Ford and GM Get SEC Request On Pension Accounting Practices
By ELLEN E. SCHULTZ
Staff Reporter of THE WALL STREET JOURNAL
October 20, 2004; Page A1
The Securities and Exchange Commission has asked two of the country's biggest companies how they used pension and health-benefits funds to adjust their earnings in recent years, raising the heat on a long-simmering debate over such practices.
Ford Motor Co. and General Motors Corp. said yesterday that the SEC has requested documents and information relating to pension and retiree-benefits accounting.
Ford and GM said that they are cooperating with the SEC and that they adhere to proper accounting. The companies aren't charged with wrongdoing.
The SEC request comes a day after Delphi Corp., the big Troy, Mich., auto-parts and electronic maker, received a similar demand from the agency. The request has major implications, especially in a union-heavy industry such as autos that carries huge pension and retiree-benefits obligations. It could ultimately mean wilder swings in earnings for these manufacturing giants and less reliance on pensions and benefits funds to ease those swings.
"People are starting to wake up now," says Jack Ciesielski, a Baltimore-based expert on pension accounting who provides research to institutional investors. Mr. Ciesielski has warned for a decade that shareholders are unaware of how pensions have enhanced earnings. "There are some big fish to fry," he said.
The impact on companies could be significant. Ford's shares fell 3.4% yesterday, closing at $12.93 in 4 p.m. composite trading on the New York Stock Exchange; GM's shares fell 2.3%, to $38 (see Ford earnings on page A2).
With less flexibility to do accounting tricks with their pensions, these and other companies may find it harder to use the plans to smooth over earnings. Already this year, the Financial Accounting Standards Board has begun to require companies to make clearer disclosures -- and is pushing for others, which companies have been resisting. But this probe by the SEC might lend the FASB renewed clout.
For more than a decade, companies have taken advantage of the flexibility within the arcane accounting provisions to treat benefits plans as corporate-finance tools. Employers make dozens of assumptions that affect their income and IOUs: mortality, marriage rates, salary increases, investment returns on pension plans, health-care inflation, and others.
Thanks to this flexibility, and poor disclosure requirements, companies have been able to come within a few cents of quarterly earnings targets by changing assumptions within its benefits plans, by cutting benefits, or both.
The rules even make it possible for companies to mint income. Raising liabilities (by changing assumptions and by offering enhanced benefits, perhaps in conjunction with an early-retirement offer), then cutting liabilities (by adjusting the assumptions and cutting benefits), generates gains that boost income.
If nothing else, greater disclosure and tougher scrutiny of accounting practices would make it easier for shareholders and analysts to strip out the role the retiree plans have played in a company's results. Companies that cut benefits to boost income in order to meet earnings targets would be less able to hide the fact from employees and retirees, as well.
However, none of the actions that have emerged so far would do much to prevent companies from tapping pension assets, or change the amount companies contribute to pension plans. (Companies use different assumptions under pension law to calculate what they must contribute to pensions.)
When pension plans were pumping hundreds of billions of dollars into income in the 1990s, most analysts were oblivious to the boost to earnings the pensions were providing. But when pension plans lost money, and falling interest rates boosted liabilities, analysts began pumping out reports complaining that companies were masking their obligations, and using overly optimistic assumptions on the returns they could expect from their pension plans.
Retiree and shareholder groups mounted campaigns to require companies to exclude pension income from earnings. They said the desire for pension income tempts companies to cut benefits to boost executive pay, which is typically based on meeting earnings targets.
The SEC says its pension probe is part of a "risk-based" initiative to identify new areas of accounting abuse. The SEC said last week it had asked six companies to produce memos, e-mails and other documents that detail how they select various assumptions for retiree liabilities and costs. The names of the three other companies haven't been made public.
Many companies are complying with guidelines the SEC has issued in recent years about how to select discount rates and expected returns, so that there are fewer using obviously odd assumptions.
Still, the SEC is known to be examining several areas of pension accounting and how different accounting assumptions affected companies.
Analysts have complained that some companies have used unrealistically high hypothetical -- or "expected" -- rates of return for pension investments to enhance earnings. (Under standard accounting practices, to smooth the impact of a pension plan on earnings, companies use expected, rather than actual returns.)
For example, in 2002, GM assumed its pension assets would return 10%, while they actually lost 5.2%. On the other hand, in 2003 GM lowered its expected return to 9% from 10%, which produced expected returns of $6.4 billion, while the actual returns were $13.5 billion. These assumptions helped lower the expense of the pension plan, mitigating its drag on earnings.
