Magazine article Global Finance

Anemic Plans Drag on Corporate Profits

Magazine article Global Finance

Anemic Plans Drag on Corporate Profits

Article excerpt

Stronger equity valuations fail to float many US pension plans that had found themselves under water.

Corporate pension plans will no doubt be handing their chief financial officers some sleepless nights this year as the financially troubled plans start to create a drag on overall corporate health.

Despite the healthy single- and even double-digit returns registered in most equity markets around the world last year, many corporate pension plans remain mired in financial problems. And as legislative changes make pensions more of a core corporate concern, financially troubled plans are starting to create a drag on overall corporate health.

Experts say that the stronger equity values found in pension plan portfolios can't counter a variety of other factors that are increasing plan liabilities-factors such as the greater disclosure requirements brought about by US legislation like the Sarbanes-Oxley Act of 2002, more stringent accounting practices and an increasing number of plan retirees who are living longer. And the managers of these traditional defined benefit plans were even left on the sidelines by last year's upward movement of interest rates in the United States. That's because the rates on the long-term corporate bonds in which they usually invest actually decreased over the past year.

All of these factors-plus the poor equity returns registered in plan assets for several years after the stock market declines of 2000-have combined to widen the gap between pension assets and liabilities in many cases. "If the plan is already in deficit, even if there is an increase in the value of the assets, the gap between assets and liability can widen," says Giles Archibald, head of international consulting in the US for Mercer Human Resource Consulting in New York City. "Some companies are making significant contributions to their plans," he notes.

In a study released in September 2004, Credit Suisse First Boston estimated that 340 corporations in the Standard & Poor's 500 Index would have underfunded plans at the end of 2004, up from 320 S&P companies in 2003. Before the strong fourth-quarter performance of US equity markets, Credit Suisse had estimated the 340 plans would be underfunded by a total of $254 billion. But with the surge in equity prices, CSFB estimates that the plans will now be underfunded by only a little more than the $172 billion underfunded total for 2003.

"The plans have faced the worst possible scenario. The low returns of the stock market drove down their assets, and the low interest rates drove up their obligations," says David Zion, an accounting analyst at Credit Suisse First Boston in New York City.

The chronic pain now being experienced by managers of these traditional benefit plans is creeping into other financial areas. If a plan's liabilities go up, that can have an impact on how investors value the company and can end up lowering its stock price. And that lower valuation can in turn reduce the assets of the pension plans of other corporations that have invested their pension assets in the first company's equities.

The deteriorating condition of a company's pension plan can also start to affect other areas of corporate health as profits decline, credit ratings drop, cash flow slows and new investment in equipment, building and employees may be curtailed.

The Pension Drag

In a survey last summer of 100 chief financial officers from North American organizations, more than three-quarters of the executives said their pension plans were having a negative impact on their corporate finances. That number was up from 61% a year before, according to the August 2004 survey conducted by SEI Investments, an asset management and investment consulting firm based in Oaks, Pennsylvania.

The biggest negative impact of troubled pension plans is showing up on the bottom line: 62% of the CFOs said the deteriorating condition of their plans was lowering the profitability of their firms. …

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