Income Statement of Repairman - DOC

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					                PENSIONS- Introduction and Definitions
Contributory (noncontributory) pension plan: Employees and the
employer (only the employer) contribute to the plan.

Defined contribution pension plan: The specific contribution that the
employer has to make to the plan are set. (The employer discharges all
responsibilities when the necessary contributions are forwarded.)

Defined benefit pension plan: Plans that promise specific monetary
payments to employees (or their remaining spouses) upon retirement, The
employer has the responsibility to make sure funds will be available to pay
the future benefits. (The employer bears the risk of shortfall in funds.)

   Defined benefit (contribution) plan represent big (no) problem to
    accountant and investors. In defined benefit plans, until all future
    payments are made, the employer is liable for the benefits.
    Throughout the remainder of the lecture, therefore, o.nly defined
    benefit plans are discussed (impact on cash flows and long-term
    solvency).

Accumulated benefit obligation: The present value of pension benefits,
promised by the company to its employees, on the basis of to date
compensation levels.

Projected benefit obligation: The present value of pension benefits,
promised by the company to its employees, on the basis of future
compensation levels.

            Economic Liability = Funded status of the plan
  = the difference between the benefit obligation and the value of plan
  assets at the end of the year
 For Going Concern -- use projected benefit obligation (PBO)
 Liquidation Analysis-- use accumulated benefit obligation (ABO)


                                 Pensions - 1
   Balance Sheet Liability — Generally not equal to Economic Liability as
   for accounting purposes the following items need not be recognized
   immediately but can be deferred and amortized over time.
1. Actuarial Gains and Losses: Gains or Losses originate when the PBO is
   recomputed each year due to changes in one or more actuarial
   assumptions, such as discount rate, quit rates, retirement dates, or
   mortality.
2. Pension Plan Gains and Losses- Accountant does not recognize actual
   returns on pension plan investments. Rather, they recognize expected
   returns based on long-term expected rate. Difference between actual and
   expected returns are pension plan gains and losses.

  Items 1 and 2 are usually netted together as Net Gains and Losses.

3. Prior Service Cost : Pension Plan Amendments may increase (or
   decrease) previously computed pension benefit obligations. The changes
   relating to periods of employment prior to the amendment are known as
   prior service cost.
4. Transition Asset/Liability - Net economic asset/liability at time of adoption
   of SFAS 87 not recognized immediately but amortized over time

  HOWEVER accounting deferrals must satisfy the minimum liability requirement:

  Minimum liability At each balance sheet date, SFAS No. 87 requires
  reporting a liability on the balance sheet which is equal, at least, to the
  unfunded accumulated benefit obligation (i.e., accumulated benefit
  obligation minus the fair value of plan asset).
          Thus if the balance of accrued benefit cost is less than the minimum
  liability we credit the liability in order to reach the minimum liability
  requirement: The corresponding debit bypasses the income statement and
  a certain portion is made to an intangible asset and the remainder is made
  to equity and a deferred tax asset.
  Note: the adjustment is made on a plan by plan basis:




                                    Pensions - 2
      Illustration:
      For each year of service, a firm promises to pay an employee at retirement an
      amount equivalent to one week‟s salary for 15 years. Our assumptions are:
      Employee‟s age =30                                     Retirement Age =65
      Current Salary Level = $1 ,500iWeek                    Interest rate = 10%
      Projected Salary at retirement = $2,000/week

      Obligation Based on Current Salary Levels:
      Accumulated Benefit Obligation (ABO) after the first year of work is equal to the
         Present Value of a 15 year annuity of $1,500 discounted 35 years;
         Using Table 4 and Table 2 for an interest rate of 10% yields

              ABO= (1,500 x 7.606) x .03558 = 11,409 x .03558 = $406

      Obligation Based on Projected Salary Levels:
      Projected Benefit Obligation (PBO) after the first year of work is equal to the
      Present Value of a 15 year annuity of $2,000 discounted 35 years;

              PBO= (2,000 x 7.606) x .03558 = 15,212 x .03558 = $541


                              REQUIRED ADJUSTMENTS

(1)     Adjust balance sheet liability/asset to equal Economic
        Liability/Asset
         Corresponding entry should go to Equity [and deferred
           taxes if adjusting on after-tax basis]
         Definition of Economic Liability/Asset depends on whether
           analysis being done as going concern or liquidation see                  --



           above.

