Baumert Report - More Factual Errors


May 2, 2003
Over the past year, I have had friends send the the Baumert Report as evidence of AMR Management problems. Lately, I decided to do some investigating into the Baumert Report to check Mr. Baumert''s facts. It really doesn''t take much Internet searching to find that Mr. Baumert consistently misrepresents the facts. Here is another edition of the Baumert Report called AMR''s Pension Mess.

The Baumert Report
AMR’s Pension Mess

Last year, AMR had to infuse $250 million of its cash into its pension, and take a $1.1 billion charge that drastically reduced shareholders’ equity. The Fitch rating agency recently estimated AMR’s pension to be under funded by $3.3 billion. And according to Business Week, if the company’s pension assets lost just 5% last year (and that’s hardly inconceivable), the company will have to contribute an estimated $415 million of its cash this year. Obviously, AMR has more important uses for that enormous amount of money.

In fact, the pension morass is probably second only to the TWA acquisition in “Cash Drains Caused by AMR Executivesâ€.

To understand how much of the pension-related cash drain was avoidable takes some background information. Deepa Babington of Reuters explains, “Pension assumptions play a big role in corporate profits because U.S. accounting rules allow companies to book pension income based on estimates of how much their plans are likely to return over the next 10 or 20 years, rather than on actual gains or losses.†So, companies that set unrealistically high assumption rates are rewarded with inflated earnings. Now you know why companies love actuaries who set high expected rates of return and why they are loathe to lower them to realistic rates no matter how poorly the markets are actually performing.

>From 1995 to 2001, AMR used a high pension rate of return assumption of 9.5%. Then, in spite of a severe bear market and a recession, they barely lowered their assumption to 9.25% in January of 2002 and then to 9.0% in 2003. Apparently, they had little desire to fund their pension based on realistic returns. Mr. Babington adds that many companies just refuse to take off the rose-colored glasses.

Here’s what Warren Buffett of Berkshire Hathaway has to say about the absurdity of the expected rate AMR used: “I’m a sporting type, and I would love to make a large bet with the chief financial officer . . . that over the next 15 years they will not average the rates they’ve postulated. Just look at the math for one thing. A [pension] fund’s portfolio is very likely to be one-third bonds, on which the fund cannot expect to earn much more than 5%. It’s simple to see then that the fund will need to average more than 11% on the two-thirds that’s in stocks to earn 9.5% overall. That’s a pretty heroic assumption, particularly given the substantial investment expenses a typical fund incurs.â€

Now, eventually the actual returns do matter. On an annual basis, the IRS checks up on corporate pension funds. If the IRS finds a plan to be under funded, the company in question must infuse cash into the plan to ensure the plan’s assets can meet its future liabilities. This is where AMR finds itself. If AMR management had just set realistic pension return assumptions they would not be diverting hundreds of millions of dollars into their pension fund and away from actual operations.

Yet, they persist in ignoring the lesson. For the last eight years AMR
management used an overly optimistic assumption rate that was healthy for its bottom line but was eventually unhealthy for the funded status of its pension. Then, in denying all the facts facing them, they’ve barely lowered it to a still unrealistically high rate of 9.00%.

Mr. Buffett, who uses a 6.5% rate for his company, warns, “Considering how poor returns have been recently and the reprises that probably lie ahead, I think that anyone choosing not to lower assumptions - CEOs, auditors and actuaries all - is risking litigation for misleading investors. And directors who don’t question the optimism thus displayed simply won’t be doing their job.â€

Adds Merrill Lynch accounting consultant David Hawkins, “In today’s
environment, (high rates) invite cynicism with respect to the credibility of your financial statements, and that’s something you don’t want to have as a CEO.â€

Fictional CEO Gordon Gekko may claim, “Greed is good.†However, in this case at least, greed is dreadful, especially when it is compounded by management’s perpetuation of a greedy mistake.

Steven Baumert
Sources: Reuters; Fortune; AMR 3Qtr 10Q; AMR 4th Qtr Conference Call; AMR 2001 Annual Report; Wall St. Journal; BusinessWeek

I am certainly not an expert in this field, but there are a lot of experts who have written about this subject. The best article I have found is at this link (,15114,395147,00.html).

I won''t bore everybody with too many details. Here is the bottom line.

1) AMR''s estimated rate of return of 9% is below the median rate of return for the S&P 500, which is 9.2%.

2) Baumert says, If AMR management had just set realistic pension return assumptions they would not be diverting hundreds of millions of dollars into their pension fund and away from actual operations. This is simply not the truth. The estimated rate of return has nothing to do with how much cash has to be infused into an underfunded plan. According to Mr. Baumert, AMR could simply assume a 0% rate of return, and contribute nothing to the pension plans.

3) The Baumert Report says that this is a cash drain caused by AMR Executives. In reality, virtually every company with large defined benefit pension plans is in the exact same boat. Hardly a case for something caused by AMR leadership, and hardly unique to AMR.

I know this is boring stuff. Obviously Mr. Baumert is either a terrible reporter or he hopes that this is all too complicated or boring for anybody to check up on.

The Baumert Report is posted on several union websites. I would hope that the members of the unions who post the Baumert Report would ask their leadership to remove a report that I have been able to completely discredit with a total of about 2 hours of fact checking. The Baumert Report only provides opinions that are based in very loose usage of the facts.