Monday, June 4, 2012

GM and Ford's Pensions Jubilee?

Deepa Seetharaman and Ben Klayman of Reuters report, GM to cut about one-fourth of U.S. pension liability:

General Motors Co will cut nearly a quarter of its U.S. pension obligation by transferring the management of its pension plans for 118,000 white-collar retirees to a third party and offering lump-sum buyouts.

The two moves unveiled on Friday will cut $26 billion from the automaker's massive U.S. pension liability of nearly $109 billion. GM's pension overhang is a top concern for investors. It was one of a handful of issues left untouched during GM's U.S.-financed bankruptcy restructuring three years ago.

"There are lots of companies with pension plans. Very few have plans in the absolute or relative size as us," Chief Financial Officer Dan Ammann said during a conference call.

"We would like to get back into the category where this is sort of a non-issue for us," Ammann added. "That doesn't mean eliminating it completely, but obviously we've taken a big step in the right direction today."

The automaker also announced a third pension-related move. GM will shift most of its salaried employees and a small number of retirees who started receiving pension benefits on or after December 1, 2011, to a new pension plan that GM will continue to pay for. These retirees are not part of the 118,000 affected by the pension overhaul announced Friday.

GM will buy a group annuity contract from a unit of Prudential Financial Inc, which will pay and manage benefit payments starting in January 2013 to retirees who are ineligible or elect not to take a lump-sum pension buyout.

GM will also offer pension buyouts to about 42,000 retirees and their surviving beneficiaries, who will have until July 20 to make a decision. The company will start sending those offers to eligible retirees next week.

To fund the transaction, GM will shift $29 billion from its pension plan assets to Prudential and put in between $3.5 billion and $4.5 billion in cash. GM's pension shortfall will also narrow by $1 billion.

GM will take a special charge of between $2.5 billion and $3.5 billion in the second half of the year. It will also result in a $200 million non-cash hit to earnings.

"Although the transaction doesn't come cheap, it serves a very important purpose of permanently de-risking 25 percent of GM's U.S. pension obligation," Citi analyst Itay Michaeli said.

The shift to Prudential and the buyouts are expected to be completed at the end of this year. The pension changes do not affect white-collar retirees' eligibility for post-retirement healthcare, life insurance and a vehicle discount.

UAW PENSIONS IN FOCUS

A growing concern for decades as U.S. automakers lost market share to foreign-based automakers in their home country, pension costs became an albatross for the U.S. industry with the sector's downturn five years ago.

Over a 15-year stretch that ended in 2006, GM put $55 billion into its workers' pension plans, compared with $13 billion it paid out in dividends, according to the 2008 book, 'While America Aged" by Roger Lowenstein.

"We will be less exposed to the funding volatility and calls on cash we have experienced in the past, which in turn, will improve our flexibility to deploy cash for alternate uses," Ammann said on Friday.

The announcement is part of a series of steps that GM and its smaller rival Ford Motor Co have taken to manage the risks posed by their pension obligations, which have hit the stock prices and the credit ratings of both automakers.

This summer, Ford will begin offering pension buyouts to the first wave of 98,000 white-collar retirees and former employees who are vested in their pension plan. The move could lop off one-third of Ford's U.S. pension liability.

GM retirees represented by the United Auto Workers union are not affected by Friday's announcement. Hourly retirees account for the bulk of GM's U.S. pension obligation.

Last year, GM and the UAW agreed to discuss ways to cut the risk posed by GM's pension plan during contract negotiations.

During the conference call, Ammann declined to shed light on those talks, beyond saying that pensions were a "significant topic of discussion" during those meetings.

"We have generally agreed with the UAW that we will maintain a dialogue on pensions going forward and continue to look at de-risking alternatives, but anything we discuss with them on that remains private between us and them," Ammann said.

A UAW spokeswoman could not be immediately reached.

GM MOVE COULD TRIGGER OTHERS -FITCH

Ammann said the pension moves represented an "important step" toward GM obtaining an investment-grade credit rating. Fitch Ratings described the changes as "incrementally positive" to GM's rating.

"Today's transaction could spark other companies to consider similar transactions in the future to reduce exposure to plan volatility," Fitch Ratings analyst Stephen Brown said.

