JANUARY 23, 2009
How Some Firms Boost
the Boss's Pension
Some major companies are boosting the value
of retirement plans for top executives by using a generous formula when
converting a pension into a single lump-sum payment.
The practice, which remained largely unknown
until a recent change in federal disclosure requirements, can increase the
value of a CEO's pension by 10% to 40%, sometimes amounting to millions of
extra dollars. The additional sums aren't always fully reflected in annual
pension-benefit tables included in proxy statements, or in company financial
statements, due to the complexities of accounting and disclosure rules.
The list of companies turbocharging their
executives' pensions includes Dun & Bradstreet, Hartford Financial,
McKesson, PPG Industries, United Technologies, Texas Instruments and U.S.
Steel, according to a Wall Street Journal examination of financial filings.
Pensions normally are paid out in
installments over a retired employee's lifetime. But many executives prefer
getting their pensions all at once, in part to avoid the risk of losing the
benefit if the company later goes bankrupt.
There's no standard way to figure a lump-sum
amount, and practices vary widely. The differences partly reflect the
age-old tension between executives and companies over pay packages.
Some companies have been basing their
calculations on an obsolete federal interest-rate formula that many experts
say tends to produce an inflated payout. "It's a sneaky way to give
executives larger pay," says Ron Gebhardtsbauer, a former U.S. Senate
pension expert, now head of the actuarial-science program at Pennsylvania
State University's Smeal College of Business.
One potential beneficiary is Ramani Ayer, the
61-year-old chairman and CEO of insurance giant
Hartford Financial Services Group Inc. He hasn't yet retired, and
company filings show his accumulated pension was valued at about $27 million
as of the end of 2007, if paid out on an annual basis after he leaves.
However, according to Hartford's regulatory
filings, Mr. Ayer plans to take the bulk of his pension in a lump sum when
he eventually retires. Because of the way Hartford calculates lump sums,
that boosted the value of his pension by more than a third, to $37 million,
according to the filings.
John Hammergren, chief executive of drug
McKesson Corp., is another potential beneficiary. McKesson's formula
increased the value of his lump-sum pension as of last March by at least $11
million, to almost $85 million, compared with a more conservative
calculation, company filings show.
In a statement, a Hartford spokeswoman,
Shannon Lapierre, said that the provisions of the pension plan covering Mr.
Ayer were set when the company was part of ITT Corp., and were carried over
after the 1995 spinoff. The actual pension payout to Mr. Ayer, she noted,
could ultimately be larger or smaller than the $37 million because factors
that go into the calculation can vary over time.
Hartford is among the major insurers that
have applied for federal bailout funds. Congress requires some limits on
executive pay for firms that tap into the bailout program, but that likely
would only affect Mr. Ayer's lump-sum pension if he's fired. "If we receive
the funds, we'd be following the guidelines on executive compensation and
corporate governance," says Hartford's Ms. Lapierre.
A McKesson spokesman confirmed figures
associated with Mr. Hammergren's pension, but otherwise declined to comment.
While some executives' benefits are being
enhanced, millions of Americans are worried about the security of their own
retirement funds. The stock-market plunge has caused a decline in the value
of many 401(k)-style accounts, which are primary savings vehicles for about
50 million U.S. workers. Benefit levels in many regular pension plans have
Business groups have successfully lobbied
Congress to be able to use a less-generous formula when it comes to paying
out pensions for regular workers. Pensions for most workers are federally
regulated, and corporations argued that their coffers were being depleted by
large lump-sum distributions.
In defending the way they calculate pension
enhancements for executives, some of the companies, including
United Technologies Corp. and
Dun & Bradstreet Corp., say it's partly aimed at compensating executives
for higher taxes they owe when they take their retirement benefits in a
single payment, instead of spread out over their remaining lives.
Just-retired executives often owe taxes at a higher average rate than they
would years later when their income is down, according to this argument.
It's difficult to determine how many
companies offer the beneficial payouts to senior executives, but pension
experts believe it's a minority.
