When General Motors left Washington empty-handed last week, among the lingering questions was whether its huge pension fund could topple and crush the government’s pension insurance program.
When any pension fund fails, usually as part of a bankruptcy, the government takes over its assets as well as its payments to retirees. In GM’s case, its plan would dwarf the nation’s pension insurance fund.
Still, GM appears to have enough money in the pension fund to pay its more than 400,000 retirees their benefits for many years—even with the markets swooning around it. That is largely because of the conservative way GM has managed the fund recently, and it explains why GM has not joined the long list of companies pressing Congress for pension relief.
But this glimmer of hope in a bleak auto landscape could change drastically, particularly if GM struggles along for a few more years, only to go bankrupt. The company’s blue-collar work force is still building up new benefits with every additional hour worked, and the pension fund will have to grow smartly to keep up with those costs.
If GM continues paying people to retire early, the costs will grow even more, because the plan will have to pay retirees for more years than it budgeted. And GM is not contributing additional money to the plan right now.
Already, GM says it will be paying retirees about $7 billion a year for the next 10 years. The fund’s assets were worth $104 billion at the end of 2007, more than enough to cover its obligations of $85 billion. Since then, the assets have declined and the obligations have grown, each by undisclosed amounts. The company says it does not plan to add any money to the fund for the next three or four years.
Even if GM were forced into bankruptcy, the government might insist that it keep the fund, and cover any shortfalls with its own money.
“We would maintain that it can afford to keep its plan intact,” said Charles E. F. Millard, director of the Pension Benefit Guaranty Corporation, the federal agency that takes over failed plans. “Based on past history, we think that argument has a reasonable chance of success.”
Whatever its ultimate fate, the GM fund may illustrate, against the odds, that it is still possible to offer traditional, defined-benefit pensions even in a historic bear market.
The other American automakers, Chrysler and the Ford Motor Company , also operate pension funds. Ford said that its fund, which is about half the size of GM’s, had a small surplus at the end of 2007. Since then, however, it is thought to have suffered a bigger percentage of losses than GM’s fund, because it uses a different investment strategy.
Little is known about the Chrysler pension fund today because the company stopped making mandatory pension disclosures when it was taken private in August 2007.
Along with pensions, GM has promised to provide health care to retirees, but those medical benefits are not guaranteed by the federal government. The total cost of these benefits in today’s dollars was estimated at $60 billion at the end of 2007, and GM had set aside only about $16 billion to cover the cost.
That year, GM and the United Automobile Workers agreed to let GM cap its health obligations to retirees by creating a separate entity to manage the retiree health plan, and making a big payment. The automaker has said it will make the payment in January 2010, and its retiree health obligations will end then. In the meantime, GM has issued securities to cover part of the cost and is holding them in a subsidiary created for that purpose.
The GM pension is viable today because of the company’s response to the firestorm at the beginning of this decade, said Nancy C. Everett, chief executive of GM Asset Management. The unit manages the company’s domestic and foreign pension funds, as well as other big pools of company money.
In the two years after the tech crash of 2000, most American pension funds suffered their worst squeeze ever. Although the stock market swings are even more severe now, pension funds have been buffered somewhat by relief provisions written into the pension law signed in 2006.
At the time of the tech crash, most pension funds had invested heavily in stocks, and stocks lost billions of dollars in value. At the same time, interest rates fell to unusually low levels, causing a painful mismatch, because low rates make retirees’ benefits more expensive for pension funds to pay. GM’s pension fund finished 2002 with a shortfall of almost $20 billion, by far the biggest of any American company.
“That was the genesis of General Motors thinking differently about how to manage the fund,” said Ms. Everett, who was running the Virginia state employees’ pension fund at the time. She joined GM in 2005.
Pensions in a historic bear market
Until then, most pension officials thought stocks were their best choice, because stocks were expected to generate more over the long run than bonds. And pension funds were thought to have a long time horizon.
Stocks have also been a favorite pension investment because of a much-criticized accounting rule that rewards the corporate bottom line when pension managers invest more aggressively.
The big mismatch of 2002 showed pension officials that stocks could produce more volatility than a mature pension fund like GM’s could bear. The company could not wait for stock prices to come back up eventually, because it had 400,000 retirees waiting to be paid about $7 billion every year.
With that in mind, GM sold more than $14 billion of bonds in 2003 and put the proceeds into its pension fund, making up for the preceding years’ losses. It also put in the proceeds of the sale of its Hughes Electronics subsidiary, for a total contribution of more than $18 billion. That was far more than the minimum required that year.
The big contributions got rid of the fund’s shortfall. (They also gave GM’s bottom line a lift, thanks to the accounting rule.)
Then, over several years, GM overhauled its investment portfolio, replacing billions of dollars worth of stocks with bonds, and adding derivatives to make the duration of the bonds better match the schedule of payments to retirees.
Bond prices can swing too, but GM plans to hold the bonds for their interest, not sell them. Ms. Everett said the company believed the interest payments would be more than enough to produce the $7 billion owed to retirees every year.
Currently, 26 percent of GM’s pension fund is invested in stocks—well below the typical pension fund’s allocation. David Zion, an analyst at Credit Suisse who tracks corporate pension funds closely, estimates that GM’s pension assets have declined by about 15 percent so far this year, compared with a 24 percent decline for the typical pension fund at America’s 500 largest companies. It will be several more months before the size of the losses is known for sure, because companies disclose precise pension numbers just once a year.
When asked why GM did not eliminate stocks from its pension fund completely, Ms. Everett cited the controversial accounting rule.
“There’s two sides to this issue,” she said. “One is making sure your pension fund is adequately funded, and the other is that pension income does come into play when you’re looking at the company’s income statement.” No company is eager to eliminate pension income if competitors still have theirs.
The Financial Accounting Standards Board has been working on revisions to keep pension activity from affecting the corporate bottom line, but it is not finished yet.
GM has a free pass on the funding rules for the next few years. It holds a so-called credit balance—a running tally of the contributions made in past years that were larger than the law required. In 2006, GM’s credit balance was worth $44 billion. The company is using that balance to offset contributions it would otherwise have to make. Over time, the size of the credit balance will fall.
Ms. Everett said modeling exercises showed that a 26 percent allocation to equities was the likeliest way to produce adequate investment returns while also preserving the pension fund’s surplus. She said managing the surplus was her top priority. If GM had to make a pension contribution, it would not have the cash on hand to do it. The company has said it will run out of cash early next year.
Meanwhile, the cost of restructuring the company could put a heavy burden on the pension fund. GM’s contract with the U.A.W. offers special benefits to workers whose plants are shut down or who are forced to retire early. Invoking these special benefits could make the plan’s obligations soar.