The pension system is heading for a crisis, or maybe two.
The first is the most worrisome for workers: Too many pension plans aren’t adequately funded or are already in default. The companies in the Standard & Poor’s 500 with traditional pension plans need to put aside another $40 billion this year to fully fund the plans, according to S&P.
The second impending crisis is an accounting change that may make pension issues more painful for corporations. Accounting regulations for both pensions and retiree health care costs are poised to change in the next five years, in what could be the largest shift in accounting rules in more than 30 years.
“We believe this project will have a significant impact on evaluations, income and balance sheets, and will become the major issue in financial accounting over the next five years,” said Howard Silverblatt, equity market analyst at Standard & Poor’s.
The Financial Accounting and Standards Board, the arbiter of the nation’s accounting rules, has said it will require companies to add their net pension and retiree-healthcare costs to their balance sheets within the next year. Then, over the next three or more years, the accounting methods for pensions and retiree-healthcare costs will also change.
The first change, which will move pension and retiree-healthcare costs from financial footnotes to balance sheets, could be dramatic, increasing companies’ leverage and changing computed returns, book value and shareholder equity ratios. These ratios are closely watched, since many loans and bonds deals cap a company’s leverage ratio. And the changes could be eye-popping. The aggregate drop in shareholder equity, for instance, will be 10 percent, Silverblatt wrote in a December report.
What about companies that freeze their pension obligations, as one in 10 pension plans insured by the federal Pension Benefit Guaranty Corp. did in 2003, according to the pension agency, and as International Business Machines Corp. announced it will do Thursday?
Freezing pensions benefits can obviously limit a company’s liabilities, but unless the company defaults on its pension obligations, it can’t walk away altogether.
“Pensions are legal obligations,” Silverblatt said. “There’s a guarantee.”
If the company’s pension plan defaults, the Pension Benefit Guarantee Corp., which guarantees pensions for 44 million people, will pay retirees up to $45,614 a year.
But retiree healthcare-costs are a muddier issue.
Of the companies in the S&P 500, 337 offer some kind of medical benefits for retirees. According to Silverblatt’s analysis, only 282 companies provide sufficient information for estimates about their retiree-healthcare plans. Those plans are scarily underfunded: Companies would have to set aside $292 billion to meet current obligations, according to his analysis.
The state of these funds “is extremely unsettling,” Silverblatt wrote.
Unlike pensions, retiree health care costs aren’t a clear-cut legal obligation, unless they’re part of a contract, which is the case at Ford Motor Co. and General Motors Corp., where retiree healthcare-obligations are underfunded by $94 billion.
For employers where retiree health care costs aren’t part of a contract, the question is what a company’s legal obligation is to fulfill the plan’s promises. “If a company tells it’s employers, ’You have to cover 99 percent of your premium,’ is that a breach?” Silverblatt asked.
No agency will step in and pay a company’s retiree-healthcare costs. In the S&P 500, retiree-healthcare plans cover 12 million employees.
The discussions around both pensions and retiree health care costs will be “lively, political and complex,” Silverblatt predicted.
Pensions and retiree-healthcare costs “have moved beyond individual companies,” he said. “Their importance to the global economy is now self-evident.”