pension fund perspective: overfunded pension plans

CFA Institute

Pension Fund Perspective: Overfunded Pension PlansAuthor(s): Patrick J. Regan and Steven D. BleibergSource: Financial Analysts Journal, Vol. 41, No. 6 (Nov. - Dec., 1985), pp. 10-12Published by: CFA InstituteStable URL: http://www.jstor.org/stable/4478879 .

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Pension Fund P0ersetive Patrick J. Regan V.P., BEA Associates

Overfunded Pension Plans by Patrick J. Regan and Steven D. Bleiberg*

For more than a decade, BEA Asso- ciates, Inc. has conducted an annual survey of the pension costs and liabilities of a cross-section of American industry. The sample consists of the four largest companies in 10 major industries and accounts for approxi- mately 12 per cent of the employees covered by ERISA and 20 per cent of all corporate employee benefit funds. Table I summarizes the findings of the latest survey, based on 1984 and fiscal 1985 data.

Pension figures have been improv- ing since 1978, and the 1984 results are comparable to 1983, which were the best ever. Pension costs fell for the second straight year, but at a slower pace than in 1983. The decline was 4.6 per cent in 1984, versus 5.5 per cent in 1983. Relative to payroll, pension costs tumbled to a new low.

Pension assets covered vested benefits by a 21 per cent margin-a slight deterioration from 1983's 24 per cent figure. Even more important, the pension coverage ratio rose to the highest level recorded by our survey.

Growth in Pension Costs Table I shows how pension costs and liabilities have grown since 1975. Pen- sion costs grew at a consistent 14 to 20

per cent a year between 1973 and 1976, as plan sponsors upgraded provisions to comply with ERISA and to reflect higher inflation rates. From 1977 to 1980, annual growth rates slowed to the 9 to 11 per cent range (with a 14 per cent upsurge in 1978). In 1981, however, a combination of higher interest rate assumptions, lower inflation and, in some cases, downward revisions of pension benefit provisions brought the growth rate down to a mere 3.8 per cent. In 1982, the same set of circumstances was bolstered by strong stock and bond markets, which boosted pension assets. As a result, pension costs rose a modest 2.3 per cent in 1982-the lowest rate of gain since we began gathering data in 1969. In 1983 and 1984, costs actually de- clined by 5.5 and 4.6 per cent, respec- tively.

The distribution of cost decreases was one-sided, but not as much as in 1983. Last year, 25 of the 40 companies reported a lower pension expense, whereas in the prior year it was 30. With inflation and wage rates stable and investment returns and interest rates in the double digits, more companies have been able to fund their vested benefits fully and to reduce their annual contributions.

Pension costs as a percentage of payroll fell by almost half, from 6.1 per cent in 1983 to 3.5 per cent in 1984. As Table I shows, except for the 5.5 per cent reading of 1982, the ratio had been in the 6 to 7 per cent range throughout the decade.

The payroll figures disclosed in annual and 10-K reports (only 18 of the 40 companies in the sample disclosed

this figure, down from 21 in 1983) include all employees, part-time as well as full-time, foreign as well as domestic. By contrast, the actuary has access to the "covered" payroll figure, which relates only to those employees covered by the pension plan. Pension costs as a percentage of covered payroll are typically 6 to 10 per cent; the figures in Table I do not relate to covered payroll.

Payroll figures are, of course, affect- ed by employment levels. According- ly, we checked the median pension contribution on a per-employee basis. The 40 sample companies employed 5.2 million people in 1981, but the figure dropped 9.8 per cent to 4.83 million in 1982. Despite the economic recovery in 1983, employment dropped another 2.7 per cent. Howev- er, aggregate employment in 1984 soared 5.1 per cent to 5 million, thanks to the recovery in the auto industry and acquisitions by Beatrice Foods and Kmart.