Texas Instruments Inc. and
U.S. Steel Corp. say their lump-sum payout formulas for executives date
back many years, and are offered to rank-and-file employees as well as
executives. Texas Instruments says it calculates the lump sums two ways, and
offers staffers whichever produces the bigger payout.
A spokesman for
PPG Industries Inc. said its payout formula uses volatile factors that
produce larger or smaller lump sums depending on the actual date an
Generous payout calculations for executives'
pensions have been around for many years. But they were almost impossible
for the public to discern until 2007, when new Securities and Exchange
Commission disclosure rules took effect. The rules required companies to
place an overall value on their executives' pension benefits, and to reveal
key assumptions underlying the calculations, among other things.
Details of how companies calculate lump-sum
payments typically are buried in footnotes in proxy statements, often
written in technical language.
Under the special executive pensions most
companies offer, high-ranking retirees are entitled to be paid a fixed sum
every year until they (or their surviving spouses) die. Typically, companies
calculate an average of the last few years of an executive's pay, then
multiply that by a percentage factor based on years of employment.
For example, a 30-year veteran might be
entitled to a pension equal to 45% of average final pay. If average final
pay worked out to $4.4 million a year, the pension would be $2 million a
year for life.
Over the years, companies and executives have
found creative ways to increase that benefit -- for example, by adding extra
years of service that the managers haven't worked. CEOs often negotiate such
enhanced pensions when they are hired.
Because of the way they are regulated,
executive pensions can carry risks for recipients that regular pensions
don't. For instance, if an employer goes bankrupt, a retired executive
usually becomes an unsecured creditor and may never see another dime in
pension payments. By contrast, most regular pensioners are protected by the
Pension Benefit Guaranty Corp., a federal body that insures retirement
benefits to a certain level if a pension plan fails.
For reasons like these, many executives
prefer to receive a lump sum. Some plans require them to do so.
To calculate a lump sum, a company-hired
actuary first must figure out how long an executive is likely to live, based
on a mortality table. Then a "discount rate," expressed as an interest rate,
is used to calculate the current value of those years of future pension
Here's where the hidden pension boost can
come in. In theory, the interest rate should be linked to a market rate, in
order to accurately value the lump sum at the time of retirement. But if the
company picks an interest rate much lower than market rates, that results in
a higher lump-sum payout to an executive. Because executive pensions are
unregulated, companies are free to choose any interest rate.
Applying low interest rates can make a big
difference. For example, for a 60-year-old male, the lump-sum value of that
$2 million-a-year annual pension would be about $33 million using a 3%
interest rate, and about $25 million using a 6% interest rate.
Compensation experts say some top executives
try to build low lump-sum interest rates into their employment contracts.
"From the executive's point of view, you're looking for the most favorable
interest rate index you can get," says Robert Sedgwick, an attorney at
Morrison Cohen LLP in New York who often represents top executives in pay
Opinions differ on what interest rate would
produce the fairest and most accurate payout for executive plans. But
experts generally cite two: An Internal Revenue Service rate used in
federally regulated plans, and a long-term corporate-bond rate. Many
companies do use these rates for their executives.
The argument for the corporate-bond rate is
that it represents what it would cost the company to fund the executive's
annuity over the rest of his or her life. The IRS rate has the advantage of
being the same one used for non-executive employees. The IRS rate, based on
a complex formula, was roughly 4.6% to 4.7% last year. The Moody's Corp.
long-term, AA corporate-bond rate is about 5.8%.
At McKesson, the 49-year-old Mr. Hammergren
has no plans for retirement, according to a company spokesman. But had he
quit or retired last March, he would have been entitled to a lump-sum
pension of $84.6 million, the company's filings show.
That number -- among the highest for any U.S.
executive -- was enhanced by a number of factors previously negotiated with
the board. For instance, McKesson credits him with years he didn't serve,
and also counts 150% of his annual bonus in the final pay calculation,
instead of just the bonus he was actually paid.
McKesson disclosures, though technical,
provide an unusual amount of detail about the way the company calculates Mr.
Hammergren's lump-sum pension payout.
