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The AAO Weblog covers accounting issues and current events as they relate the practice of investment analysis. All posts prior to September, 2007 are in the public domain, but after September 4, only subscribers to The Analyst's Accounting Observer will see all posts going forward. Only selected, occasional posts will be released to the public domain from September 4 forward.
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| IBM's Pension Bombshell
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Location: Blogs AAO Weblog (Public) |
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| Posted by: Jack Ciesielski |
1/6/2006 6:43 AM |
This morning's Wall Street Journal should get your attention: "IBM to Freeze Pension Program in '08." The information services giant will still have a defined benefit pension plan, but its participants will not earn more rights to a pension under the plan after January 1, 2008. The defined benefit plans will still exist, and will still be paying out benefits earned by employees in the plan, for many years to come. IBM's obligation under these plans will stop growing, however, at least in regard to benefits earned by the covered employees.
It's not a one-way street. Simultaneously, IBM will be substantially increasing its contributions to defined contribution plans. While those costs will increase, they're quite "plannable" compared to the pension costs associated with defined benefit plans: the expense is simply the plan sponsor's contribution. Because it's a predictable, controllable expense, firms would generally prefer this kind of plan. Contrast that to the pension cost for defined benefit plans, which is a noxious stew of service costs, interest cost, amortization of various gains and/or losses, and expected returns on plan assets. It's less predictable, but can provide bottom-line boosts, when the moon and stars are in alignment -which happens less frequently than it once did.
IBM's move won't relieve it from having to report the effects of its defined benefit plans. Over time, however, as the covered employees draw down the assets, the plans' relative effect on IBM's financials should diminish. Nor does this move exempt IBM from any changes that might occur in pension accounting as the FASB's two-stage reform project inches forward. Those plans could very well introduce measurement of plan assets and obligations that could result in more existing volatility being displayed in the financials. In that IBM's defined benefits plans will be frozen, this action will limit their exposure to the developing accounting reforms.
IBM's plans might touch off a wave of lemming-like imitators, and with good capitalistic reason. If one competitor gains a cost advantage, and it's available to others, they'd be foolish to pass on it. Don't count on imitators coming from IBM's competitors in the technology sector: there simply aren't that many firms in IBM's playground that sponsor defined benefit plans. Their software and services compadres in the S&P 500 without defined benefit plans include Adobe, Affiliated Computer Services, Autodesk, BMC Software, Citrix Systems, Computer Associates, Compuware, Electronic Arts, Fiserv, Intuit, Microsoft, Novell, Oracle, Paychex, Symantec, Veritas, and Yahoo! Likewise, their S&P 500 hardware/equipment counterparts without defined benefit plans include Apple, Ciena, Cisco, Comverse Technology, Dell, Gateway, JDS Uniphase, Network Appliance, QLogic, Qualcomm, Sanmina-SCI, Solectron, and Tellabs. This is a tough bunch; in the past, when analysts overlooked the bottom-line boosts provided by pension accounting, the defined benefits plan was a distinct advantage for a firm like IBM over its competitors. Those days are waning; analysts are now more aware of "pension credits," funding requirements, and expected returns. When the accounting becomes even clearer in coming years, IBM's former advantage might become a handicap.
IBM's iconic status in American business might inspire firms outside of its industry to follow suit. If that happens, analysts and investors should not dismiss analytical pitfalls associated with defined benefit pension plans, nor should they ignore forthcoming changes in the accounting for such plans. Freezing a plan is not the same thing as terminating a plan. Defined benefit plans might be the dinosaurs of a past era, but unlike the real dinosaurs, they'll live on for a long time after their heyday. And they'll still need to be included in investors' assessments of operating performance and investment valuation.
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