Ammann said GM does not have an estimate for how many retirees would likely take the lump-sum offer. The company is offering free independent financial counseling and group meetings for those eligible for lump-sum payments. GM also has established websites to outline the pension changes.

GM has also created two separate call centers to help answer retirees' questions.

Before the pension announcement, GM shares were down as much as 3.4 percent as the automaker posted weaker-than-expected May auto sales.

But the stock recouped its losses and rose as much as 5.1 percent on the news of the pension changes. GM shares closed at $22.01, down slightly less than 1 percent.

As stated in the article, Ford readies first set of landmark pension buyouts:

Ford Motor Co will pursue its boldest attempt yet to tackle a nearly $50 billion risk to its business when it begins offering lump-sum pension payout offers to 98,000 white-collar retirees and former employees this summer.

The voluntary buyouts have the potential to lop off one-third of Ford's $49 billion U.S. pension liability, a move that could shore up the company's credit rating and stock price. It is unclear to Ford, retirees and analysts just how many people will gamble on the offer, which pension experts described as unprecedented in its magnitude and scope.

"We think if we can get at least a meaningful number of employees, this will take billions of dollars of obligations potentially off the table," Chief Financial Officer Bob Shanks told Reuters in an interview.

A growing concern for decades as U.S. automakers lost market share to foreign-based automakers in their home country, pension costs became an albatross for the U.S. industry with the sector's downturn five years ago.

The offers are the latest in a series of steps Ford and its larger rival General Motors Co have taken to cut these risks. Since 2000, Ford's U.S. pension liability has increased almost 50 percent. Several companies have asked Ford how the buyout offers will be rolled out, a sign that others may follow suit if Ford is successful.

The No. 2 U.S. automaker sketched out its pension buyout offer for current retirees when it released first-quarter earnings in April, but until now had offered few details.

As early as August, between 12,000 and 15,000 U.S.-based workers will receive the first wave of offers to swap their monthly pension checks for a one-time payment.

The offer shifts the responsibility of managing those funds from Ford to the retiree. It is rare for a company to amend an existing pension plan.

"I feel schizophrenic at times," said Rick Popp, Ford's director of employee benefits. "There are times when I think it will be very popular. Other times, I think nobody will take it. To us, it's an opportunity."

At the end of 2011, the gross pension liabilities of both GM and Ford rose to record levels, Citi analyst Itay Michaeli said. Ford finished 2011 with a global pension obligation of $74 billion, nearly double the company's $40 billion stock market value.

Ford's global pension plan was underfunded by $15.4 billion as of end 2011. This shortfall, which widens and contracts based on asset returns and interest rates, is typically viewed as debt by credit ratings agencies.

The voluntary buyouts will not change the pension shortfall, but lowering the overall size of the obligation will help Ford align plan assets with liabilities. Like many businesses, both GM and Ford have taken steps to shift their pension assets to steady, fixed-income investments and are pouring in cash to fund those plans.

The idea of the voluntary buyouts came after a meeting between Ford's top financial executives and in-house pension experts three years ago. In the midst of the financial downturn, Ford's then-CFO Lewis Booth met with Shanks, Ford Treasurer Neil Schloss and in-house pension experts to consider ways to slash the company's pension liability.

Ford received governmental approval to make the lump-sum payments in March. Shanks said the approval came after Ford showed the deal would give "an incremental favorable option to the plan participant." Shanks and Ford declined to elaborate.

Ford shares have lost 16.4 percent since mid-February. The stock closed down 1.7 percent at $10.66 on Wednesday.

WEIGHING MORTALITY

Earlier this month, Popp and Schloss met with retired Ford engineers in Dearborn, Michigan. Over a lunch of roast pork and whitefish, they fielded questions about the lump-sum offer and how the plan would roll out.

Consideration of the offers, which have not been mailed to former employees yet, will rely on each worker's health, projected lifespan and finances - subjects that can be difficult to broach.

"Some of it was half-heartedly and jokingly talking about mortality," Popp said, referring to the meeting. "It is something that you don't sit around and talk about that often."