According to McKesson's 2008 proxy, Mr.
Hammergren's lump-sum pension benefit as of last March was calculated using
a 3% interest rate. For comparison, using instead the IRS rate in effect
last March, Mr. Hammergren's lump sum would have been worth roughly $66.4
million. Using instead the 5.85% Moody's AA corporate-bond rate in effect
last March, his lump sum would have been worth about $59 million, according
to Bolton Partners Inc., an actuarial firm.
McKesson froze its traditional pension plan
for ordinary employees in 1997, replacing it with a 401(k) plan in which the
firm matches employee contributions with its own stock.
McKesson is among a number of companies that
tie their executives' lump-sum payouts to an interest rate published by PBGC,
the federal pension insurer. Using a government rate appears to provide an
official imprimatur: McKesson's most recent proxy describes the rate as one
"prescribed" by the PBGC for "the purposes of determining the present value
of a lump-sum distribution on plan termination."
In fact, the PBGC has no authority over
executive pension plans. Critics say the PBGC rate, based on a formula that
dates to the 1970s, tends to be much lower than virtually any market
interest rate, and so produces much larger lump-sum payouts. Over the past
five years, the monthly PBGC rate has fluctuated from 2.25% to 4.75%. It's
now at 3%.
The PBGC itself uses the rate only to value
lump sums under $5,000, and says it considers the rate to be outmoded. The
agency tried to stop publishing it several years ago, but reinstated it
after some companies objected. The PBGC declined to comment on use of the
rate to calculate executive lump-sum payments.
Using the PBGC rate to calculate executive
pensions "borders on the scandalous," says Norman Stein, a pension-law
professor at the University of Alabama at Tuscaloosa. "It's a gimmick to pay
executives even more than the pension plan suggests they should be getting."
Not every company that uses the PBGC rate is
significantly overpaying its pensions. Some, such as U.S. Steel, also use an
older mortality table, which assumes that people don't live as long. That
can offset some or even most of the effect of using a low interest rate.
Some companies tie their pension calculations
to other relatively low interest rates besides the PBGC one. A few, such as
United Technologies, use municipal-bond rates.
A United Technologies spokesman called its
formula a "typical, normal approach" for executive plans. He said half of
recipients still choose annual payments, which wouldn't be the case if the
lump sum were viewed as being more generous. He said United Technologies
used a 3.7% interest rate to calculate Chairman George David's pension as of
Dun & Bradstreet uses an interest rate pegged
to 85% of the 15-year Treasury-bond yield. Company officials say the
favorable rate dates back to the 1990s, when it was chosen to help
compensate executives for an added tax bite on lump-sum distributions.
Some critics say the argument that executives
might face a tax expense is correct, but overstated. Most executives
receiving a big pension will have a sizeable tax bill no matter how the
money is parceled out.
"There might be a bigger tax hit" with a lump
sum, says James Verlautz, chairman of the pension committee at the American
Academy of Actuaries. "Does that justify going from a 6% to a 3% rate? No."
Even as some companies give their executives
favorable pension terms, there has been a movement toward less-generous
terms for rank-and-file employees. In lobbying Congress a few years ago,
big-business groups vociferously argued that the official rate then in
effect -- the 30-year Treasury-bond rate -- was too low and should be
replaced with the AA corporate-bond rate.
One major lobbyist was the American Benefits
Council, which represents a few hundred major employers, including some,
such as Hartford, that use the PBGC rate for their executives' pensions. In
2003, the group said the 30-year Treasury rate "artificially inflates
lump-sum distribution calculations" and argued that the resulting oversized
payouts "do not reflect the true value of a participant's benefit under the
At the time, the 30-year Treasury rate was
4.7%, less favorable to retirees than the PBGC rate, then at 3%.
In the 2006 Pension Protection Act, Congress
largely gave the American Benefits Council and other business groups what
they wanted. The official lump-sum rate is set to change gradually by 2012,
to a mix of corporate-bond rates that is expected to significantly cut
lump-sum pensions for ordinary workers.
Write to Mark Maremont at
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