Firms set to mull pension obligations
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Record low interest rates have been wreaking havoc on corporate pension plans, inflating the cost of promises employers made to workers and forcing them to spend more cash to finance those promises.
General Motors and Ford -- which are burdened with some of corporate America's largest pension obligations -- are tired of waiting for relief from higher interest rates. The carmakers have announced plans to take billions of pension obligations off their books, either by shifting the risk to retirees through lump sum payouts or to insurance companies, which provide annuities that will fund the pension payments.
Their moves are expected to make other companies think longer and harder about doing the same thing.
"I guarantee you there's a lot of corporate [chief financial officers] and treasurers reading these headlines and asking the same questions," said Jeffrey B. Saef, of BNY Mellon Asset Management.
GM estimates it will take $26 billion in pension liabilities off its books by the end of the year by offering lump sum payments to 42,000 of its 118,000 retired salaried workers. For retirees who do not take the one-time payment to settle their pension claims, GM will purchase an annuity that will make pension payments.
Ford is offering lump sum payments to 90,000 retirees, but will not use an annuity to pay for benefits for retirees who do not accept the offer. How much its pension liability will be reduced depends on how many of the 90,000 agree to take the lump sum payment.
Both companies can afford the measure because their pension plans are relatively well funded compared to other companies. Mercer, which advises companies on human resource issues, said pension plans sponsored by S&P 1,500 companies are 76 percent funded, meaning they can pay 76 cents of every $1 in pension benefits they are obligated to pay.
BNY Mellon said overall U.S. private sector pension plans are only 70 percent funded.
"The more well funded you are, the more you can afford to transfer pension risk," said Jay Dinunzio, of Dietrich & Associates, a Plymouth Meeting, Pa., firm that helps pension plan sponsors find annuities to fund retirement benefits.
Low interest rates are part of those costs.
Companies measure their pension obligations based on long-term interest rates. The lower rates are, the more pension liabilities grow. That's because low interest rates mean assets in the pension fund will not grow as fast, so there has to be more money to meet future obligations. Conversely, pension liabilities shrink when interest rates rise, relief that companies have been waiting for in vain.
Because of the anemic recovery, the Federal Reserve intends to keep interest rates low through late 2014. Companies interested in purchasing annuities to reduce their pension burden but waiting for higher interest rates to lower the price tag for doing that "are probably going to be waiting a long time," said Byron Beebe, of Aon Hewitt, a benefits consultant.
GM decided to forego that by paying a premium to free itself of $26 billion in pension liabilities. That will allow it to invest in its business instead of its pension plan.
They are saying "we don't want to be in the interest rate game any more. We want to be in the car business," said Gordon Fletcher, an actuary with benefits consultant Mercer.
Mr. Fletcher said many companies do not have enough cash to write a check for what GM will pay to retire its pension obligation.
He and other pension advisers said companies with pension obligations that are relatively large compared to the value of their business are the most eager to shed pension liabilities. Prime candidates are companies with pension obligations valued at 50 percent or more of the company's market capitalization -- the price of a share of its stock times the number of shares outstanding.
"For a CFO, if your pension plan is more than half your market cap, you're going to be paying a lot of attention to it," Mr. Fletcher said.
Many steel companies fall into that category. U.S. Steel has a market cap of $2.6 billion and had projected pension obligations of $10.8 billion at the end of last year, when its pension plans were 78 percent funded. Allegheny Technologies' year-end pension obligations of $2.8 billion represent nearly 90 percent of its $3.1 billion market cap. The specialty metals producer's pension plans were 81 percent funded at year end.
U.S. Steel declined to comment on whether it is considering offering lump sums to some retirees or purchasing annuities to shed a portion of its pension liabilities. Allegheny Technologies could not be reached for comment.
U.S. companies buy enough annuities annually to take about $1 billion in pension assets off their books, according to Mr. Beebe. Experts say the magnitude of GM's plan could cause more companies to go the annuity route.
"The transaction itself is larger than many life insurance companies in the United States," Mr. Dinunzio said. "I was surprised by this deal and that it was with one insurance carrier."
He said Dietrich helps companies purchase annuities to cover $1 million to $100 million of their pension obligations, with the typical transaction falling in the $1 million to $10 million range.
Pension consultants say insurance companies are willing to sell annuities covering small batches of pension obligations, but said the industry may not want to take on larger deals like the one Prudential Insurance signed with GM.
"The market may not have the capacity to do many more of these mega-transactions," said Mary Mitchell, of Buck Consultants, Downtown.
Whether it's a pension plan, an insurance company or a retiree considering a lump sum payment, taking on pension risk is a complicated equation that Mr. Dinunzio describes as "more art than science."
Pension plans and insurers writing annuities have to estimate how long retirees will live, which determines how long benefits will have to be paid. Retirees considering a lump sum look at the same issue from the other side: Can they make the one-time payment last as long as they live?
One worry for insurers is that retirees who do not expect to live long will take the lump sum. That will leave them on the hook for paying benefits for healthier retirees who will live longer.
Insurers "are going to want to be smart about being paid for that risk," Mr. Dinunzio said.
Thus far, the expense that low interest rates add to the cost of shedding pension obligations has kept many companies pursuing the strategy GM is implementing. But the carmaker's blockbuster decision could convince them to stop waiting for interest rates to rise.
"We have seen a lot of latent demand for this," he said. "We've been talking to our clients about this for years as a risk-reduction technique."
First Published June 17, 2012 12:00 am
