LITTLE ROCK — AT&T Inc. and Verizon Communications Inc., the two largest U.S. phone carriers, may be underestimating obligations to their pension funds, according to an analyst for Sanford C. Bernstein & Co.
The two companies have projected higher returns on their investments and lower growth in expenses than most of their peers in the Standard & Poor’s 500 index, which may force them to make unexpected cash payments, said Craig Moffett, an analyst at Sanford Bernstein in New York.
AT&T and Verizon have the two largest unfunded liabilities for retired employees in the S&P 500, accounting for almost 12 percent of the pension gap for the entire index, Moffett said. The two companies are using “aggressive” methods to predict the amount of money they’ll need to spend on retiree health care and pensions, and the interest rates the funds are likely to receive,Moffett said.
“What you worry about is the ability of these companies to continue to earn attractive returns,” said Moffett. “The wireless business has to run very fast to outpace these enormous legacy obligations.”
Verizon doesn’t expect to make “material” contributions to its pension fund this year and can’t comment beyond that, said spokesman Bob Varettoni. The company funds the benefit on a pay-as-yougo basis from operating cash flows.
“During 2010, there have been many moving parts that would impact pension funding in future years, specifically the spinoff of the wireline business to Frontier and also the voluntary separation packages” that employees received as Verizon cut jobs, he said. Verizon sold 4.8 million rural phone lines this year to Frontier Communications Corp. in an $8.6 billion deal.
AT&T declined to comment through spokesman Mc-Call Butler.
Moffett was No. 1 in Institutional Investor magazine’s annual ranking for the fifthstraight year among analysts covering cable and satellite companies. Besides Verizon and AT&T, he covers companies such as Comcast Corp. and DirecTV.
Verizon and AT&T have such large obligations because of pensioners from the days when the U.S. phone systemwas one of the largest employers in the nation. Verizon had 222,900 employees and 213,000 retirees at the end of last year.
Verizon’s pension plan cost the New York-based company $1.88 billion in the first nine months of this year, up from $722 million a year earlier, according to regulatory filings. AT&T, based in Dallas, spent $868 million on pension and retirement plans in the same period, down from $1.55 billion in 2009 as interest costs fell.
Chief financial officers calculate their pension obligations by estimating the return on the accounts they’ve set up to pay out benefits, as well as future obligations to employees, said Robert Willens, president of the Robert Willens tax and accounting service and author of articles on accounting.
They set estimates for the pension accounts’ investment returns and compare them with the benefits currently being paid, predictions for salary increases, the number of pensioners the company will have to cover over time, retiree life expectancies and other statistics, he said.
The projected interest rates, known as the discount rate in pension accounting, can makea big difference in the amount of money a company has to save for pensions. A company that chooses a higher discount rate is predicting that its fund will have higher returns over time. This cuts the amount it has to save today. A lower discount rate is a more conservative estimate of the account’s returns.
Investors tend to ignore pension obligations since they are small relative to the phone companies’ size, and the carriers usually single out the expense when they report earnings, said Christopher King, an analyst at Stifel Nicolaus & Co. in Baltimore. Verizon reported $25.2 billion in cash flow from operations in the first nine months of the year. AT&T took in $25.4 billion.
The stock market has done well this year, increasing the returns on the companies’ funds, King said. Carriers also have reduced employees who have pension agreements, typically workers on the fixed-line phone service side of the business, lowering future obligations, he said.
“Any type of contribution would be rather meaningless in the grand scheme of things,” King said. “Investors will kind of overlook that.”
Business, Pages 74 on 11/28/2010