Between 1981 and 1983, the pension contribution per employee fell slightly from $1,583 to $1,477 to $1,465. But in 1984 it tumbled 15 per cent to $1,259. In the decade prior to 1982, there were three years when employment de- clined (1975, 1979 and 1981), and in each case the pension contribution per active employee rose, as companies tended to lay off the younger workers first. In 1982 and 1983, entire plants were shut down, with the result that total employment and contributions per employee fell. In 1984 this trend continued, as the median gain in employment was only 0.2 per cent despite the fact that total employment

* Steven Bleiberg is a Research Associate with BEA Associates, Inc.

Table I Relative Growth of Pension Costs and Liabilities

1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 Growth of Pension Costs 14.7% 20.5% 8.5% 14.0% 11.0% 9.6% 3.8% 2.3% -5.5% -4.6%

(Median) Pension Costs as % of 6.7% 6.8% 6.7% 7.0% 6.7% 6.5% 6.3% 5.5% 6.1% 3.5%

Payroll (Median) Pretax Profits Per Dollar of $4.41 $5.45 $4.88 $4.68 $4.65 $4.44 $4.32 $3.44 $4.76 $6.90

Pension Contributions Pension Assets as % of 85.5% 80.3% 78.1% 81.9% 84.0% 109.1% 102.8% 113.4% 124.2% 121.4%

Vested Benefits

FINANCIAL ANALYSTS JOURNAL / NOVEMBER-DECEMBER 1985 a 10



grew over 5 per cent. One of the most encouraging items

in the latest survey was the improve- ment in the pension coverage ratio, which measures the ability of corporate sponsors to pay. It rose to a record level in 1984. As Table I shows, during the 1975 recession the sample companies reported $4.41 of pretax profits for every dollar they contributed to retire- ment funds. The figure recovered to $5.45 in 1976, but deteriorated in each of the following six years, as pension contributions grew faster than pretax profits. In 1983, with rising profits and lower pension contributions, the ratio rose to $4.76, the best since 1977. But in 1984, it soared to $6.90-its highest level in the 15-year history of the survey.

We observed that the sample companies began to curtail costs in 1981, when half of them raised their investment return assumptions. In 1982, nine companies reported significant changes in interest rate assumptions.

In 1983, only five companies amend- ed their interest rate assumptions, but nearly a third of the sample made amendments that resulted in lower contributions, including changes in employee turnover assumptions, esti- mated remaining service lives and changes in funding method. In 1984, six companies reduced their interest rate assumptions (though they tended to be at the upper end to begin with) and nine raised theirs.

As in the prior two years, dedicated bond portfolios were responsible for some of the major pension cost decreases in 1984. Several companies took advantage of high interest rates to structure bond portfolios that matched income streams with their pension liabilities. Actuaries looked with favor upon such programs and allowed the use of higher interest rate assumptions, which had the effect of reducing annual contributions. In 1982, Firestone, Goodrich and Wool- worth implemented such plans and in 1983, Beatrice Foods, Honeywell and Westinghouse followed suit.

In 1984, long government bond yields soared to nearly 14 per cent and several of the companies with large liabilities seized the opportunity to set up dedicated bond portfolios. Chrys- ler placed 80 per cent of its fund assets

in such a portfolio. Since the return in that portion is virtually certain, Chrys- ler was able to boost its assumed rate of return from 9.75 to 12.7 per cent. Bethlehem Steel dedicated 45 per cent of its portfolio-$1.3 billion. The liabilities covered by this dedicated bond portfolio are now discounted at 14.25 per cent-nearly double the 8 per cent rate used for the other liabilities.

For the year, Bethlehem Steel reported a 17 per cent drop in pension expense and an almost 9 per cent decline in the present value of vested benefits. Another steel company in the survey, Armco, also set up a dedicated bond portfolio in 1984. It now dis- counts that portion of its liabilities at a 13.5 per cent rate, compared to 8.5 per cent for the rest of its liabilities. Thanks in large part to the dedicated portfolio, Armco reported a 14 per cent decline in pension expenses in 1984 and only a slim 1.7 per cent increase in the present value of vested benefits.

