Profit Center: HOW PENSION AND RETIREE
HEALTH PLANS BOOST EARNINGS


IN ACTUARIAL CIRCLES, there’s a joke that goes something like this: A CFO is interviewing candidates for a job as a benefits consultant. He calls the first one, an accountant, into his office and asks, “What’s two plus two?” The accountant says “Four.” The CFO sends him away, calls an actuary into the room, and asks, “What’s two plus two?” The actuary closes the door, pulls down the blinds, then leans in and whispers, “What do you want it to be?” He gets the job.
As much as this anecdote unfairly maligns the vast majority of actuarial professionals, it nonetheless sums up the view that some in the profession have toward their more aggressive brethren. Until the 1990s, benefits consulting firms generally handled standard pension tasks, like helping companies figure out how much to put into their pension plans, based on the ages and life expectancies of their employees, plus other factors. More closely aligned with the human resources department, they were one of the costs of operating a business, like accountants and the janitorial staff. But over the next two decades, large benefits consulting firms began aggressively marketing “themselves to the finance departments. Their pitch? They could help employers turn pension plans into profit centers.
Their primary tools included the new accounting rules* that employers implemented in 1987, which require employers to disclose the size of their pension obligations, as they do other kinds of debts, and show how these pension debts affect income each quarter. Though the new accounting standard, FAS 87, was intended to increase transparency—allowing shareholders to see the full liability on a company’s books—it was the beginning of the end for pensions. Before the new rules went into effect, employers got only one benefit from cutting pensions: The money that would someday have been paid to retirees would instead remain in the pension plan. Under the new accounting rules, employers got a second benefit when they cut pensions: Reducing the liability generated gains. These are paper gains, not cash, but when it comes to calculating earnings, the gains are treated the same as income from selling software or trucks. IBM’s pension cuts in 1999 reduced its pension obligation by $450 million, resulting in a pot of gains worth roughly $450 million that the company could add to income either right away “or over time. IBM added $200 million of these gains to its 1999 income.
The ability to convert pension benefits that would have been paid out to retirees over the coming decades into immediate profits for shareholders, today, changed the game: Pension plans weren’t just piggy banks to tap for cash. They were also cookie jars of potential earnings enhancements.
It works something like this: Let’s say a person earns $1,000, but he and his employer agree that he won’t be paid until next year. Under FAS 87, this IOU is a debt, which the employer records on his books: Deferred compensation, $1,000.
But what if the employer decides to cut the employee’s salary to $600 after the company has already recorded this debt on his books? Two things happen. The following year, the employer pays only $600—a cash savings of $400—and enjoys a secondary benefit: It has reduced its debt by $400. Under accounting rules, a forgiven debt is recorded as a gain, and boosts income.
To see how this plays out in the retirement heist, add a few zeros to the $400 and think of the deferred pay as a pension: You’re earning it today, “but it will be paid later. Add ten thousand colleagues and the resulting obligation is billions of dollars. Reducing that obligation by $400 million generates gains.

PENSION TEMPTATION

There’s nothing magical about these accounting rules. What made pension debt different from other kinds of debt was that it was easier to erase. A company that borrows $100 million to build a factory can’t later wave a wand and make the debt go away; it can restructure the debt, or shed it in bankruptcy, but otherwise it’s sticking around.
Pensions are different. Companies have a lot of leeway to change the benefits, and thus the size of the pension debt—but not all of it: A company can’t touch the retirees’ monthly checks. And it can’t take away amounts people have already earned. But it can slow the growth of their pensions or halt it altogether by freezing the plans or laying off workers. This explains why, even when a pension plan has plenty of money, a company will profit if it cuts benefits.

It didn’t take benefits consultants long to realize that every dollar a company had promised a retiree—for pensions, prescription drugs, dental coverage, life insurance, or death benefits—was the equivalent of a dollar that could potentially be added to a company’s income. Suddenly, the $1 trillion that companies owed three generations of employees and retirees for pensions and retiree health benefits became potential earnings enhancements. Cuts generate gains, which lift earnings, which help the stock price, which boosts the compensation of the executives whose pay is based on performance. What CFO could resist that?”

Excerpt From: Ellen E. Schultz. “Retirement Heist.” Portfolio/Penguin, 2011-09-15. iBooks.
This material may be protected by copyright.

Check out this book on the iBooks Store: https://itun.es/us/nuBWw.l