(2)     If there is Minimum Liability, additional adjustment required                     --



        that is; Credit intangible asset and debit Equity [and deferred
        taxes if adjusting on after-tax basis]




                                          Pensions - 3
Example:                       HYPOTHETICAL COMPANY I
ABO                                $1,000
PB0                                 1,400
Plan Assets                           900
PBO Greater than Plan Assets          500
Unrecognized:
Net Losses                            150
Prior Service Cost                    175
Transition Asset                      (25)
Balance Sheet Liability               200

Economic Liability as Going Concern         = 500 (1400-900)
Economic Liability as Liquidation           = 100 (1000-900)

Balance Sheet Liability = 200 differs from Economic Liability (Going
Concern) as did not recognize liabilities of
        (1&2) net losses                   150
        (3) prior service cost of          175
        (4) transition asset of            (25)


Adjustments:
Going concern       Economic Liability = 500
                    B/S Liability      = 200
Equity 300                                        or after tax assume 35% tax rate
                  Liability 300                   Equity                  195
                                                  Deferred Tax Asset      105
                                                           Liability               300




                                      OR

Liquidation      Economic Liability = 100
                 B/S Liability      = 200
Liability 100                                     or after tax assume 35% tax rate
                  Equity 100                      Liability                 100
                                                            Deferred Tax Asset     35
                                                            Equity                 65




                                  Pensions - 4
Example:                         HYPOTHETICAL COMPANY II
ABO                                    $1,200
PB0                                     1,400
Plan Assets                               900
PBO Greater than Plan Assets              500
Unrecognized:
Net Losses                                 150
Prior Service Cost                         175
Transition Asset                            (25)
                                           200
Minimum Liability Adjustment               100 (charged 100% to intangible asset)
Balance Sheet Liability                    300

Economic Liability as Going Concern             = 500 (1400-900)
Economic Liability as Liquidation               = 300 (1200-900)

Balance Sheet Liability = 300 differs from Economic Liability (Going
Concern) as did not recognize liabilities of
        (1&2) net losses                   150
        (3) prior service cost of          175
        (4) transition asset of            (25)

Therefore without minimum liability adjustment B/S liability would be
500-150-175+25 = 200. However as must equal liquidation economic
liability, accountant made minimum liability adjustment of 100 to bring B/S
liability to 300.
Adjustments:
Going concern          Economic Liability = 500
                       B/S Liability      = 300
(1) Equity 200                                         or after tax assume 35% tax rate
                     Liability 200                     Equity                  130
                                                       Deferred Tax Asset       70
                                                                Liability               200
(2) Remove Intangible asset
    Equity 100                                         Equity                    65
                    Intangible Asset 100               Deferred Tax Asset        35
                                                              Intangible Asset        100
For Liquidation only need (2) -- removal of intangible asset


                                      Pensions - 5
 DEERE CO.
 Pension Benefits
 The company has several pension plans covering substantially all of its United States employees and employees in
 certain foreign countries. The United States plans and significant foreign plans in Canada, Germany and France are
 defined benefit plans in which the benefits are based primarily on years of Service and employee compensation
 near retirement.
           Provisions of FASB Statement No.87 require the company to record a minimum pension liability relating
 to certain unfunded pension obligations, establish an intangible asset relating thereto and reduce stockholders’
 equity. At October 31, 1994, this minimum pension liability was remeasured, as required by the statement. As a
 result, the adjustment to recognize the minimum pension liability was increased from $515 million at October 31,
 1993 to $545 million at October 31, 1994; the related intangible asset was adjusted from $181 million to $158
 million; and the amount by which stockholders’ equity had been reduced was adjusted from $215 million to $248
 million (net of applicable deferred income taxes of $119 million in 1993 and $139 million in 1994).
          The components of net periodic pension cost and the significant assumptions for the United States plans
 consisted of the following in millions of dollars and in percents:
                                                                          1994      1993        1992
            Service cost                                                   $79       $74         $63
            Interest cost                                                  286       283         259
            Return on assets:
             Actual gain                                                   (86)     (590)       (157)
             Deferred gain (loss)                                         (218)      324         (87)
            Net amortization                                                43        32          18
            Net cost                                                      $104      $123         $96
            Discount rates for obligations                               8.0%      7.25%        8.0%
            Discount rates for expenses                                  7.25%     8.0%         8.25%
            Assumed rates of compensation increases                      5.0%      5.0%         5.7%
            Expected long-term rates of return                           9.7%      9.7%         9.7%
     A reconciliation of the funded status of the United States plans at October 31 in millions of dollars follows:

