Leverage World –November 19, 2004 Copyright

2004 by FridsonVision LLC. All Rights Reserved.

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INDEPENDENT INQUIRY…

Lucent to Push for Pre-Funding of Health Benefits

By Terence Flanagan, CFA

Terry@FridsonVision.com

Lucent Technologies Inc. said on November 9 it will seek legislative

action further expanding flexibility in transferring surplus pension assets

to fund retiree health care benefits. The statement came after the U.S.

House and Senate last month passed a provision in the JOBS Bill (H.R.

4520, Section 719) that will allow more flexibility in making pension

transfers starting January 1, 2005. (President Bush signed the bill on

October 22.) Leverage World’s independent research finds that Lucent

wants to pre-fund retiree health care obligations and may push for

additional legislation to be enacted by 2006.

Background

The cost to employers and retirees for health benefits rose 13.7% to $20.6

billion in 2003 from $18.1 billion in 2002. According to a survey of 408 firms

conducted by the Kaiser Family Foundation and Hewitt Associates, 64% of

CEOs were very concerned about retiree health care costs in 2003. Lucent,

which slashed its workforce to 31,800 employees as of September 30, 2004,

down from 126,000 in 2000, amid a protracted slump in demand for telecom

equipment, had 129,000 retirees covered by health care benefits as of September

2003, the company said in its most recent 10-K. In the filing, Lucent estimated

its annual funding requirements for retiree health care benefits would be $300

million ``for the next year or two,’’ and said the company was taking steps to

reduce its obligations. The company would not be able to meet its obligations

for retiree health care without using pension funds, said Edward Potter,

President of the Employment Policy Foundation, which studies workplace trends

and policies.

The Jumpstart Our Business Strength (JOBS) Bill, passed by the Senate

Finance Committee in the 108

th

Congress of 2003-2004, loosens restrictions on

Lucent and other companies with substantially over funded pension plans in

transferring excess money from a plan to pay for retiree health care. Firms that

currently make transfers (known as 420 transfers) cannot reduce benefits by

more than 10% annually for five years subsequent to a transfer, must maintain

spending per beneficiary in that time, and the pension plan affected must be at

least 125% funded after a transfer. To maintain per-capita spending, Lucent

could reduce the cost of benefits only by dropping groups of people from the

plan, such as spouses and dependents of higher-paid employees. As of January

1, 2004, Lucent dropped health care coverage on dependents of management

retirees who retired on or after March 1, 1990, and whose base salary was at

least $87,000, according to the Lucent Retirees Organization (LRO). Effective

January 1, 2005, Lucent will lower the salary threshold to $65,000, expanding to

about 20% the total number of Lucent retirees affected by the benefit cuts, the

LRO said. Lucent’s pension plan was 159.2% funded as of 2001, according to

the most recent Form 5500 (Annual Return/Report of Employee Benefit Plan)

posted on FreeERISA.com.

Lucent wants still

more flexibility in

tapping its overfunded

pension plan

The company will drop

another group from

benefits on January 1

Leverage World –November 19, 2004 Copyright

2004 by FridsonVision LLC. All Rights Reserved.

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INDEPENDENT INQUIRY…

When the JOBS bill becomes effective on January 1, 2005, Lucent will be

able to cut costs by reducing benefits across the board by a targeted percentage

rather than having to drop groups from coverage. This will make it easier for

Lucent to cut costs. In the past, dropping groups of people from benefits often

did not add up to 10%, and because the company couldn’t exceed that number,

full cost savings were not realized, said Professor Phyllis Borzi of the George

Washington University Medical Center’s Department of Health Policy. Borzi

has served as an adviser the National Retiree Legislative Network, which

opposed Section 719.

A person familiar with Lucent’s plans, who spoke on condition of anonymity,

said Lucent’s next legislative push to reduce costs for retiree health benefits will

be for more flexibility in pre-funding obligations. Currently, the law allows

Lucent to use funds from 420 transfers to reimburse itself for spending on retiree

health care already made for a given year. If pre-funding were allowed, the

company could reduce the funded status of its pension plan to closer to 125%,

rather than have the money stuck in the pension plan, the person said. There is

nothing specific in the works now and a new bill may not be crafted until 2006,

the person said. John DeBono, an investor relations representative for Lucent,

said he is not aware of any legislation in the works. This type of legislation

would typically go through the House Ways and Means Committee and the

Senate Finance Committee.

Pre-funding retiree health care benefits may be an effective means to reduce

taxes, said Mike Johnston, a practice leader in the retirement line at Hewitt. A

company could contribute more in profitable years to maximize the available tax

deduction, and contribute less in lean years where a deduction may not apply, he

said.

Legislation in recent years has gradually ``whittled away’’ benefits for

retirees, and that trend will likely continue with another four years of the

business-friendly Bush administration, said Borzi. That gives Lucent a

legislative tailwind, she said.

Overall, the regulatory and legislative landscape has been somewhat

employer-friendly in recent years with regard to health care benefit plans, but

not so much with pension plans, Johnston said. He doubts any significant

legislation allowing easier funding of retiree health care with pension assets will

happen in 2005.

Company Description

Lucent, headquartered in Murray Hill, New Jersey, is the biggest U.S. maker

of telecom equipment. For its fiscal year ended September 2004, Lucent

recorded revenue of $9.05 billion and net income of $1.14 billion. A tax refund

of $861 million subsequently increased reported net income to $2 billion.

Currently, Lucent has about $2.91 billion of nonconvertible high yield debt

outstanding. The company last tapped the (nonconvertible) public debt market

in March 1999. Lucent’s senior unsecured debt is rated B2 by Moody’s

Investors Service and B by Standard & Poor’s.

LW

Our source says Lucent will

push next for more pre-

funding flexibility

Based on FreeERISA.com data,

the following companies among

the 25 biggest high yield issuers

had pension plans funded by more

than 125% as of 2001:

Company Funding Level

Qwest 137.2%

El Paso 129.3%

AT&T 181.3%