The benefit obligation (“BO”), arising from SFAS No. 132, is the same as ABO only it includes an estimate for compensation increases. The ruling also requires the company to disclose all plans and whether the BO is exceeds or is exceeded by plan assets. The projected benefit obligation (“PBO”) is an estimate of the present value of a company’s total liability if the pension plan continues forever. Investors can use this information to see if a pension is over or under funded.
An example of under funded pension
According to the company's 2003 10K, IBM has benefit obligations of $21.101 billion yet has deposited only $12.985 billion in assets into these plans. That is a shortfall of $8.116 billion, or more than the company’s reported 2003 earnings! Even if one considers that the company has other plans where pension assets exceed benefit obligations by $2.787 billion ($13.561 billion plan assets - $10.774 billion benefit obligations), the company's plan assets are still a net $5.329 billion short of total benefit obligations. Sooner or later, shareholders are going to have to pay the price.
A perfect storm brewing?
The under funding of corporate pensions combined with the disappointing performance of equities over the past few years leads some experts to believe we are heading for a “perfect storm” scenario. American corporations, faced with the mass-retirement of Baby Boomers, will suddenly realize the asset levels of their plans are not sufficient to service the promises they have made to retirees. They will then be forced to make large contributions to plans, leading to several painful years for stockholders who must watch the net earnings of their holdings plummet until the disparity is corrected. The lower reported earnings may cause equity prices to fall, further exasperating the situation.Many corporations, IBM included, have been lowering the discount rate and return on plan assets assumptions in recent years, paving the way for more conservative accounting in the future. Still, given the ground that has been lost, it may not be enough. Until the situation sorts itself out, investors need to keep a watchful eye on the footnotes of the corporations in which they have equity.