                                                           1994                              1993
                                                   Assets      Accumulated           Assets      Accumulated
                                                   Exceed       Benefits             Exceed        Benefits
                                                  Accumulated Exceed                Accumulated    Exceed
                                                  Benefits      Assets              Benefits       Assets
 Actuarial present value of benefit
  obligations
  Vested benefit obligation                        $(1,522)         $(1,693)        $(1,555)        $(1,689)
  Nonvested benefit obligation                         (73)            (270)            (94)           (276)
  Accumulated benefit obligation                    (1,595)          (1,963)         (1,649)         (1,965)
  Excess of projected benefit obliga-
   clan over accumulated benefit
   obligation                                          (340)            (20)           (378)               (21)
  Projected benefit obligation                       (1,935)         (1,983)         (2,027)            (1,986)
    Plan assets at fair value                         1,756           1,767           1,805              1,510
  Projected benefit obligation in excess
   of plan assets                                      (179)            (216)          (222)             (476)
  Unrecognized net loss                                  35              415            114               373
  Prior service cost not yet recognized
   in net periodic pension cost                           9             154                 3             176
  Remaining unrecognized transition
   net asset from November 1, 1985                      (73)             (10)            (83)             (13)
  Adjustment required to recognize
    minimum liability                                  -----            (545)           -----            (515)
Pension liability recognized in the
consolidated balance sheet                           $ (208)         $ (202)         $ (188)            $ (455)
 Source Deere, 1994 Annual Report




                                                   Pensions - 6
Other Postretirement Benefits                                      United States, which were announced on
The parent company and certain subsidiaries                        December 31, 1992. These changes provide for
provide medical dental and life insurance benefits                 increased cost control through prevention and
to pensioners and survivors. The associated plans                  managed care, and for increased cost sharing by
are unfunded, and approved claims are paid from                    employees and pensioners. The impact of these
company funds. Under the terms of the benefit                      changes resulted in an unrecognized prior service
plans, the company reserves the right to change,                   credit of $1,219 at the beginning of 1993; the
modify or discontinue the plans.                                   accumulated postretirement benefit obligation was
   In 1992, the company adopted SFAS No. 106,                      reduced by a similar amount
“Employers‟ Accounting for Postretirement Benefits                   The following provides a reconciliation of the
Other Than Pensions.” Medical, dental and life                     accumulated postretirement benefit obligation to
insurance costs for these plans and related                        the liabilities reflected in the balance sheet at
disclosures are determined under the provisions of                 December 31 1994 and 1993.
SFAS No.105. Cash expenditures are not affected                                                           Health       Life
by this accounting change. At January 1, 1992, the                                                        Care      Insurance Total
accumulated postretirement benefit obligation was                  1994
$5,990, and related accrued liabilities were $68,
                                                                   Accumulated postretirement benefit
resulting in a transition charge of $5,922. Other                  obligation for:
postretirement benefits cost includes the following                 Current pensioners and survivors $(2,366)       $ (570) $(2,936)
components:
                                     Health Life                   Fully eligible employees                 (139)      —      (139)
                                     Care Insurance Total          Other employees                          (674)    (319)    (993)
1994                                                                                                      (3,179)    (889)   (4,068)
Service cost—benefits allocated
 to current period                  $56       $17     $73          Unrecognized net loss/(gain)           (1,267)       3    (1.264)
Interest cost on accumulated                                       Unrecognized prior service credit      (1,059)      —     (1,059)
 postretirement benefit obligation  288        77     365
                                                                   Accrued postretirement benefit cost $(5,505) $ (886) $(6,391)
Amortization of net gains and
 prior service credit               (78)        8    (70)
Other postretirement benefits cost $266      $102   $368           Amount included in Other
                                                                    Accrued Liabilities (see Note 18)                        $ 333
                                                                   Amount included in Other Liabilities
1993                                                                (see Note 21)                                            $ 6,058
Service cost—benefits allocated
                                                                   1993
to current period                    $ 55    $ 12   $ 67
Interest cost on accumulated                                       Accumulated postretirement benefit
postretirement benefit obligation    305      69     374           obligation for:
                                                                    Current pensioners and survivors $(2,933) $ (692) $(3,685)
Amortization of net gains and
                                                                   Fully eligible employees             (146)     —      (146)
prior service credit                  (94)    —       (94)
                                                                   Other employees                          (934)     (404) (1,338)
Other postretirement benefits cost $266      $ 81   $347
                                                                                                          (4,073)   (1,096) (5,169)
1992                                                               Unrecognized net loss/(gain)            (285)      252      (33)
Service cost—benefits allocated                                    Unrecognized prior service credit      (1,139)      —     (1,139)
to current period                    $ 82    $ 11   $ 93           Accrued postretirement benefit cost $(5,497) $ (844) $(6,341)
Interest cost on accumulated
 postretirement benefit obligation   431      67     498           Amount included in Other
                                                                    Accrued Liabilities (see Note 18)                        $ 343
Other postretirement benefits cost $513      $78    $591           Amount included in Other Liabilities
                                                                    (see Note 21)                                            $ 5.998
The lower health care costs in 1994 and 1993
versus 1992 were due to changes in the
company‟s health care benefits programs in the

