.9 billion, the biggest surplus in corporate
Helen Quirini of Schenectady, N.Y., who is 79 years old and worked at
GE for 39 years, spoke up. She retired in 1980 and doesn't recall her final
pay level, but she said that her pension is $576 a month. "Our pension fund
has a huge surplus, and it is a shame that such pitiful pensions are still being
paid to earlier retirees," Ms. Quirini said.
The retirees, without being specific in their request, asked shareholders
to approve a proposed increase in pensions for GE directors without also
giving one to retirees. Mr. Welch replied that market fluctuations might
reduce the pension plan's assets, so it would be risky for the company to
provide the many retirees an increase.
Shareholders approved a 50% increase for directors with five years'
service, raising their pensions to $75,000 annually.