Be Pension Wise

If you're flinching at the recent losses in your brokerage and 401(k) accounts, imagine how the managers of America's huge pension funds feel. The top 100 U.S. pension funds boasted a gargantuan $3.5 trillion in combined assets last September. Now, despite having fortified their reserves with huge stock-market gains in recent years, public and private pension funds are facing steep declines. Northrop Grumman, a giant in the aerospace and defense industry, called attention to this little-known fact in December. It warned that a drop in income from its pension investments could knock $50 million in pre-tax dollars off corporate profits this year. After final numbers for 2000 came in, the situation looked even worse. The company says pension income may decline $238 million or more in 2001. Most investors probably aren't aware that Northrop--like a host of other companies--has been relying on proceeds from its pension funds (which retirees count on for a defined benefit payout) to contribute to more than half of the company's bottom line.

Pension funds may have profited nicely when the equity markets were booming, but now a range of companies are struggling to bolster their pension plans to make up for the markets' swoon. This does not mean your pension is in danger, just that companies may have to scramble to make up for lost profits--a potential matter of concern if you're an investor.

Pension funds have had such strong returns for years that many firms have not had to contribute to them. Indeed, Mark Lay, a Pittsburgh-based money manager who advises several public and private funds, says some companies started enhancing pension accounts by putting 80%--not the traditional 60%--of their assets into equities.

That may have helped for a while. Blue chips like AT&T;, Boeing, IBM and Phillip Morris have seen their bottom lines boosted by pension income, according to a study by the benefits consulting firm Towers Perrin. The study found that in 1999 alone, companies in the Dow Jones industrial average saw their pension funds' income increase more than $1 billion--the same amount that accounted for pension expenses the year before.

The concern now: stock-market woes could be a drag on pension accounts.

It's too early to tell the extent of the damage. "While 2000 looks as if it will produce asset losses rather than gains, many firms use asset smoothing," says Adam Reese, author of the Towers Perrin study. Those calculations can soften the impact of pension expenses on earnings. Moreover, most companies do not readily break down pension-fund costs in their earnings reports. Investors may need to comb through SEC filings like 10Qs and annual reports for indications of how serious the problem is.

If you are a retiree, a decline in returns on pension investments won't alter your check. But shareholders should be wary. If management dips into a company's operating cash flow to top off an underfunded pension account and the market downturn continues, earnings--and thus the share price--could be affected. Which is to say, while we've had a nice ride, it's time to tighten our belts and look to the future.

Sharon Epperson is a correspondent at CNBC Business News. You can e-mail her at sharon.epperson@nbc.com