The health care accumulated postretirement benefit obligation was determined at December 31,1994 using a health care cost
escalation rate of 8 percent decreasing to 5 percent over 8 years and at December 31,1993 using a health care escalation rate of 10
percent decreasing to 5 percent over 10 years. The assumed long term rate of compensation increase used for life insurance was 5
percent The discount rate was 9 percent at December 31, 1994 and 7.25 percent at December31, 1993. A one percentage point
increase in the health care cost escalation rate would have increased the accumulated postretirement benefit obligation by $251 at
December 31, 1994, and the 1994 other postretirement benefit cost would have increased by $44.




                                                        Pensions - 7
October 25, 2000
Retiree-Medical Plans Are Transformed Into Source of Profits by Sears, Others
ELLEN E. SCHULTZ Staff Reporter of THE WALL STREET JOURNAL

Sears Roebuck & Co. has figured out how to turn its medical-benefits program for retirees into a source
of corporate income.

You read that correctly. Last year, the giant retailer's retiree-medical plan added $46 million to the Sears
bottom line. And that was on top of the $38 million the benefits program contributed in 1998.

The key to these surprising profits is an arcane accounting rule introduced in the early 1990s. The rule
required companies for the first time to report their total anticipated costs for retiree-health coverage.
Many companies used the rule to justify cutting that coverage, or shifting its cost to retirees. As a result, a
lot of older Americans are struggling to pay their medical bills.

The rule also offered companies a way to arrange their financial statements so that retiree-benefit
programs actually became new profit centers. Employers and benefits consultants have received heat
recently for turning pension plans into sources of corporate income. Now, the transformation of retiree-
medical programs into opportunities to bolster earnings demonstrates that these companies and their
outside advisers possess multiple subtle methods to squeeze profits from their current and former
employees

Using Trust Funds to Pay Retiree Benefits Can Help the Bottom Line

This latest corporate maneuver was made possible by Financial Accounting Standard 106. Accounting
authorities required that large companies adopt the rule by 1993. At a time when medical-cost inflation
was running in double digits, the rule was supposed to force companies to acknowledge the potentially
huge retiree-medical liability many of them seemed to face. Some of the charges that companies initially
reported on their income statements under the new rule were indeed gargantuan, and they fueled an
atmosphere of crisis surrounding corporate health-care costs. Many companies invoked the mammoth
liabilities to explain why they had to reduce retiree benefits.

But the crisis turned out to be exaggerated. An analysis of corporate filings with the Securities and
Exchange Commission reveal that over the 1990s, companies faced lower medical-cost inflation rates
than they had predicted when standard 106 took effect and, as a result, smaller retiree-health liability.

What's more, many companies actually had incentives to err on the side of taking overly large initial
charges under the new rule. One incentive was that excessively pessimistic estimates of future health-
care liability provided a rationalization for reducing retiree benefits. That spelled bad news for millions of
retirees, such as Elaine Russell, a 77-year-old former Sears worker in Seattle, whose rising medical
premiums have forced her to rely on a free food bank. Retired Unisys Corp. accountant Albert Shaklee,
70, was forced to go back to work at a minimum-wage factory job for a time to keep up with his increased
premiums.

Companies had a second incentive to take inordinately huge retiree-benefit charges: If the estimates
proved too big -- which is, in fact, what happened in many cases -- companies knew they could adjust
their retiree liability downward by recognizing a series of paper gains on their income statements. This
pool of potential gains could be drawn upon over a period of years and used to offset retiree-medical
expenses.

