AUSWR
The Association of U S West Retirees
 

 

 

Health Benefits Ail as Pensions Heal

Large Companies' Funding
For Retiree Medical Costs
Continues to Come Up Short

By IAN MCDONALD
June 6, 2006; Page C3

Major U.S. companies' pension plans appear to be on the mend, but their retiree benefits are still in intensive care.

At the start of this year, the pension plans and postretirement health-care obligations of the companies in the Standard & Poor's 500-stock index were underfunded by $140 billion and $321 billion, respectively, according to an S&P report due out today. In other words, should the companies have to pay out all their estimated future obligations to employees right now, that's how much of a shortfall their retirement and health-plan funds face.

S&P and other pension trackers expect rising interest rates to alleviate much of the pension-plan shortfall, but the money available for retirees' medical costs -- "other post employment benefits," or OPEB, in the jargon of accounting -- will continue to be well short of projected outlays.

"OPEB is in very poor shape," says Howard Silverblatt, S&P's senior index analyst in New York and author of the research report. "The pension situation is much more manageable because there are more assets set aside to cover those liabilities."

[IOUs]More than 340 companies in the S&P 500 offer some form of traditional pension plans, 47 of which were actually overfunded at the start of this year. Only four of the 290 companies with OPEB liabilities had a surplus in those plans at the beginning of 2006, according to S&P.

For years, U.S. companies and their investors have fretted over the rising costs of paying benefits as workers' life expectancies and medical costs continue to climb. Next year, these outsize IOUs will get broader attention when they move from companies' financial-statement footnotes -- where they were less noticeable -- onto their balance sheets, in accordance with new accounting rules.

On the pension front, there is hope these liabilities will be less of an eyesore. Several events are working to heal pension plans. Rising stock prices are helping the funds' investments grow, and rising interest rates are lowering the funds' obligations. Pension funds' long-term obligations are forecast decades into the future. That total cost is then discounted back to today's values using a "discount rate," or the rate that the plans' assets must grow to meet future obligations. Rising rates raise the discount rate, thus lowering the amount the plan needs today.

At the same time, more companies -- large and small -- will move to close their traditional, "defined benefit" pension plans in favor of 401(k)s and other "defined contribution" plans, thus greatly limiting obligations to new employees.

The upshot: S&P-500 companies' traditional pension plans were 90%-funded at the start of this year.

Postemployment medical plans, on the other hand, won't benefit much from higher bond yields and stock returns, because companies have set little money aside to pay these bills. These funds were only 22% funded.

Why the disparity? One factor is that companies get a tax-break on "prefunding" their pensions. The plans are also backed by a federal guarantor, the Pension Benefit Guaranty Corp., which closely monitors underfunding. Health-care plans don't have similar tax benefits or backing, and health-care costs are rising much faster than other living expenses.

While traditional pension plans often are contractual obligations at companies that have them, health-care benefits often aren't. Thus, many companies are capping or trimming their postretirement health-care spending.

"You can see that there's more flexibility for companies there, because the plans have been cut back," says Jack Ciesielski, publisher of The Analyst's Accounting Observer.

Still, health-care plans are an albatross for many companies. Underfunded pensions at struggling U.S. auto makers have gotten a lot of ink, but their health plans are in far worse shape. Of the $110 billion total pension- and health-care-plan underfunding at the start of this year at General Motors Corp. and Ford Motor Co., more than $97 billion of that amount was accounted for by retiree health-care costs, according to S&P. (Recent labor agreements could change that landscape.)

All eight telecommunications companies in the S&P 500 have overfunded pension plans, but the money these eight have set aside for retiree health-care benefits is more than $58 billion short of projected costs.

Many U.S. companies complain that retiree health-care costs are covered by the government in many other countries, putting U.S. employers at a disadvantage. Meanwhile, medical and drug costs continue to rise.

"The light at the end of the OPEB tunnel is an oncoming train," S&P's Mr. Silverblatt says. "Someone is going to have to pay."

Write to Ian McDonald at ian.mcdonald@wsj.com