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READING COMPREHENSION

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Ticking Bomb

Unfunded benefit promises to retired employees are now too big to ignore.
from The Economist, November 2002

Of all the troubles facing America's car makers, the worst may be their unfunded promises to workers, especially retired ones. Fitch, a rating agency, estimates that in 2002 the aggregate pension shortfall of car firms will top $30 billion, most of it attributable to Ford and General Motors. Things look worse when the other post-employment benefits (OPEBS), primarily retiree health care, are added in. Last year, GM doled out a hefty $857 in OPEBS for every vehicle it built.

Car makers are not alone. Three years of paltry equity returns and low interest rates have led to an aggregate shortfall of funds compared with pension liabilities, for all firms in the S&P 500, of around $300 billion in 2002. The total doubles when OPEBS are added, as these are typically unfunded because, unlike pensions, firms get no tax breaks for setting aside assets against future liabilities. In Europe, too, pension deficits are causing waves in the Netherlands and Britain, the two European countries in which pre-funded defined-benefit schemes (which pay a pension related to an employee's final salary) are prevalent. Pension underfunding in Britain will reach £100 billion ($160 billion) this year, says Watson Wyatt, a consultancy.

Even an uptick in the stockmarket, not a racing certainty to say the least, may not much help. "What people are missing is how high returns have to be just to stop the underfunding problem getting worse", says Trevor Harris of Morgan Stanley. If pension-fund returns average 6% a year in future, American firms may have to stump up another $80 billion to close the gap, calculates Goldman Sachs. At 4% a year, the figure rises to $110 billion. That would hurt profits, especially if, as is quite likely, accounting bodies introduce standards that force firms to reflect properly the impact of their pension obligations.

In October, Standard & Poor's, another rating agency, downgraded GM, citing pension deficits as a main reason. Last week, Northwest, an airline, announced a pension-related charge that could exceed $700m in the fourth quarter. It also petitioned the government to let it contribute shares in lieu of cash and to reschedule other contributions to avoid a liquidity crunch during the industry downturn. Others will follow.

Many of the hardest-hit firms are in mature industries - airlines, steel, cars - with large (and growing retiree populations. The average ratio of active employees to retirees for GM in America is 2.3-to-one; in the steel industry it is three-to-one. Strong unions mean that simple solutions on paper - eg, trimming OPEBS - are not so simple in practice.

Can anything be done? OPEBS are easier to wriggle out from than pensions. American firms are legally obliged to make good any pension-fund shortfall of more than 10%. Other than praying for 36,000 on the Dow, bosses may feel better off not having to worry about whether their pension fund will bankrupt their business. Several British firms are considering paying insurers to take on their pension obligations, says Kevin Wesbroom of Hewitt Bacon and Woodrow, a consultancy. That would not get rid of the underfunding problem, but it might stop it getting any bigger.

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