The New Math

The kicker is that at numerous companies, including Sears, the paper gains not only erased the retiree-
benefit expenses, but exceeded them. And that is how benefit plans came to boost the bottom line.


                                                Pensions - 8
Taking a Scalpel to Retiree-Medical Benefits

This sort of income isn't like cash that can be spent. But it can be used to buff a company's financial
image by smoothing over dips in operating income. "It can sand the rough edges in a bad quarter," says
Jack Ciesielski, an independent accounting expert who publishes The Analyst's Accounting Observer, a
newsletter.

Consider the case of Sears. In response to accounting standard 106, the retailer took a whopping one-
time charge of $2.9 billion in 1992 to reflect the present value of its entire obligation to pay for retirees'
health care. Wall Street analysts didn't fret much about this accounting estimate because it had no
immediate effect on operating cash flow. The analysts also knew that unlike vested pensions, which
under federal law, companies must pay out, health coverage generally may be curtailed, either by killing
benefits outright or making beneficiaries pay some or all of the bill.

Sears used the charge as justification to increase substantially the amounts that retirees would have to
pay for health coverage. Shifting the financial burden to retirees has been the only way for Sears, based
in Hoffman Estates, Ill., to "remain competitive with the retail industry, as far as costs go," company
spokeswoman Peggy Palter says. Over the course of the 1990s, however, the rate of inflation of medical
costs levelled off and decreased, making the initial Sears charge vastly overblown. In addition, the
company's shifting of costs to retirees reduced its own obligation. To illustrate: In 1992, Sears reported an
annual expense of $301 million for retiree-health benefits. The comparable figure for 1996 was just $76
million, a 75% drop.

To reflect its own earlier overestimate of its liability, Sears posted credits in its financial statements in the
mid- and late-1990s. The combined effect of these accounting adjustments and the retailer's continued
benefit cuts was that by 1997, the Sears retiree-benefit plan was adding $41 million to overall net income.
Ms. Palter of Sears confirms this account. Other companies that have boosted their bottom lines by this
method include R.R. Donnelley & Sons Co., Sunbeam Corp., Tektronix Inc., and Walt Disney Co.,
according to the analysis of corporate filings with the SEC.

How It Worked at One Company: Walt Disney

Step #1: Following its 1993 change in accounting standards, the company took a $202 million pre-tax
charge to reflect retiree-health liability.

Step #2: Citing the accounting change and large liability, Disney slashed retiree-health benefits, reducing
its expenses by more than half the next year.

Step #3: But then, estimates of benefit liability turned out to be excessive, so the company began to
report paper gains to reflect lower-than-anticipated expenses. In 1995, Disney's gain was $43 million. The
company reported a total of $47 million more in gains from 1996 through 1998. Thus, its retiree-health
plan boosted its bottom line.* *Disney confirms the figures but declines further comment.

Meanwhile, retirees like Ms. Russell of Seattle are paying the price. She stopped working for Sears in
1984, after nearly four decades of full-time clerical duties at the retailer. When she turned 65, the federal
Medicare program began reimbursing her for routine doctor and hospital bills. Her Sears retiree coverage
provided supplemental reimbursement for prescription drugs.

In 1998, when her prescription costs were about $50 a month, the premium for her supplemental
coverage doubled to $58. That might not sound like a lot, but proportionally, it was a huge bite out of her
monthly Sears pension of $183.

The premium increase prompted Ms. Russell to drop out of the Sears plan in 1998. That gamble has hurt,
because today she needs additional medications for colitis and a thyroid condition. He monthly
prescription bill has leapt to $180.

"I've always saved," says Ms. Russell, a widow who collects $974 a month in Social Security. She drives
a 1977 Datsun station wagon and makes her own clothes. Still, it wasn't until Sears doubled the cost of
                                                 Pensions - 9
her benefits in 1998, she says with evident embarrassment, that she started taking advantage of a Seattle
senior center's free food bank for herself and her two cats. One day recently, she picks out hot dogs
donated by a local grocer because they are close to their expiration date. She also chooses overripe
bananas, which she says aren't bad if cooked.

Sears maintains that even after shifting costs to retirees, it is "far more generous with benefits than others
in our industry," says Elisabeth Rossman, vice president for benefits. "We have taken measures to
prudently reduce our costs," she adds. "We were trying to strike a balance between duty to shareholders,
so they could get an adequate return on investments, with our duty to retirees."

