Cashless Contributions

Are noncash assets really a smart way to fund pension liabilities?

The sagging stock-market performance of the past three years hasn’t been kind to pension plans. By one estimate, companies are carrying underfunded pension liabilities in the neighborhood of $400 billion. And the economic environment that has left pension plans with gaping deficits has left companies with little cash with which to fix them.

Now those liabilities are coming due. A recent Watson Wyatt Worldwide report estimates that Fortune 1,000 pension-plan sponsors with underfunded plans will contribute at least $83 billion to their plans this year. Even assuming annual returns of 8 percent, these employers will be on the hook for another $80 billion in 2004.

Three of the biggest industries affected are airlines, steel, and automakers. “They’re not particularly performing well, so they’re not in a position to contribute much cash,” says Ari Jacobs, east regional actuarial leader at Hewitt Associates.

Instead, many of them are digging deep into their balance sheets for any other asset with which to prop up their plans. Some companies are depositing their own stock; others are putting in stock of subsidiaries or real estate. General Motors Corp., for example, put shares of its Hughes Electronics Corp. subsidiary into its pension plan. U.S. Steel Corp. is putting in timberland it has owned for nearly 100 years.

But cash alternatives aren’t always applauded by pensioners. First, the assets in question can be tricky to value. If the bottom falls out on a stock the company has contributed, it’s the pensioners who are left holding the bag. Second, the assets can have a big impact on the risk characteristics of the plan, especially if they are tied to the same troubled industry as the company that sponsors the plan.

Little wonder, then, that strict rules govern the use of noncash assets to fund pension plans. Companies that want to make contributions of assets other than their own stock typically need to get a prohibited-transaction exemption from the Employee Benefits Security Administration of the Department of Labor. These exemptions aren’t easy to get, however. Steve Pavlick, a partner in the Washington, D.C., office of law firm McDermott, Will & Emery, estimates that the DoL issues only a few dozen each year for in-kind contributions. Still, he says, “if there just isn’t any cash available, this is the only game in town.”

Breaking the Covenant

More and more companies are choosing to play that game—and winning. “You can contribute anything you own,” says Pavlick. The DoL just doesn’t “like to see a lot of junk put in these plans,” he adds.

In August, for example, the DoL granted Northwest Airlines Inc. permission to contribute as many as 11.4 million shares of Pinnacle Airlines Corp., an affiliated regional airline, to its three pension plans, which were a combined $3.9 billion in the red at the end of last year. (Pilots, contract employees, and management have separate plans.) What is unusual about the transaction is that the Pinnacle shares are not publicly traded. Critics questioned whether it made sense to strengthen a shaky pension plan with nontradable shares of a struggling airline. In fact, the DoL received a number of comment letters suggesting that the stock was risky because it was illiquid, and that the transaction involved a conflict of interest on Northwest’s part.


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