Similarly, Ford used an expected return of 8.75% for its U.S. pension plans in 2003, which produced "expected returns" of $3.2 billion. The pensions actually returned more than twice that: $7.7 billion. The prior year, Ford used the same expected return, which generated $3.6 billion in income, even though the pension plan actually lost $3.3 billion.
If the investments exceed their "expected" return, the company can stockpile the gains to use later, which is what happened commonly throughout the 1990s. But if the investments do worse than expected, which was typically the case in 2001 and 2002, the losses can be postponed. Whether a company has abused the assumption is impossible to tell from a glance at its filings.
Another concern is that companies can raise and lower their projected retiree liabilities at will by making small adjustments in their discount rates. Employers generally use rates based on high-grade corporate bonds. According to its filings, Ford's discount rate for its U.S. pension plans fell to 6.25% in 2003 from 6.75% in 2002; GM lowered its discount rate even more, to 6% in 2003 from 6.75% in 2002. The decline in the discount rate boosted the liabilities of the auto makers by billions of dollars.
It's impossible to conclude looking at filings whether a company is using an inappropriate rate. Only the company knows when the expected payments will go out, which depends on tenure and age.
Companies also make assumptions about future salary increases, mortality and marital status -- all of which can affect liabilities.
The SEC is also examining assumptions about health-care inflation that companies use to calculate liabilities in retiree health plans. Employers have enormous latitude to come up with this figure, which, combined with changes in the discount rate, enables them to raise or lower liabilities by hundreds of millions of dollars.
Some analysts have criticized the auto makers for using what they say are unrealistically low inflation assumptions. Ford, for example, lowered its health-care inflation rate to 9% in 2003 from 11% in 2002; according to its filings a one-percentage-point decrease would reduce liabilities by $3.8 billion.
By comparison, GM raised its health-care inflation assumption to 8.5% from 7.2% Still, on a conference call to discuss third-quarter results last week, GM said it will increase its cost assumption for post-retirement health benefits to the "double digits" percentage rate. According to its filings, a one percentage point increase will boost liabilities by $7.6 billion.
Write to Ellen E. Schultz at ellen.schultz@wsj.com4
Staff Reporter of THE WALL STREET JOURNAL
October 20, 2004; Page A1
The Securities and Exchange Commission has asked two of the country's biggest companies how they used pension and health-benefits funds to adjust their earnings in recent years, raising the heat on a long-simmering debate over such practices.
Ford Motor Co. and General Motors Corp. said yesterday that the SEC has requested documents and information relating to pension and retiree-benefits accounting.
Ford and GM said that they are cooperating with the SEC and that they adhere to proper accounting. The companies aren't charged with wrongdoing.
The SEC request comes a day after Delphi Corp., the big Troy, Mich., auto-parts and electronic maker, received a similar demand from the agency. The request has major implications, especially in a union-heavy industry such as autos that carries huge pension and retiree-benefits obligations. It could ultimately mean wilder swings in earnings for these manufacturing giants and less reliance on pensions and benefits funds to ease those swings.
"People are starting to wake up now," says Jack Ciesielski, a Baltimore-based expert on pension accounting who provides research to institutional investors. Mr. Ciesielski has warned for a decade that shareholders are unaware of how pensions have enhanced earnings. "There are some big fish to fry," he said.
The impact on companies could be significant. Ford's shares fell 3.4% yesterday, closing at $12.93 in 4 p.m. composite trading on the New York Stock Exchange; GM's shares fell 2.3%, to $38 (see Ford earnings on page A2).
With less flexibility to do accounting tricks with their pensions, these and other companies may find it harder to use the plans to smooth over earnings. Already this year, the Financial Accounting Standards Board has begun to require companies to make clearer disclosures -- and is pushing for others, which companies have been resisting. But this probe by the SEC might lend the FASB renewed clout.
For more than a decade, companies have taken advantage of the flexibility within the arcane accounting provisions to treat benefits plans as corporate-finance tools. Employers make dozens of assumptions that affect their income and IOUs: mortality, marriage rates, salary increases, investment returns on pension plans, health-care inflation, and others.
Thanks to this flexibility, and poor disclosure requirements, companies have been able to come within a few cents of quarterly earnings targets by changing assumptions within its benefits plans, by cutting benefits, or both.