Coming Soon: More Cuts

Next Jan. 1, the company plans to cease paying anything for health coverage for employees over 65 who
retire after that date, Ms. Rossman says. However, in 1998, she points out, Sears doubled, to 20%, the
discount retirees may receive on clothing purchases.

Companies such as Sears stand to gain when retirees like Ms. Russell drop out of the medical plan,
because that ends a company's obligation to pay anything for coverage. Of the roughly 120,000 Sears
retirees today, only about 80,000 are receiving medical coverage. Ms. Palter, the company
spokeswoman, says costs may be one reason people drop the coverage, but that some retirees do so
because they receive benefits under a spouse's plan or they return to work.

Bill Rodino, a 72-year-old retired Sears appliance repairman and supervisor in Brooklyn, N.Y., got a new
job to help pay for his Sears coverage. He now works 10 to 15 hours a week as a receptionist at a funeral
home. That provides the extra cash to afford last year's 600% jump in his Sears premium, which is now
roughly $80 a month. His prescription co-payments have risen to $75 a month.

Even with his part-time job, he and his wife, Jeanne, have gradually drawn down their savings for day-to-
day expenses. They weren't aware of the improved Sears clothing discount, says Mrs. Rodino, because
they haven't bought new clothes in years.

Seeds of a Windfall

The seeds of the retiree-health windfall for many companies were planted in the late 1980s, when the
Financial Accounting Standards Board, the accounting industry's rule-making body, began to develop
standards for reporting retiree-health obligations. Major companies, such as General Electric Co. and
International Business Machines Corp., played an active role in the process, suggesting ideas to the
accounting board. Companies showed the board computer simulations of how various proposals would
affect corporate bottom lines.

Corporations would have preferred not to have to report retiree-medical liability at all. But once that
became inevitable, big companies urged the board to give them flexibility in how they projected their
retiree-benefit costs, according to people involved in the process. The accounting board went along with
many of their suggestions when it issued standard 106. Jeffrey Petertil, an independent actuary who was
an adviser to the accounting-board task force that drafted the new rule, warned in 1992 that standard 106
was so flexible that it would permit companies to overstate or understate their liabilities. But when he
expressed this dissenting view in a newspaper opinion piece, his largest client, a major accounting firm,
fired him the next day, Mr. Petertil says. He declines to name the firm.

Smoothing the Dips

One illustration of the flexibility is the great leeway standard 106 allowed companies to adjust the
medical-cost inflation rate used to estimate retiree liability. Having pegged that rate very high early in the
decade, companies were able in later years to report income-statement credits that could be used to
smooth earnings dips, says Mr. Ciesielski, the independent accounting expert.



                                               Pensions - 10
Sears, for example, initially used a 14% medical-inflation rate to estimate its liability in 1992, which was in
line with national trends. By 1997, Sears had lowered its estimate to 11%. In 1998, it slashed the rate
again to 6%.

The proportionally huge rate reduction in 1998, along with less generous benefits, permitted the retailer to
report credits that allowed its retiree-health plan to contribute income to the company's bottom line. In
1998, the $38 million credit was the equivalent of a 2% increase in operating income.

The rate changes were made at a time when the company was struggling with credit-card delinquencies
and weak apparel sales. Mr. Ciesielski says it's fair to assume that Sears and other companies have used
credits from these plans "to smooth earnings during rough times."

Ms. Palter, the Sears spokeswoman, confirms the medical-inflation figures but stresses that the company
didn't act to smooth its earnings. Sears changed the inflation assumptions "to be consistent with industry
trends," she says. "It was a fiduciary duty to be as accurate as we could. Our experience was already
showing that our estimates were too high, and the expenses would be lower."

Donnelley was another company that used standard 106 to justify benefit cuts and improve its earnings
numbers. The company said in a letter to retirees in October 1992 that the new accounting rule would
have "a serious negative impact on our earnings." The letter noted that because of "skyrocketing" health-
care costs, the Chicago-based printing company was forced to begin charging retirees for their once-free
medical benefits. Otherwise, Donnelley warned, it would fail to remain "competitive."

Thanks to the new fees, the company slashed its annual retiree-medical expense by more than half in
1995. By the next year, Donnelley's retiree-benefits plan was adding income to the company's bottom
line. (Donnelley and some other companies also saw their benefits expenses fall, thanks to investment
returns in trust funds set up to finance retiree-health benefits.)