Ford benefits from a change in U.S. pension law this year that allows companies to use a corporate bond rate in calculating lump-sum payments, rather than the 30-year Treasury rates. That would make it less expensive to make those offers, said Jonathan Barry, a partner at benefits consulting firm Mercer.

Initially, Ford said the deal would be offered to about 90,000 workers, but the final tally came in higher. Ford has already hammered out the buyout figures for all the eligible employees and plans to roll out the plan in stages. Each wave of retirees will be randomly selected.

Employees will each receive a postcard followed by an informational kit with their offer. After that, they have 90 days to make a final decision on the one-time offer.

"This is a major decision for every employee who receives that offer," said Howard Freers, chairman of the Ford Retired Engineering Executives, which hosted the lunch. "Do I take the lump sum or stay where I am? That's totally, totally dependent on what that offer is, how long they project you will live and whether or not you're in good health."

Ford employees and Deloitte experts will conduct group and one-on-one meetings in-person and by phone to discuss the buyouts during the next year around the United States.

"I don't know how to emphasize any stronger that I can't even start thinking about a decision or anything like that until I have a piece of paper in my hand," said the 85-year-old Freers.

'ISN'T FOR EVERYBODY'

Of the 98,000 eligible workers, 65,000 are Ford retirees or their surviving spouses. The rest are former employees who are vested in their pension plans and salaried workers who are also part of the United Auto Workers union.

A small number of hourly workers in Cleveland represented by the International Brotherhood of Electrical Workers and the International Association of Machinists will also receive deals.

Retirees represented by the UAW account for the bulk of Ford's U.S. pension liability, but changes to those plans must be negotiated with the union.

During contract talks last year, GM won an agreement from the UAW to discuss pension buyouts. That same option was discussed during talks between Ford and the UAW, but Ford did not receive a similar guarantee.

Ford executives emphasized that the company is not offering a financial incentive to take the buyout.

"This isn't for everybody," Popp said. "We're real open about that. If people don't think it's for them, then please don't take it."

And Mercer sent me this update:

US Pension Plan Q1 2012 funding gains wiped out in April and May

  • Global economic worries drive plan liabilities to record highs
  • General Motors announcement, for which Oliver Wyman and Mercer acted as insurance advisor to State Street, the independent fiduciary for the GM plan, likely to set a precedent to shift volatility risk

New York, June 4, 2012

The aggregate deficit in pension plans sponsored by S&P 1500 companies grew $80 billion in May to $488 billion, according to new figures from Mercer.This deficit corresponds to an aggregate funded ratio of 76% as of May 31 2012 compared to a funded ratio of 79% as of April 30, 2012, and just barely above the funded ratio from 75% at December 31, 2011. Effectively the funding gains achieved in the first three months of 2012 were wiped out by market trends in April and May.

The decrease in funded status in May was attributable to the falling equity markets as well as an increase in liabilities due to declining interest rates. Interest rates on high quality corporate bonds, which are used to measure the pension liability, fell 10-15 basis points during the month, as measured by the Mercer Pension Discount Yield Curve.

The yield curve hit an all time low driving the aggregate S&P 1500 liability in excess of $2 trillion for the first time. US equity markets fell 6 percent during May as measured by the S&P 500 total return index. Plan sponsors who hedged their liability by holding a higher allocation in long duration bonds would have seen better asset performance during the month.

“We saw a big step backwards for most US pension plans in May which, on top of declines in April, essentially wiped out the positive performance we saw in the first quarter of the year,” said Jonathan Barry, a partner in Mercer’ Retirement Risk and Finance business. “It’s further proof of the significant volatility that most US plan sponsors are exposed to – in just the past two months we have seen a decline of $152 billion. However, those plan sponsors who have implemented risk management strategies have likely cushioned the blow.

The incentive for defined benefit plan sponsors to address volatility risks was underscored by General Motors’ announcement on June 1 to transfer the pension volatility for most of the company’s salaried retirees, through a combination of voluntary lump sum offers and an annuity purchase by Prudential. Oliver Wyman and Mercer were appointed by State Street, the Independent Fiduciary for the General Motors plan, to act as its insurance advisor on the transaction.

