During July and August of last year, I wrote an article series on the pension footnote disclosure. You can find the articles here:
Part I, Part II ,Part III ,Part IV
In Part III and Part IV of the article series, I analyzed GM’s (GM, Financial) 2012 pension footnote disclosure based on what I knew back then. In the end, I concluded with the following statements:
1. GM’s pension plan had a deficit of almost $28 billion in 2012.
2. GM paid a 10% premium or $2.5 billion to Prudential for the transfer of 25% of its pension obligations.
3. GM’s management seems to be more conservative in making pension-related assumptions.
4. GM’s pension managers are very likely to be mediocre.
It seems to me that a prudent GM shareholder should revisit the following reminder from Mr. Buffett:
In no other managerial area can such huge aggregate liabilities – which will be reflected in progressively increasing annual costs and cash requirements – be created so quickly and with so little immediate financial pain. Like pressroom labor practices, small errors will compound. Care and caution are in order.
Fast forward to today, I’ve known a little bit more about GM and a little bit more about pension accounting, I’d like to walk through the exercise again with the readers. Let me clarify I have no intentions with recommending for, or against GM’s stock, this article is an attempt to keep track of GM’s pension situation.
First of all, let’s take a look at the main pension tables disclosed by GM:
A few things jumped out to me:
- As of 12/31/2014, GM’s pension and other retirement benefit plan had a deficit of $30.7 billion, compared to the $28 billion at 12/31/2012. Not bad.
- The ending U.S. pension obligation increased more than $5 billion from 2013, largely due to a decrease in discount rate from 4.46% to 3.73%, a 73 basis points decrease.
- Offsetting the increase in obligations is the remarkable return from both U.S plans and international plans. GM’s U.S. plan has achieved actual return of 11.4% and GM’s international plan has achieved an actual return of 12.6% during 2014.
- More than 60% of the plan assets are allocated to fixed income investments while about 16% of the plan assets are allocated equities.
So how should we look at these numbers?
First of all, the lower interest rates have hurt GM’s pension obligations and benefited the fixed income portfolio. The low interest rates environment also lowered the reinvestment income for the fixed income portfolio. Higher interest rates will benefit pension obligations, decrease the fair value of the fixed income portfolio but also benefit the reinvestment income. GM discloses that a 25 bps increase in discount rate will result in $ 2 billion decrease in U.S. obligations and almost $1 billion savings in international obligations. If rates increase by 1%, this will result in $8 billion savings in U.S. and $4 billion savings international, ceteris paribus. I don’t know enough to quantify the effect of a 100 bps increase in interest rates on the fixed portfolio or on the reinvestment income.
GM’s pension obligation sensitivity to change in interest rate.
Secondly, I personally think that the 12% return on plan assets is not sustainable. GM’s expectation is 6.5%, much lower than what it achieved in 2014. If we think the expectation is not unreasonable given the asset allocation strategy, GM’s 2014 funded status would be approximately $4 billion worse.
If we put everything together, I feel comfortable with GM’s pension situation as of 12/31/2014 if I were a GM shareholder. That doesn’t mean it will get better over time. If history is a guide, it will get worse year after year. But so far, so good.
