More Earnings Trouble On Horizon Due To Pensions - Study Arden Dale Dow Jones News Service 3-June-2003

Retirement plans may cause companies more earnings trouble in 2004, despite stock market gains that have helped the plans lately.

Pensions continue to get weaker because low interest rates have expanded their benefit obligations this year, outpacing a rebound in plan assets.

Those were key conclusions of a report published Tuesday by Credit Suisse First Boston accounting analyst David Zion.

"Investors have been saying recently that since the market's performing well, the pension becomes less of an issue," Zion said in an interview. "But interest rates are a reminder to keep an eye on the pension plan. There's a very important part of the plan that's not getting healthier, and that's the pension obligation."

As companies get a clearer picture of their plan finances later this year, they may well report that earnings, balance sheets and cash flow will be hit by the pensions, according to Zion.

At issue are defined-benefit pensions - traditional plans that pay retired workers fixed sums and put investment risk solely on the employers.

A report Zion issued in September 2002 accurately predicted many of the troubles companies experienced with their defined-benefit pensions at the end of that year.

In the report issued Tuesday, he said that assuming pension plans' assets are invested 65% in equities and 35% in fixed income, the average pension portfolio is up 8.5% this year.

But pensions aren't out of the woods because their obligations - the projected future benefits plans must cover - have grown in relation to declining interest rates. Low interest rates produce bigger obligations, also known as liabilities.

Zion details how the growth in pension obligations is linked to the recent sharp decline in bond yields, using the Moody's Aa Bond Index as a reference point. Year-to-date, the yield on the index has moved down 79 basis points, from 6.52% at the end of 2002 to 5.73% on Thursday.

"If we were to assume that pension discount rates suffered the same fate, we estimate the pension obligation would grow by approximately 10%, outpacing the increase in the pension plan assets year-to-date," the report states.

Pension sponsors use bonds as a key benchmark for calculating their obligations. Specifically, the law requires them to use the 30-year Treasury bond, but because it's no longer being issued, the government has approved a stopgap measure that lets them use a range of rates instead.

Zion said he was somewhat surprised when he analyzed the potential impact on defined-benefit plans of the nearly 80-basis-point drop in the Aa corporate bond rate.

"The health of the pension is very sensitive to changes in the interest rate," he said.

When a company's pension obligation grows, its pension costs rise, putting pressure on earnings and raising the possibility that it will have to contribute to the plan.

The situation could amount to "deja vu come the beginning of the fourth quarter" of 2003 of a slew of negative pension-related reports that occurred late last year, Zion wrote in the report. Big pension plans and actuarial firms have been lobbying the administration to change the law requiring them to use the 30-year bond rate as a benchmark. A pension reform bill now before Congress would replace the 30-year rate by a benchmark tied to long-term corporate bonds.

 By Arden Dale, Dow Jones Newswires; 201-938-2052; [email protected]