“This is a landmark action,” said Sean Brennan, a principal in Mercer’s Financial Strategies Group. “For some time, we have anticipated that one of these large transactions would occur and would set a precedent. Many other sponsors of large plans have to be looking at this option.”

My analysis: When it comes to pensions, when it rains, it pours. These 'landmark' deals are all about shifting pension risk from companies to employees and they are setting a dangerous precedent, one that will bring about widespread pension poverty.

Go back to listen to comments made by HOOPP's President & CEO, Jim Keohane, at last week's Walrus HOOPP debate on pensions. These historic pension deals only prove that the U.S. and the rest of the developed world need to tackle the retirement crisis with radical new thinking.

"We would like to get back into the category where this is sort of a non-issue for us," GM's Ammannis quoted in the first article above. Couldn't agree more except I don't like the way GM and Ford are going all about it. The real winners in these pension buyouts are the companies and insurance companies, not the employees.

Importantly, any time a company 'de-risks' its pensions by shifting out of its obligations to pay defined-benefits, the real losers are workers and retirees. Sure, GM and Ford will package this as a win-win for everyone, but the truth is that to create real winning conditions, we need to shift the burden of pensions off companies and onto well governed public defined-benefit pension plans.

Mark my words, this is where capitalism is ultimately heading. But to get there, we need to break the financial lobbies and their silly private sector solutions. When it comes to healthcare, education, and pensions, we need to ensure that all citizens are treated fairly and have access to outstanding service in all three public goods.

In an ideal world, companies would focus only on business, not pension plans. Pensions would be treated like a public good, portable anywhere, and managed by well governed public defined-benefit plans. This would boost long-term productivity, reduce costs, and ensure retirement security for our aging population.

And when it comes to pensions, we know that public defined-benefit plans are vastly superior to any private sector solution. This isn't even a matter of debate. You just have to get the governance right, pay your pension fund managers properly, get oversight from an independent board which operates at arms length from the government, and introduce incentives that reward long-term risk-adjusted returns.

Of course, once I push for this 'radical' idea, I'm accused of being a leftist communist who wants to socialize losses. This is pure rubbish. I'm a fiscal conservative/ social liberal who believes in efficient government. I'm also a Keynesian who believes the real crisis is unemployment, not debt, and force fed austerity has been an abysmal failure everywhere, especially in the peripheral economies of the eurozone.

In my open letter to Prime Minister Harper last year, I said we have to review spending in every government department and consolidate some Crown corporations to cut costs where needed and re-allocate resources to departments that are severely underfunded.

I also stated that when it comes to pensions, we need to stop peddling half-baked measures which pander to banks and insurance companies and build on the success of our large Canadian defined-benefit plans. After my meetings in Toronto last week, I'm more convinced than ever that this is the way to go.

Finally, a long time ago, I met with a few senior officials at GM's pension plan. At the time, it had considerable allocations to alternative investments such as private equity, real estate, and hedge funds. If I was consulting GM, Ford or any other company looking to exit pensions, I would tell them to forget insurance companies and go straight to the large Canadian public pension funds, like the Canada Pension Plan Investment Board.

Importantly, any company dealing with insurance companies to offload pension risk will get royally screwed! I guarantee it.

Rates are at record lows now and stocks are getting trashed as investors fear another terrible summer, exacerbating pension deficits. But the world isn't coming to an end, rates will re-normalize, and when they do, these insurance companies will make off like bandits (which is why some top hedge funds bought them in their portfolio).

I know everyone is worried about the upcoming Greek elections, Spain's banking system, Merkel's foolish stance on a common eurobond market, a slowdown in China, and the end of the world as we know it. Relax! Take a deep breath, forget market volatility and follow activity from top funds closely (added many more funds to that comment). Enjoy the Queen's Jubilee concert on Monday evening.

Below, Bloomberg's Sara Eisen reports that billionaire investor George Soros urged German Chancellor Angela Merkel to lead on the debt crsis and preserve the European Union as he warned of the Euro's demise. She speaks on Bloomberg Television's "Inside Track."

I happen to think it's only a matter of time before Merkel caves in to demands to introduce a common eurobond market. But as Soros warns, the longer she waits, the harder it gets, so she'd better act soon.

No comments:

Post a Comment