Now for the Reckoning

Retirement benefits promised to employees are becoming a crippling burden for a growing number of firms, especially in America.

Despite this trend, some three-quarters of the companies in America’s S&P 500 index have a defined-benefit pension fund. The total liabilities of these funds were around $1.4 trillion at the end of 2004 and, according to Credit Suisse First Boston (CSFB), these were underfunded by 13 percent, or some $165 billion. The more cautious PBGC reckons that the total obligations of America’s single-company defined-benefit plans were underfunded by over $450 billion at the end of 2004. According to CSFB, in the S&P 500 these liabilities are concentrated in relatively few firms, airlines and carmakers prominent among them.

Equally worrying are multi-employer pension funds, says Trevor Harris of Morgan Stanley. They are administered by the unions — the Teamsters, for example, runs one for the trucking industry called Central State — but funded by employers. They are opaque even to the PBGC, but certainly are seriously underfunded. It is unclear which firms owe how much. If that were not bad enough, continues Harris, corporate pensions are but a leading indicator of what lies ahead for state and local-government defined-benefit plans, which are even more severely underfunded.

Of course, corporate America is by no means alone in its pension crisis. Many British firms have similar problems, including British Airways and Corus, which includes what was once British Steel. Worries about pension liabilities have helped to scupper takeover bids for two prominent British retailers, Marks & Spencer and WH Smith, and caused wobbles in this year’s acquisition of Allied Domecq by Pernod Ricard, another drinks firm.

America is unique however in the central role played by employers in financing health care. In most countries, health care is largely funded by the taxpayer and is thus much less of a direct burden on companies. Rick Wagoner, GM’s boss, spoke for many American executives earlier this year when he said that the “cost of health care in the U.S. is making American business extremely uncompetitive versus our global counterparts”. Strikingly, as if to prove his point, the car industry has been booming in Canada in recent years as Detroit’s Big Three and their suppliers have shifted operations north of the border in search of savings.

Hurt by Health

True, the competitiveness problem can be overstated. After all, in theory, state funding of health care abroad should mean a higher tax burden compared with America, some of which is likely to be felt, one way or another, by the corporate sector. But legacy healthcare costs, in particular, probably do hurt American firms.

Unlike pensions, which have funding requirements under the 1974 Employee Retirement Income Security Act, there is no legal obligation to set money aside for future healthcare promises. Health care for retirees is largely paid out of current cash flow, adding to a firm’s costs relative to its foreign rivals but not to its output that year. Future OPEB obligations can affect the perceived creditworthiness of American firms and thus their cost of capital, by more than the impact of potentially higher future tax bills or labor costs on foreign rivals in countries with state-financed healthcare.


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