Local corporate pension funds take a hit

By Frank Cho
Advertiser Staff Writer

Struggling with a slow economy, falling returns of their stock market investments and a possible war with Iraq on the horizon, Hawai'i's largest companies are facing another threat to their bottom lines.

Experts say the declines don't threaten pensioners' incomes because for now there is enough money to meet fund obligations in a particular year, and the federal government guarantees the benefits under certain conditions.

But the financial impact is starting to hit corporate bottom lines this year and next as companies begin recognizing the losses on their earnings reports — and setting aside more money to shore up their underfunded plans.

"This is something that is really going to hit Hawai'i companies this year," said Neal Kanda, chief financial officer of Central Pacific Bank.

Throughout much of the 1990s, a hot stock market and stellar returns in pension funds allowed many Hawai'i companies to contribute little or no money to meet the financial obligations of their employee pension plans.

Financial hole

But the last three years have left some of the plans in a deep financial hole. And now companies who routinely booked annual returns inflated with pension fund gains are having to find a way to cover pension fund investment losses.

But Hawai'i companies are not alone. At the end of 2002, pension fund analysts estimated 87 percent of the companies that make up the S&P 500 using traditional pensions were expected to have underfunded pensions, including such corporate heavyweights as General Motors, Hewlett-Packard and ExxonMobil.

State pension funds have also taken huge hits in recent years. In Hawai'i, the state Employees' Retirement System has watched its assets fall from nearly $10 billion in 2000 to less than $8 billion today — not only because of the poor stock market but because the increasing outflow of pensions has outpaced incoming contributions.

The bad news for Hawai'i CEOs, however, is that the deteriorating situation could cause some investors to take another look at their stock portfolios and share prices of Hawai'i publicly traded companies. Experts, however, fear this could create a vicious cycle where lower earnings further depress stock prices, again deflating pension fund investments, leading to lower earings and lower stock prices.

"You are going to start seeing several Hawai'i employers report to members that their plans are now underfunded beginning in the middle to the later part of this year as they are required to do," said Charles Furuike, chief actuary at Benefit Plan Consultants, a Hono-lulu employee benefit consulting firm.

Furuike said that in Hawai'i, multi-employer plans, such as union pension funds, are in much better shape than plans under a single employer. He said single-employer plans typically negotiate the benefits of the plan, but not how much the employer should pay into the plan each year. That allows some employers to withhold payments when times are tough or pad their own bottom lines.

"That is something we saw in both good and bad times because of the fact that the employer had the discretion (to contribute or not)," Furuike said. "The real question is the viability of the company itself. As long as the company itself is financially solid, I don't think employees have anything to worry about."

Significant costs

Because most Hawai'i companies have not yet filed their annual reports, it is difficult to assess exactly how much these pension fund obligations will hurt profits this year. But what is clear is the cost will be significant, most executives said.

"We have a situation basically of going from a credit during the past several years to what is amounting to a significant charge to income," said James Andrasick, Alexander & Baldwin's treasurer and chief financial officer as well as president and chief executive officer of its Matson subsidiary. "This has become a nationwide, perhaps a worldwide, trend over the past several years and it is going to affect profits this year."

Alexander & Baldwin, which employs about 2,000 workers at its Matson Navigation Co. Inc., Kauai Coffee and A&B Properties Inc., said it will go from receiving a pre-tax credit of $1.4 million in 2002 to recording a charge of $15 million this year — a swing of more than $16 million.

"Our pension plan has gone from being overfunded three years ago to being underfunded today," Andrasick said. Alexander & Baldwin's pension is funded at 88 percent right now, down from 120 percent a few years ago, Andrasick said.

Hawaiian Electric Industries, the parent company of Hawaiian Electric Co. Inc., also said it expects its pension fund expense to increase to $12.6 million this year, compared to a credit of 4.5 million last year. Despite the swing of more than $17 million, the company, one of state's biggest employers, said its pension fund remains adequately financed.

Plans are underfunded

A plan becomes underfunded when the value of the assets in the plan, assuming it grows at a conservative rate, is not enough to meet the obligations of current or future retirees.

Consider Hawaiian Airlines' predicament. The carrier's pension plan had $164 million, according to its annual report filed in March 2002. But even with $164 million assets, the company's retirement plan was still underfunded by nearly $70 million.

"Like other companies in our industry and in the economy as a whole, our pension plan has become more expensive for two reasons; one is the return on investments have been reduced; and two, interest rates have come down," said John Adams, chairman and chief executive officer for Hawaiian Airlines.

And just like other companies, Hawaiian's situation may be even worse than it appears. To estimate its future pension obligations, companies use a discount rate which is supposed to reflect the prevailing interest-rate environment. The discount rate tells pension fund managers what kind of return on investments they should expect if they invested in high-quality corporate bonds. So the higher the rate, the lower the obligations and the less money the company needs to set aside.

Pensions costs rise

Hawaiian Airlines used a discount rate of 7.25 percent in 2001 while the federal Pension Benefit Guaranty Corp., which insures such plans, recommended a rate of 5.8 percent — almost 2 points lower. At Hawaiian's rate, it would have needed $227 million in its pension fund at the end of the year for it to be fully financed.

If Hawaiian followed the lead of the PBGC and many other companies that year and lowered its discount rate, it would have significantly increased its pension obligations by tens of millions of dollars. But for each point Hawaiian lowered its discount rate, it would increase its pension costs by $24 million, or nearly $35 million if it had followed PBGC's recommended discount rate.

"I know we are underfunded, and it is something that is of very much concern to us," said Reno Morella, a member of Hawaiian Airlines' board of directors and incoming union representative for Hawaiian's West Coast pilots.

Morella said pilots are required by federal law to retire by age 60, giving them only a limited number of earning years.

"When US Air went bankrupt, and despite federal guarantees, pilots there were only able to get about $28,000 a year each. That opened up a lot of eyes," Morella said.

Record shortfall

The PBGC, which is supposed to protect the retirement income that workers earn in employer-sponsored pension plans, is now itself in financial trouble, according to a report it released Thursday.

The program posted a record $3.6 billion shortfall in 2002 after burning through its entire $7.7 billion surplus. Most of that $11.3 billion net loss last year — also the largest in the agency's 28-year history — came from securing a record number of underfunded pension plans at bankrupt and financially troubled companies.

The PBGC's executive director, Steven A. Kandarian, said the insurance program still had sufficient assets to pay benefits to retirees "for a number of years." But officials must find new ways to financially strengthen the program to meet future obligations, he said.

About 80 percent, or $9.3 billion, of the $11.4 billion net loss was because of underfunded single-employer plans. Declining interest rates accounted for nearly $1.7 billion of the loss. The PBGC's last deficit was in 1995, at $315 million. The only surpluses it has recorded were in 1996 through 2001.

The situation illustrates a share reversal of the the 1990s stock-market boom. Until a few years ago, pension funds outperformed expectations and the excess was used to pad corporate earnings. By one estimate, as much as 30 percent of earnings reported for S&P 500 companies was due to pension fund gains.

Today, the Dow Jones industrial average is roughly 20 percent below its early-2000 peak. Local CEOs have had the problem on their radar for some time, but awareness among the general public has been limited.

Experts said this should change this year as increasingly larger expenses begin to appear on corporate income statements, weakening balance sheets and heightening fears among employees.

Reach Frank Cho at fcho@honoluluadvertiser.com or at 525-8088.

Correction: Alexander & Baldwin's pension funds were funded at 122 percent at the end of 2001 and 155 percent at the end of 2000, according to the company. A previous version of a chart that appeared with this story contained other numbers based on initial company information.