Freedom Lawyers of America

Dead Ahead: $144 Billion Pension Shortfall

The rules for calculating pension liabilities have been so lax in recent years, hundreds of major US corporations have been legally manipulating the way they calculate the value of the portfolios.

The market plunged in 2000, driving their pension fund assets into the hole, and they ignored it. The market plunged again in 2001, and they still ignored it.

But now, as the market continues to fall for a third year, they can't ignore it anymore. So they're starting to admit the shortfalls, but only one small piece at a time.

Here's what we see coming:

* If the corporate pension funds of S&P 500 companies lose just 5% this year, the shortfall in pension funding is going to be at least $109 billion!

* If they lose closer to 10%, then the shortfall is going to be in excess of $144 billion.

* If you look beyond just the S&P companies, the problem is even larger -- thousands of smaller pension funds that could drag down corporate profits for years to come.

* If the pension funds really take a major beating of 20% or more in the next year or two, the losses could set off a chain reaction of events that will make the recent accounting scams look like a Sunday school picnic. You'll see wholesale dumping of shares by investors ... mass protests by employees ... draconian new countermeasures by Congress and the SEC.

The crisis could affect $3 trillion, even up to $4 trillion in market cap. Unbelievable? Yes. True? Absolutely! For the evidence, take a look at ... The Numbers Game Behind The Coming Pension Fund Disaster

There are three fundamentally flawed accounting rules that are at the root of the pension fund scam:

Flawed Rule #1. Companies are allowed to calculate a pension's funding requirements based purely on hypothetical projections of annual returns, rather than on how well, or how badly, a pension's investments have fared in the real world.

In other words, let's say Company A is projecting an annual return of 10% of its pension fund assets of $100 million, or a $10 million return. But in reality, Company A's pension has unrealized losses of 5% this year or $5 million. What do you think Company A puts down on its profit & loss statement? A loss of $5 million?

Sadly, no. GAAP accounting rules let the company spread out the unrealized losses over a period of time. Let's assume it's 10 years. As a result, Company A shows a net profit of $9.5 million (the $10 million projected gain minus the half million dollar amortized loss) less any costs associated with maintaining the pension fund. This phantom "profit" of $9.5 million allows the company to postpone contributing the needed money to its pension fund, and avoid deducting that amount from its corporate bottom line. In short, they postpone the day of reckoning based on the blind assumption that the losses will "naturally go away."

The original intent behind this kind of creative accounting was to smooth out annual swings in income for pension funds, so companies can better plan their contributions.

The practical result, however, is far more sinister: Companies are allowed to legally hide massive losses in their pension plans, avoid contributing additional funds, and therefore exaggerate their profits in any given year.

Flawed Rule #2. A pension fund's projected gains can be based on seriously unrealistic assumptions regarding how well the pension investments will perform.

Let's say you're managing your own retirement program and you determine you'll need $1 million in 20 years when you retire. If you assume you can get a 10% annual return on your investments, then you only need to contribute $17,459 a year to reach that goal. But if, in reality, you only get a 6% annual return on your investments, then you need to contribute $27,184 each year -- or 56% more.

For CEOs with fat options packages anxious to show investors high net earnings, the temptation to exaggerate their estimated pension fund returns -- and add that money to the bottom line instead -- is almost overwhelming.

It's hardly surprising, then, that dozens of America's largest companies base their pension fund contributions on an assumption of a 10% annual return or greater -- including Bank of America, Bristol Myers Squib, Campbell Soup, FedEx, General Mills, Mattel, Lehman Brothers, Pepsi, Sprint, and Weyerhaeuser, among others.

According to Milliman USA's 2002 pension study, the average assumed rate of return in 2000 for the 50 largest American companies was 9.38%, with an expected projected profit of $51 billion. However, the actual return on investment that year was only $14 billion -- or $37 billion short.

In 2001, the average projected rate of return for the 50 largest companies was a bit higher -- at 9.39%, with an expected profit of $54 billion.

Give me a break. The stock market had just taken a beating in the previous year, and they were projecting even higher returns!? Actual results for 2001: A loss of $36 billion -- or a shortfall of $90 billion from what companies expected.

And it gets worse ...

Flawed Rule #3. Companies can count the hypothetical gains in their pension funds as part of their own bottom line, even though it has nothing to do with their operations, and even though the money doesn't even belong to them.

Companies show their projected returns from their pension funds on their P&L statements. As The Times of London put it, "any major U.S. company that is worried about its earnings can therefore engineer a $100 million boost simply by tweaking its expectations about pension fund returns."

Consider this example: You own a hot dog stand that usually makes $10,000 a year in profits. Plus, you have $100,000 in your pension plan, which you optimistically project will earn 10% a year.

Now, let's assume this has been a horrible year for hot dogs -- not one meager dime in profits. What's worse, your pension plan, instead of making 10% this year, has actually lost 5% -- or $5,000.

Pretty miserable, right? Not if you use the "legal" GAAP gimmicks to jury-rig the numbers! First you could spread the $5,000 pension fund lost over five years -- just $1,000 each year. Then, you could assume a $10,000 pension fund gain. Bottom line: Deduct the $1,000 loss from the $10,000 gain, and voil� ... your loss of $5,000 has been transformed into a $9,000 profit.

How common is this kind of creative accounting? It's systemic ... and massive. As I told you earlier, based on our review of S&P 500 corporations, 150 out of 354 companies reporting pension data were able to boost their earnings -- or actually turn net losses into profits -- by adding hypothetical pension fund income when calculating the company's annual net earnings. For example:

* Verizon Communications had multi-billion dollar losses in 2001. But just by adding in its projected pension fund gains exceeding $2 billion, the company was able to magically report a net profit for the year of $389 million.

* Eastman Kodak lost tens of millions last year. But by including its projected $100-million-plus profit from its pension fund, the losses were magically transformed into a $76 million profit.

* TRW also lost tens of millions in 2001. But by adding in a $100-million-plus projected gain in its pension fund, it transformed the huge loss into a $68 million profit.

* Whirlpool should have told its investors that it lost over $20 million last year, but because of the pension fund accounting rules, it was able to goose up its bottom line, wash away the loss, and magically create $21 million in profits.

* Honeywell International's loss of $99 million in 2001 would have been several times greater. But they counted the company's projected pension fund gain of hundreds of millions on the corporate bottom line.

* Prudential Financial's loss would have been equally catastrophic -- over half a billion dollars instead of just $154 million -- if they had not added their pension fund's phantom "gain" to the corporate bottom line.

* Northrop Grumman's 2001 income of $427 million would have been cut down to about a quarter of that amount. Weyerhaeuser's 2001 profit of $354 million would have been sliced by two-thirds. Consolidated Edison's profit would have been cut practically in half. Boeing's earnings would have been reduced by about a third.

The examples go on and on. More than 140 other major companies in the S&P 500 did essentially the same thing. Now do you see why I call this the greatest accounting scam of all time?