3M Pension Underfunding Reaches 16-Year High

March 20, 2003 (PLANSPONSOR.com) - Despite a $1.1-billion infusion last year, 3M Company's pension plan is $2.1 billion in the red - a level not seen since 1987.

The pension shortfall was revealed in the footnotes of the annual 10k report the Maplewood, Minnesota-based conglomerate recently filed with the Securities and Exchange Commission (SEC).   However, the company announced it intends to fully fund the plan within three to five years, according to a Saint Paul Pioneer Press report.

As stated in the 3M’s 10(k) regulatory filing, reported earnings included $760 million in pretax gains on its pension investments, even though those gains never materialized and the plan actually lost $707 million. The phantom gains were offset by service fees, interest and other costs, and 3M ended up recording a net loss of $92 million on its income statement related to its pension fund, or about $0.16 per share, not including the $1.1-billion cash infusion made in October 2002 (See  3M Reveals Upcoming $1B Pension Charge ).

The 2002 loss would have been greater if the company had used actual, instead of projected, gains, a process known as “smoothing” (See  Smooth Move ).   Smoothing allows companies to take certain assets and obligations off their balance sheets and amortize them as income or expenses over time.  Additionally, companies may be allowed to report their expected return on assets, instead of actual losses and gains.  

In 3M’s case, pension expenses are expected to impact 2003 earnings by $0.27 per share, not including future cash infusions to make up the deficit. Supporters of the pension accounting rules, who say that the gaps between accounting assumptions and reality even out over the long run, point to the period between 1996 and 1999, when the company’s pension plan actually earned far more each year than it projected.

3Year Plan

3M’s plan calls for voluntarily funding the plan to capacity within three to five years. The company needs to look no further than its roughly $50-billion market capitalization and shareholder equity of nearly $6 billion, to realize its current obligation of $2.1 billion is manageable. Additionally, the company is in a relatively strong financial position, with reasonable debt levels and $600 million in cash.

However, 3M has other areas of concern.   Like other major corporations, 3M is assuming a 9% long-term rate of return on plan assets and lowering its discount rate from 7.25% to 6.75%. The discount rate, which is tied to investment grade corporate bond rates, is used to calculate the present value of future payments.  

The SEC has previously raised a wayward eyebrow at rate of return assumptions higher than 9% (See  Pension Reporting Draws SEC Criticism ). A 0.25% decrease in the discount rate would increase 3M’s pension expenses by about $32 million pretax. However, 3M spokesman Stephen Sanchez said the company is “comfortable with our current assumptions.”