A Donnelley spokesman confirms this account but stresses that the company had reserved the right to
change retiree benefits. Richard Mebane retired from Donnelley in 1993, at 60, when the Chicago plant
where he worked closed. He qualified for a $277 monthly pension, on top of his Social Security check of
$936. With expensive prescriptions for high blood pressure, cholesterol and a bladder problem, he felt the
squeeze when Donnelley in 1996 imposed a $250 annual deductible, which since has doubled to $500,
for health coverage that supplements Medicare. He also pays an $18-a-month premium.

"Most of the time, I take the medicine every other day, to keep the cost down," says Mr. Mebane, now 67.
Even with the company coverage, he's responsible for a 30% co-payment for prescriptions. By cutting his
dosage, he saves about $40 a month, he says. "If I start to feel light headed, I take it every day until I feel
better."

Three years ago, Mr. Mebane took a part-time janitor's job at St. Elizabeth's preschool on Chicago's
Southside, where he polishes floors and swabs out toilets. He receives no medical benefits from the
minimum-wage post.

Another company that wasted little time between adopting standard 106 and slashing retiree-health
benefits was McDonnell Douglas Corp. In January 1992, the aeronautical giant reported a $1.5 billion
after-tax retirement-benefits charge. In October 1992, it announced that over four years, it would phase
out all health-care coverage for its 20,000 nonunion retirees.

In an Oct. 7, 1992, letter to retirees, John McDonnell, then the company's chief excutive, said: "The
problem we have been wrestling with is not 'just' that health-care costs continue to skyrocket, as
everybody knows." In addition, he wrote, standard 106 "threatened to deal a heavy blow to our bottom
line."

In fact, by ending retiree benefits, McDonnell Douglas generated $698 million in pretax income reported
in 1992. A separate benefits reduction affecting a group of retired unionized engineers generated another
gain, this one a more-modest $70 million, reported in 1993. A spokesman for Seattle-based Boeing Corp.,
which has acquired McDonnell Douglas, confirms the numbers and the letter's authenticity but declines
any further comment. McDonnell Douglas retiree Robert Taylor couldn't believe the news about the
                                               Pensions - 11
benefits cut in 1992. He was especially outraged that the company's pension plan was lavishly
overfunded, but McDonnell Douglas wouldn't use that surplus to pay for retiree-medical benefits, as
companies are legally allowed to do.

Mr. Taylor, who had joined McDonnell Douglas shortly after World War II and retired as supervisor of
technical publications in 1979, died at the age of 79, just before the cut took effect. His wife, Rhada
Taylor, now 87, chose to have the new $168 monthly premium for coverage supplementing Medicare
deducted from her widow's pension of $420 a month. But the premiums have increased every year. By
1999, her pension money had shrunk by roughly 60%. After another premium increase scheduled to take
effect Jan. 1, her monthly pension will be only $79.

McDonnell Douglas's health-care reductions have "wiped me out," says Ms. Taylor, who receives a
monthly Social Security check of $1,009. She says she has cut back on wedding and graduation gifts.

As McDonnell Douglas was dispensing bad news to its retirees in October 1992, Unisys was doing the
same.

That month, the Blue Bell, Pa., computer company dispatched a letter to 25,000 former employees,
saying that "increasing medical costs and growing world-wide competition" were forcing it to "replace"
their coverage. The new plan, Unisys said, "will be cost-effective, will provide financial protection against
the high cost of illness or injury, and will continue to be available at group rates."

The bad news was that the company, which had paid for past coverage, would now shift the entire cost to
retirees over a four-year period. The missive angered the retired Unisys accountant, Mr. Shaklee, then
61. When deciding in 1989 to retire early, he says he had relied on the company's written promises that
he and his wife would have medical coverage for life. Such promises of lifetime coverage were common
in the downsizing waves of the late 1980s and 1990s.

Despite his irritation, Mr. Shaklee bought the coverage at first, because his wife Doris, then in her late
50s, had been diagnosed with breast cancer. The Lake Kiowa, Texas, couple couldn't have bought
insurance for Doris elsewhere because of her illness, and she hadn't yet hit the Medicare-eligibility age of
65. By 1996, the couple's monthly premium had jumped to $784, exceeding Mr. Shaklee's pension of
$727. So, Mr. Shaklee dropped the Unisys coverage and sought a job that would offer more-affordable
insurance. Retiree health-care coverage typically costs more than group plans that include younger,
healthier people. At the Gainesville, Texas, parts-grinding factory where he applied for a midnight-shift job
"they kept looking at my resume, asking me whether I knew it was minimum wage," he recalls. He had
earned $70,000 a year at Unisys. Hesitant to state the real reason he wanted the job -- the $110-a-month
health insurance -- Mr. Shaklee told his interviewers he wanted to work with his hands.