The rules even make it possible for companies to mint income. Raising liabilities (by changing assumptions and by offering enhanced benefits, perhaps in conjunction with an early-retirement offer), then cutting liabilities (by adjusting the assumptions and cutting benefits), generates gains that boost income.
If nothing else, greater disclosure and tougher scrutiny of accounting practices would make it easier for shareholders and analysts to strip out the role the retiree plans have played in a company's results. Companies that cut benefits to boost income in order to meet earnings targets would be less able to hide the fact from employees and retirees, as well.
However, none of the actions that have emerged so far would do much to prevent companies from tapping pension assets, or change the amount companies contribute to pension plans. (Companies use different assumptions under pension law to calculate what they must contribute to pensions.)
When pension plans were pumping hundreds of billions of dollars into income in the 1990s, most analysts were oblivious to the boost to earnings the pensions were providing. But when pension plans lost money, and falling interest rates boosted liabilities, analysts began pumping out reports complaining that companies were masking their obligations, and using overly optimistic assumptions on the returns they could expect from their pension plans.
Retiree and shareholder groups mounted campaigns to require companies to exclude pension income from earnings. They said the desire for pension income tempts companies to cut benefits to boost executive pay, which is typically based on meeting earnings targets.
The SEC says its pension probe is part of a "risk-based" initiative to identify new areas of accounting abuse. The SEC said last week it had asked six companies to produce memos, e-mails and other documents that detail how they select various assumptions for retiree liabilities and costs. The names of the three other companies haven't been made public.
Many companies are complying with guidelines the SEC has issued in recent years about how to select discount rates and expected returns, so that there are fewer using obviously odd assumptions.
Still, the SEC is known to be examining several areas of pension accounting and how different accounting assumptions affected companies.
Analysts have complained that some companies have used unrealistically high hypothetical -- or "expected" -- rates of return for pension investments to enhance earnings. (Under standard accounting practices, to smooth the impact of a pension plan on earnings, companies use expected, rather than actual returns.)
For example, in 2002, GM assumed its pension assets would return 10%, while they actually lost 5.2%. On the other hand, in 2003 GM lowered its expected return to 9% from 10%, which produced expected returns of $6.4 billion, while the actual returns were $13.5 billion. These assumptions helped lower the expense of the pension plan, mitigating its drag on earnings.
Similarly, Ford used an expected return of 8.75% for its U.S. pension plans in 2003, which produced "expected returns" of $3.2 billion. The pensions actually returned more than twice that: $7.7 billion. The prior year, Ford used the same expected return, which generated $3.6 billion in income, even though the pension plan actually lost $3.3 billion.
If the investments exceed their "expected" return, the company can stockpile the gains to use later, which is what happened commonly throughout the 1990s. But if the investments do worse than expected, which was typically the case in 2001 and 2002, the losses can be postponed. Whether a company has abused the assumption is impossible to tell from a glance at its filings.
Another concern is that companies can raise and lower their projected retiree liabilities at will by making small adjustments in their discount rates. Employers generally use rates based on high-grade corporate bonds. According to its filings, Ford's discount rate for its U.S. pension plans fell to 6.25% in 2003 from 6.75% in 2002; GM lowered its discount rate even more, to 6% in 2003 from 6.75% in 2002. The decline in the discount rate boosted the liabilities of the auto makers by billions of dollars.
It's impossible to conclude looking at filings whether a company is using an inappropriate rate. Only the company knows when the expected payments will go out, which depends on tenure and age.
Companies also make assumptions about future salary increases, mortality and marital status -- all of which can affect liabilities.
The SEC is also examining assumptions about health-care inflation that companies use to calculate liabilities in retiree health plans. Employers have enormous latitude to come up with this figure, which, combined with changes in the discount rate, enables them to raise or lower liabilities by hundreds of millions of dollars.
Some analysts have criticized the auto makers for using what they say are unrealistically low inflation assumptions. Ford, for example, lowered its health-care inflation rate to 9% in 2003 from 11% in 2002; according to its filings a one-percentage-point decrease would reduce liabilities by $3.8 billion.
By comparison, GM raised its health-care inflation assumption to 8.5% from 7.2% Still, on a conference call to discuss third-quarter results last week, GM said it will increase its cost assumption for post-retirement health benefits to the "double digits" percentage rate. According to its filings, a one percentage point increase will boost liabilities by $7.6 billion.
Write to Ellen E. Schultz at ellen.schultz@wsj.com4
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