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BY JIM ROGERS |
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Reminder to Verizon
Communications shareholders: You should send a thank-you note to the
company's pensioners. Those dusty, old defined-benefit plans helped turn a
down year into a profitable one. How's
that possible? The numbers tell the story: In 2001, the telecommunications
behemoth reported a profit of $389 million, not bad considering the year
brought substantial operating losses and a 5 percent decline in Verizon's stock price. The
pension plan, it appears, came to the rescue. According to the annual report,
income from Verizon's pension plan totaled $1.8
billion. The pension plan, the report states, earned an impressive 9.25
percent return in 2001. Verizon, mind you, isn't doing anything criminal; this is
no Enron. It's perfectly legal for companies to add income from investment
gains in their defined benefit pension plans to the bottom line. Nor do they
hide that fact from investors; it's an assumption written directly into
annual reports (although sometimes you have to go hunting through footnotes
and appendices for the details). What's
unsettling, though, is that Verizon's pension plan
didn't really earn 9.25 percent last year. The pension actually lost
money-$3.1 billion, to be more exact. That's
because Verizon, like many other companies, is
allowed to assume an expected rate of return for its defined benefit pension
plan. Informally known as "smoothing," it's a method of ironing out
the good years and the bad to guarantee a consistent rate of return. The
theory is that in the long run everything will balance out. Income from
pensions is understated in years when the stock market is strong --as in much
of the go-go 1990s -- and overstated when the market is down, as it is now. Such
assumptions, however, aren't always reasonable. That's an issue brought to
light in a compelling recent study by Milliman USA,
a benefits consulting firm. The study looks at the assumed rate of return for
50 of the largest That
said, some big names are on the list, with expected
rates of return as ambitious as Verizon's. IBM's
expected return on its pension plan was 10 percent in 2001. Ford's, 9.5 percent.
Coca-Cola? A mere 8.5 percent. The average for all 50 companies was 9.38
percent. Most
companies Milliman studied kept their rates of
return the same from year to year. A few, such as gas and oil giants Phillips
Petroleum and ChevronTexaco, lowered their expected
rates of return in 2001, anticipating a rough year in the market. Given the
S&P 500 was down 13 percent, I'd say they were onto something. Eight
companies, on the other hand, actually increased their expected rate of
return in 2001, by as much as 100 basis points. Such expectations, Milliman's study concluded, are "optimistically
high." There's an understatement! Based on these assumed rates of
return, the 50 companies studied reported a combined $54.4 billion of profits
from pension fund investments. In reality, those pension funds lost $35.8
billion -- a difference of more than $90 billion. That's the problem with
real earnings; they just never sound as good as manufactured ones. We'll
have to wait and see what happens in 2002, but so far the estimates are at
best mediocre: According to benefits experts Mercer Human Resource
Consulting, the median corporate pension plan earned 1 percent in the first
quarter of 2002. I've said it before: A market doesn't bottom at six- or
12-month lows, it bottoms with 10- or 15-year lows. Shareholders
have a right to be upset. Many companies claiming to have earned profits
actually may have lost money. Remember that management bonuses and stock
option contracts are often tied to profit levels. Adding pension income into
the equation is just another way to jack up earnings results and, in turn,
the bonuses. It's an even bigger concern for those 15 million people who
currently live on their pension plan, not to mention those who expect to. My
own father collected a pension from Borden Company, then a diversified
corporation, for 17 years until he passed away. People with pensions from the companies in Milliman's
report may not be so lucky. These funds made substantial gains in the 1990s,
finishing the decade in surplus. Only eight pension plans among the 50
companies surveyed were underfunded in 1999. By
2001, more than half were in the red. The
folks at Milliman aren't worried that these pension
funds will go bankrupt, but I'm concerned just the same. Companies believe
their assumed rate of returns reflect historical
figures, but they quickly forget there have been long periods of time when
the stock market did absolutely nothing. In 1966, for instance, the Dow Jones
Industrial Average was trading around 1,000. By 1982, it was down to 800.
It's hardly surprising that during the 1970s and 1980s, many companies had
seriously underfunded pensions. Unless
something changes, these pension plans will only become more underfunded. Some companies may be forced to cut back on
defined-benefit plans or infuse large amounts of money into pension funds to
pay out current retirees. That's going to be an enormous drain on profits and
earnings. Don't forget one of the reasons the steel industry is in so much
trouble today is the massive pension obligations built up over decades. In
the post-Enron era of transparency and honest accounting, it's good to see
these games are under scrutiny. Recently, the debt-rating agency Standard
& Poors announced it would start calculating a
new type of core earnings that deducts the expenses associated with employee
stock options and pension income. As a result, many companies will find their
earnings are much lower than current calculations would have us believe.
Cisco Systems, for instance, would have lost more than twice as much as it
reported last year, using the S&P's new
formula. It still shocks me that more isn't done about common practices
that shortchange investors. Regulators spend so much time looking for major
offenses that they can neglect smaller, more-insipid ones that chip away at
confidence in our economic system every day.
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