He held the factory job, and got the insurance, for two years, quitting when his wife got closer to qualifying
for Medicare. But today they are scrimping. Prescription drugs cost the Shaklees about $220 a month. To
save money, they scratched visits to their grandchildren in California for three years. "If we have a
medical catastrophe, we'll be in trouble," says Mr. Shaklee. He is one of a group of Unisys retirees who
have sued the company in U.S. district court in Philadelphia, seeking restoration of their benefits.

A Unisys spokesman declines any comment on retiree benefits, citing the pending lawsuit. The company
has maintained in the court case that it had reserved its right to terminate the disputed benefits.

Beyond standard 106, another accounting-rule change that became effective in 1992 also has helped
employers. Financial Accounting Standard 109 allowed companies to take credit immediately for certain
tax deductions expected in the future. The deductions in question are those associated with liabilities
such as retiree-medical benefits. Companies could use standard 109 to reduce -- or even cancel out --
their initial charges for retiree-health liability. Unisys, for instance, took a charge in 1992 of $195 million
for retiree-medical benefits. But under Standard 109, the company was permitted to show a $425 million
credit on its 1992 income statement for anticipated tax deductions associated with all manner of liabilities.
The result was that in 1992, Unisys reported a net one-time gain of $230 million, courtesy of the changes
in accounting standards.



                                               Pensions - 12
Utilities Forced to Pay Refunds

The one industry where at least some employers have faced public criticism for their retiree-health
accounting is the utility field. Certain state regulators have been willing to act in this area by using their
authority to require consumer refunds.

Warning of escalating retiree-health benefits in 1993, Pacific Gas & Electric Corp. sought additional funds
to pay the costs. The California Public Utilities Commission said PG&E could raise rates $181 million that
year. Simultaneously, PG&E adopted plan changes that limited the amount it would actually contribute to
retiree benefits. The company also used layoffs and attrition to cut its payroll by 17% from 1993 through
1995, further reducing its retiree-benefit burden. PG&E's annual retirement-benefits expense stood at
only $12 million last year, down 90% from 1993. In 1998, the California utilities commission said the
company shouldn't have been rewarded for overestimating its retiree-health costs. The commission
required the utility to credit a total of $191 million to ratepayers for the years 1993 through 1995. PG&E
didn't restore any benefits to retirees. Chris Johns, a vice president and controller at PG&E, says the
company didn't deliberately overestimate its benefit costs. Instead, the costs fell because of strong
investment gains by the company's retiree trust fund, he adds. The refunds were made as a part of the
routine regulatory process, he says.

For retirees across the country, health coverage soon could get even more scarce and expensive.
Companies are running out of the paper gains they can take because of their early-1990s overestimates
of retiree-health liability. And health-care inflation is creeping up again.

In marketing material sent to current and potential corporate clients, the benefits-consulting firm Towers
Perrin says employers need to think about "new strategies and approaches to managing health benefits."
Among those strategies: new benefits cuts.
 „
                                          Tallying the Cuts
         The figures in the left-hand column are the expense amounts a company reported
        in the first year of operating under the new accounting standard for retiree-health
        benefits. In some cases that was 1992, in others 1993.

        Figures in parentheses reflect income-statement gains.
        Company                   1992/1993 (in millions) 1999     % DECLINE
        Anheuser-Busch                    75                 16             79%
        Black & Decker                    21               (0.5)           100
        Campbell Soup                     46                 14             70
        Eastman Kodak                    255                 15             94
        Walt Disney                       30                 10             66
        R.R. Donnelley                    20                (4)            100
        Dow Chemical                     165                 50             70
        Gannett                           18                 10             44
        GTE                              386                106             73
        Hartford Financial                28                (3)            100
        Hewlett Packard                   32                 0             100
        Merck                             90                 6              93
        J.P. Morgan                       26               (16)            100
        Norfolk Southern                  35                 8              77
        Pacific Gas & Electric           124                12              90
        Procter & Gamble                   3              (336)            100
        Sears Roebuck                    301               (46)            100
        Sunbeam                            4              (0.5)            100
        Tektronix                          6                (2)            100
        Unisys                            25                 6              76




                                               Pensions - 13

				
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