Pension Woes Loom for Large Midwest Firms

Rising pension costs threaten to eat into the profits of many of the Chicago area’s largest companies as they divert billions of dollars to shore up funds depleted by the stock market swoon.

Aon Corp., Exelon Corp., Abbott Laboratories, Caterpillar Inc., Motorola Inc. and Sara Lee Corp. are among the region’s companies that started the year without enough in their pension funds to cover projected payments to retirees. Those shortfalls almost certainly have deepened, observers say.

Kraft Foods Inc., Allstate Corp., Pactiv Corp. and others whose pension funds were only slightly in the black are likely to be running deficits by the end of the year.

Assessing how the market sell-off has affected individual companies is difficult because they file financial reports on their pension funds only once a year. But new rules require companies to book any pension shortfalls as liabilities on their balance sheets—potentially putting pressure on credit ratings — and to top up the funds at a much faster rate.

“Contribution requirements are going to be much larger and much sooner than they anticipated,” said Rick Pearson, managing principal in Chicago for Towers Perrin, a corporate risk management and actuary consultancy. “This is going to require more cash to get back to a full-funded status.”

Besides squeezing profits, the pension shortfalls come as companies try to conserve cash amid a credit freeze that has shut off access to capital from banks and the bond market. Draining corporate cash pools to bolster pensions leaves less money for shareholder dividends, stock buybacks or investments that could enhance earnings just as a weakening economy puts profits under pressure.

“Companies are going to have to put cash in pensions when earnings are not going to be that great for a lot of them,” said Howard Silverblatt, an analyst with Standard & Poor’s Investment Services in New York.

Signs of trouble are emerging already. Peoria, Illinois-based Caterpillar said last quarter that a decline in asset values in the first half had driven up its unfunded pension liability by an estimated 161 percent, to $2.43 billion. A spokesman last week declined to comment on the impact of the market plunge since then, but at the start of the year, more than two-thirds of Caterpillar’s pension assets were invested in equities.

“We know it’s going to cost them more money,” said Eli Lustgarten, an analyst with Ohio-based Longbow Research.

Aon’s unfunded pension liability could nearly triple to $2.8 billion by the end of the year, said Bijan Moazami, an analyst with Virginia-based FBR Capital Markets Corp. Making up that shortfall could trim per-share earnings by about 25 percent, he wrote in a note to investors last week.

“It’s premature for us to estimate on that,” a spokesman for the Chicago-based insurance broker said. “A lot can happen between now and the end of the year.”

Nearly 350 companies in the S&P 500 index have defined-benefit pension plans, which typically invest about two-thirds of their funds in stocks. At the start of the year, those plans had a combined $1.5 trillion in assets, exceeding obligations by $63 billion.

With the S&P 500 down about 36 percent for the year, analysts estimate that those companies’ assets have lost 15 to 20 percent of their value, leaving a funding shortfall that could approach $200 billion.

Observers expect the ballooning pension deficits to provide additional incentive for companies to continue to curtail or drop traditional pension plans, which guarantee retirees’ incomes. The number of such private-sector plans fell by 34 percent from 1998 to 2005.

Under a 2006 federal law, companies are required to make up unfunded balances within seven years. In the past, they were allowed to spread out payments for pension shortfalls for as long as 30 years. As part of the new law, companies will be forced to limit employee benefits if pension plan assets fall below 80 percent of obligations.

Filed by Bob Tita of Crain’s Chicago Business, a sister publication of Workforce Management. To comment, e-mail editors@workforce.com.