Unfunded Liabilities Rising stock and bond markets, use of dedicated bond portfolios, union give- backs and other factors combined to create an outstanding pension liability picture at year-end 1984. As Table I shows, unfunded pension liabilities began to improve in 1978 but it wasn't until 1980 that the typical sample company had sufficient pension assets to cover vested benefits.

Figures from before and after 1980 are not really comparable, however, because in 1980 the Financial Account- ing Standards Board, in Statement No. 36, began requiring disclosure of the component parts instead of the net figure "unfunded vested benefits." The change has provided analysts with more relevant data. A liability for unfunded vested benefits of, say, $10 million is much less worrisome if the pension fund has $100 million in assets than if it has only $1 million.

As Table I shows, the median company in the sample had vested benefits equal to 121.4 per cent of vested benefits at the end of 1984, about the same as the 124.2 per cent ratio of 1983. From 1975 through 1979, the ratio was in the 78 to 86 per cent range; since 1980, however, the average company in the survey has been fully

funded. Over the last five years, investment results have been very good and interest rates have been historical- ly high, so most companies raised their interest rate assumptions. This, combined with the slowdown in the growth of wages and salaries, held down increases in vested benefits. Vested benefits of the median company rose 9.1 per cent in 1984, roughly comparable to the 10.5 per cent gain in 1983, the 7.4 per cent of 1982 and the 8.1 per cent of 1981.

FASB Statement No. 36 allows companies to use a different interest rate assumption for disclosure purposes than for funding purposes, and many of the sample companies used much higher figures for the former. For ex- ample, General Motors used a 7.0 per cent rate for funding but 10.25 per cent for disclosure. Several companies claimed that they used the rate pre- scribed by the Pension Benefit Guar- anty Corporation, but the rates used ranged from 8.5 to 10.0 per cent.

Table II illustrates the relation between the funding status and the interest rate assumptions used for disclosure purposes. The table ranks the 39 companies that revealed the neces- sary information by the degree of funding on vested benefits. Except for three companies (Uniroyal, American Motors and Western Union), all the companies are fully funded or nearly so. The interesting thing is that the better funded plans used the lower interest rate assumptions. For exam- ple, of the eight companies with unfunded vested benefits, five used interest assumptions of 10 per cent or more and only one was below the 8.5 per cent median of the 40-company sample. In contrast, of the eight most overfunded plans, seven were under that median.

Trust assets grew 8.4 per cent (median), considerably less than the 17.2 per cent rate of 1983 or the 11.2 per cent rate of 1982. Since vested benefits grew 9.1 per cent, the median funding level fell slightly, as pension assets were equal to 121.4 per cent of vested benefits.

Recovering Excess Assets In sum, the survey indicates that pension costs are declining, as most plans are fully funded on vested benefits

FINANCIAL ANALYSTS JOURNAL / NOVEMBER-DECEMBER 1985 EO 11



Table II Funding Status (millions of dollars)

