Doing a story on defined-benefit pension plans is a lot like going to a museum of natural history. The word “relic” seems to come up an awful lot.
With good reason, too. For the most part, defined-benefit plans are relics — dusty vestiges of a bygone era when unions were able to negotiate plum retirement plans from employers. Under a defined-benefit setup, a plan sponsor guarantees a specific payout to plan participants. By contrast, defined-contribution schemes — 401(k) plans, for instance — only require employers to guarantee the kick-in, not the payout.
Generally, plan sponsors have found it much easier to guarantee contributions than investment gains. Indeed, over the past two decades, defined-benefit plans have been supplanted by less-onerous defined- contribution plans as the retirement scheme of choice among most employers.
Despite this steady decline in popularity, a fair amount of old-guard companies still operate defined-benefit plans. And many of those companies have benefited mightily from their antiquated defined-benefit plans.
How? Thanks to the magic of pension accounting, defined-benefit plan sponsors are able to treat gains on plan investments as earnings. Given the bull market of the late nineties, that added income has substantially boosted income for many publicly traded corporations.
But expect most of those paper gains to vanish — and soon. For one thing, the bear economy has made the bullish forecasts of the investment returns of many plans look downright Pollyanna.
Moreover, analysts and auditors are beginning to take a dim view of companies that repeatedly use their pension plans to inflate earnings. As CFO.com reported last week, Standard & Poor’s excluded pension-generated earnings from its much trumpeted “core earnings” metric. S&P’s new earnings gauge is designed to show the true financial performance of a business — and not bookkeeping gains.
Adding injury to insult: S&P’s new earnings metric treats pension payouts as a cost. That’s a big shift from GAAP accounting.
In the coming months, S&P plans to plug its core earnings calculation into its massive database. The rating agency’s newfangled treatment of pension plans will no doubt help lower the earnings of many companies listed on its indices.
Can’t Touch This
But despite the pain, at least one retirement-plan consultant says finance chiefs would do well to follow Standard & Poor’s lead in placing less stress on pension-related income numbers.
“CFOs should be managing their companies to do what their company does and [use the] pension to attract and retain employees,” says John Ehrhardt, a principle and consulting actuary with Milliman USA. “They should look at what their operating earnings look like without the pension plans — and be managing to that number.”
Gains in pension assets, of course, have never really ended up in corporate coffers. “It’s really a negative expense that looks like profits,” he says.