In this part of this article series, I’d like to walk through the pension disclosure of the General Motor Company for the year of 2012, which is a 16 page monster footnote. For the purpose of illustration, I will only select the sections of the footnote that will add the most value.
Let’s start with the general description and 2012 contribution section.
This is just the description of the type of plan. There are two types of plans - defined contribution plans and defined benefit plans. In a defined contribution plan, the company contributes cash to a pension fund in the employee’s name every year and the employee is responsible for choosing from a list of possible investments and thus, bears the investment risk. In a defined benefit plan, the company hires a pension fund manager to manage investment and bears the investment risk. GM’s pension plans are mostly defined benefit plans so GM is responsible for hiring the pension fund manager and make up the shortfalls if the pension fund manager vastly underperforms.
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GM contributed $3.2 billion, $2.8 billion and $4.9 billion to the plan assets during 2012, 2011 and 2010. However, $1.9 billion of the contribution during 2011 were in the form of GM common stocks. As we can tell from later disclosures, although GM claimed the contributions were voluntary, in reality, they are almost mandatory in nature as GM faced massive funding shortfalls.
Moving on to the pension obligation and plan assets summary table.
Starting from the top and focusing only on pension plans, we can immediately tell that GM’s beginning pension obligation was $134.4 billion, a huge amount. You may note that this is different from the $27.4 billion on the balance sheet. This is because the balance sheet number is the funded status, which is simply the difference between obligations and plan assets. We’ll see the funded status further down the table.
During 2012, GM’s employees earned $835 million (452+383) additional pension benefits from their current year’s service at GM. This is reasonable considering the service cost for 2011 was $893 million.
Interest cost of $5.17 billion is the elapsed time value of money of future pension obligations as the employees are one year closer to their retirement date.
Actuarial losses of $11.2 billion are due to change in assumptions. GM further disclosed that most of this loss is due to a decrease in the discount rate used. Indeed, in later tables, we can tell that the discount rate used has been reduced from 4.96% in 2010 to 3.59% in 2012 for the U.S plans. This is in line with the ultra-low interest rates environment orchestrated by the Federal Reserve. Generally speaking, low interest rates are bad for pension plans because on the liability side, future obligations are discounted at a lower rates, which means higher present values and on the asset side, bonds held in the plan assets have lower yield and less interest income to be used for benefit payments.
Benefits paid totaled $9.98 billion. Not too much explanation is needed here. GM’s pension fund wrote a big fat check to its retirees.
Curtailment, settlement and other of $30.9 billion should immediately catch your attention as this is an enormous and unusual amount. GM disclosed very little about the details of this $30.9 billion settlement. The majority or $25.1 billion was explained by the following disclosure:
A little further digging reveals that this $25 billion is a result of a deal between GM and Prudential to shift GM’s pension obligations to Prudential through an annuity deal.
Essentially, GM transferred pension obligations to Prudential by buying a group annuity for its employees at a price that includes a premium. Prudential then agrees to use the funds it gets from GM’s pension plan to make regular payments to GM retirees for as long as they live. GM paid a hefty 10% premium or $2.5 billion to Prudential.
I don’t think this deal makes too much sense because GM basically paid out 110% of what GM owned just to get rid of the liabilities on the balance sheet. In a sense, it’s an expensive hedging because management lacked the confidence in its pension manager’s ability to deliver returns that will meet future obligations. If you are a GM shareholder, you probably want to take a $2.5 billion haircut off GM’s intrinsic value.
Moving on to the U.S plan assets. For 2012, GM’s US plan returned 10.95% (calculated by dividing actual return of $10,332 by beginning plan assets of $94,349) assuming contributions of $2.4 billion were made at year end. In reality, the return should be lower as contributions were likely to be made throughout the year, which would make the asset base larger. Even this most optimistic 10.95% return vastly lagged S&P’s 16% total return during 2012. But 10.95% is not bad for a pension plan as large as GM’s. In fact, this 10.95% in 2012 was better than the projected return of 8.00% on plan assets from 2011.
Employer contribution of $3.275 billion for the U.S and Non-U.S plan combined is self-explanatory. GM transferred $3.275 billion to the pension fund for benefit payments and investment purposes.
Benefits paid and settlements were explained above.
Now we’ve moved all the way down to the most important figure – funded status. Both GM’s U.S and international plan are almost $14 billion short, which combined make it a deficit of almost $28 billion. And remember, this is after GM has shifted 25% of the obligation to Prudential. Now you understand why pension obligation causes so many headaches for management.
Ok, this is taking much longer than I thought it would have. I will cut off here so readers can digest the analysis above. In my next article, we will look at GM’s assumptions, GM’s pension plan’s past performance and the pension plan assets mix.