Fund Assets Accrued as a % of Unfunded Interest Vested Fund Vested Vested Rate

Company Industry Liability Assets Liability Liability Assumption

Uniroyal Tire $705.0 $330.0 46.8% $375.0 10.40% American Motors Auto $726.8 $372.9 51.3% $353.9 7.00% Western Union Misc $390.7 $221.0 56.6% $169.7 9.10% Chrysler Auto $2,856.1 $2,511.4 87.9% $344.7 12.70% LTV Steel $3,173.3 $2,936.9 92.6% $236.4 10.00% General Motors Auto $20,216.2 $19,457.3 96.2% $758.9 10.25% Bethlehem Steel Steel $3,212.5 $3,118.9 97.1% $93.6 10.00% Ford Auto $8,770.0 $8,550.0 97.5% $220.0 8.00% Armco Steel $1,526.6 $1,591.5 104.3% ($64.9) 8.50% Westinghouse Elect $3,020.3 $3,162.2 104.7% ($141.9) 8.25% Goodrich Tire $524.3 $563.6 107.5% ($39.3) 10.70% Xerox Office $1,205.6 $1,296.7 107.6% ($91.1) 8.00% Dow Chemical Chem $1,190.0 $1,314.0 110.4% ($124.0) 8.00% U.S. Steel Steel $7,396.0 $8,185.0 110.7% ($789.0) 9.00% Warner Lambert Drug $653.5 $738.0 112.9% ($84.5) 8.50% Combustion Engineering Elect $497.9 $565.5 113.6% ($67.6) 7.00% Woolworth Retail $375.0 $429.0 114.4% ($54.0) 9.00% Caterpillar Tractor Misc $2,193.0 $2,586.0 117.9% ($393.0) 9.00% Goodyear Tire $1,607.2 $1,917.1 119.3% ($309.9) 8.50% Honeywell Office $929.0 $1,128.1 121.4% ($199.1) 8.00% Firestone Tire $830.0 $1,019.0 122.8% ($189.0) 11.00% Sears Retail $2,034.5 $2,565.7 126.1% ($531.2) 8.00% Borden Food $247.3 $314.7 127.2% ($67.4) 8.25% Pfizer Drug $320.7 $418.7 130.6% ($98.0) 9.75% Monsanto Chem $1,554.0 $2,074.0 133.5% ($520.0) 7.50% Lockheed Misc $2,291.0 $3,137.0 136.9% ($846.0) 8.50% Beatrice Foods Food $464.0 $638.0 137.5% ($174.0) 8.00% General Electric Elect $8,331.0 $11,695.0 140.4% ($3,364.0) 7.50% DuPont Chem $5,631.0 $8,359.0 148.4% ($2,728.0) 9.40% Eastman Kodak Misc $2,651.0 $3,992.0 150.6% ($1,341.0) 9.00% McDermott Elect $618.1 $944.7 152.8% ($326.6) 9.00% Sperry Corp. Office $942.7 $1,463.4 155.2% ($520.7) 8.00% General Foods Food $911.4 $1,426.1 156.5% ($514.7) 7.50% Dart & Kraft Food $676.4 $1,062.2 157.0% ($385.8) 8.00% Union Carbide Chem $1,544.0 $2,436.0 157.8% ($892.0) 9.00% IBM Office $7,016.0 $11,444.0 163.1% ($4,428.0) 5.50% J.C. Penney Retail $435.0 $737.0 169.4% ($302.0) 8.50% Kmart Retail $318.3 $574.0 180.3% ($255.7) 7.00% Johnson & Johnson Drug $283.0 $567.9 200.7% ($284.9) 8.50% American Home Products Drug NA NA NA NA NA

Source: 1984 BEA Pension Survey, based on figures disclosed in 1984 and fiscal 1985 annual and 10K reports.

and have enjoyed investment returns in excess of their actuarial assumptions. Whereas several years ago there was concern over unfunded liabilities, today the key issue is excess pension assets.

Under current law, the only way a sponsor can obtain the excess assets is to terminate the pension plan. Accord- ing to the Pension Benefit Guaranty Corporation, 236 plans with 284,665 participants terminated their plans in

1984 and recaptured $2.75 billion in excess assets. As of June 30, 1985, there were 216 plan terminations pending, with another $2.75 billion in assets to be recaptured. Several of these were of companies involved in takeovers or corporate restructurings, including AMF, Stauffer Chemical and Union Carbide.

These pension asset reversions are controversial. The Reagan Administra- tion would like to impose a 10 per cent

excise tax on recaptured assets. One interesting idea came from former Congressman John Erlenborn, one of the original architects of ERISA. He would allow companies to withdraw excess assets without terminating the plan so long as they kept an adequate cushion. Depending on the volatility of the assets in the fund, he would consider 120 per cent of vested benefits to be an adequate cushion.

FINANCIAL ANALYSTS JOURNAL / NOVEMBER-DECEMBER 1985 O 12



pension fund perspective: overfunded pension plans

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