Bethlehem Steel Case Study

Case Summary

In the early 2000’s, there were many fortune 500 companies that offered defined benefit pension plans to their employees. When a large company like Bethlehem Steel fails, the Pension Fund Guarantee Corporation (PBGC), a federally funded corporation is responsible for ensuring the company’s defined benefit plans, as well as take control of Bethlehem’s assets in order to ensure participants receive their guaranteed portion of the earned benefits. In the case of Bethlehem Steel, the PBGC assumed a $xxxx liability they must insure. Failures such as Bethlehem, as well as many other companies around the September 11 attacks have caused the PBGC to incur a deficit of approximately $xxxx billion.

The PBGC does not receive any funding from general tax revenues. The funding the PBGC receives is from investment income, insurance premiums, defined benefit plan inheritances and assets from failed companies formerly offering these plans. If this trend of failing companies continues, the PBGC could very well drain their assets, and the responsibility of insuring failed company defined benefit plans will ultimately fall into to someone else’s hands, such as taxpayers.

After the bankruptcy filing of Bethlehem Steel, Anita Cavell is inspired to assess the employee pension plans of her father. The economy was already in a shaky state when the tragedy of the September 11 attacks occurred, which resulted in a greater weakening of U.S. economy as the stock markets closed for the first time since World War II. With her father on the verge of retirement, Cavell applied her own financial knowledge into examining the true condition of the assets compared to the liabilities of the PBGC, in an attempt to advise her father on his impending retirement. With a down trending (bear) stock market and falling interest rates, along with a multitude of failing companies, there is a deep concern that there could be a pension crises in America.

Analysis

In a DB pension system, the plan sponsor committed to make fixed monthly payments,similar to annuities, to plan participants(and often to surviving spouses) from retirement until death. For each year of employment, participants earned future benefits according to a pla formula that typically was a function of salary and length of service, and subject to vesting schedule.The benefits that participants earned by any given date were the sponsor's long term liabilities, which linked DB plans intimately to corporate financial policy.

  The Pension Benefit Guaranty Corporation plays a role in the US economy by ensuring that an individual is paid the money they are owed by a previous employer through a pension fund.   The PBGC gets its funding to repay an employee whose previous pension fund has been terminated by charging an annual fee to the pension sponsor based upon the number of participants as well as how well funded the pension is upon termination.  For example, a company who owed $500,000 in pension payments to an employee with annual payments of less than or equal to $40,705 would additionally owe about $19 in annual tax to the PBGC for insurance, based upon several assumptions.  The most critical assumption being made is that the company’s pension is not underfunded.  If the pension is underfunded, then the company would owe an additional $9 per year in taxes for every $1,000 that pension liabilities exceed assets.  Asset allocation should be unaffected other than a decrease for each payment made to the employee, assuming the company had previously created and contributed to an accumulated benefit obligation fund.  With each additional payment, the pension liability of the company should also decrease.  Both the asset and liability allocation would be influenced by the specific discount rate used by the company, as well as the current actuarial value being used.

 While incorporating a pension plan into thinking about a company’s market value balance sheet, it is important to look at the company in regards to the rest of the market. Bethlehem Steel was the second largest U.S. integrated steel producer with $4.2 billion in sales and about 14.700 employees in 2000. Because of how large Bethlehem’s pension and retiree health plans were, it played a huge role in the company’s condition after going bankrupt. The company’s employment costs were 37% of sales in 2001. $48 per ton of steel in legacy costs for pension and retiree health plan expenses out of a total average company production of $484 per ton of steel. In regards to the balance sheet, the bankruptcy listed $4.2 billion in company assets, $4.5 billion in liabilities and negative stockholder’s equity of $300 million on Sept. 30, 2001. The assets of Bethlehem Steel’s pension plan were invested approximately 70% in equities and mutual funds as of year-end 2000.

                Although Bethlehem Steel probably never thought they would be thrown into this situation, it is questionable if they’ve thought about their assets and liabilities in regards to a bankruptcy and fulfilling those pension and retiree health plans. Even if the company meets the minimum pension funding requirements under ERISA it can still put them in extreme deficits. Because corporations must report its pension liabilities in its balance sheet as of 2005, it is important to always look back at the numbers and see worst-case scenario with the pension plans. Pension plan policies should be adjusted accordingly to how the company treats pension debt and how the stock market values pension assets and liabilities.

The government creates many incentives for firms through multiple various pension regulations like tax treatment, ERISA and PBGC. The Employee Retirement Income Security Act was enacted in 1974 and required basic-benefit corporate DB plans to operate as fully funded plans. This allowed collateral to be available to pay retirement benefits. It granted plans favoring tax treatment but applied heavy penalties against any sponsors with underfunded plans.  There were no limits to a sponsor’s contributions to its pension fund but all assets in a pension trust were solely for the pay of pension benefits.  The only way an employer could use excess pension assets for non-pension use was to completely terminate the plan, pay all accrued benefits and revert excess cash back to the company. However, in the early 1980’s, because of strong equity market performance and high interest rates, many corporate pension plans became overfunded. ,