General Motors Co.'s annuitization of $26 billion in pension obligations should be a game-changer for corporations in the way they finance and manage defined benefit plan risk.
It also could take some pressure off the fragile financial condition of the Pension Benefit Guaranty Corp. while offering a creative, alternative way to insure retirement benefits.
General Motors announced on June 1 that it would offer lump-sum payments to 42,000 U.S. salaried retirees. Employees who decline the lump sums would be included in a group annuity contract GM will buy from Prudential Insurance for another 76,000 U.S. salaried retirees.
Prudential will administer future benefit payments to those covered by the annuity. Neither GM nor Prudential will pay PBGC premiums for the annuitized obligations, and the PBGC no longer will insure the benefits.
Companies ought to give the technique serious consideration for a number of reasons.
Among them, it could relieve them of significant parts of their pension liabilities, which weigh against corporate finances and shareholder value. It puts the responsibility on the insurance companies that sell the group annuities.
At the same time, the new structure continues to secure those annuitized pension benefits, although outside the PBGC.
In addition, it can reduce the cost of complying with complicated federal pension regulation and the accounting standards of the Financial Accounting Standards Board and other rulemakers.
Companies that buy private group annuities for their pension obligations no longer have to pay PBGC premiums — either the flat rate that all corporate sponsors pay or the variable rate that sponsors pay based on underfunding — for those annuitized obligations. Annuitization also ends the risk that PBGC premiums will increase, possibly based on the credit standing of the plan sponsors.
With a large part of their obligation outsourced, companies can focus more resources to strengthen their remaining pension liabilities as well as corporate operations.
For the PBGC and plan participants, the move encourages an alternative source of pension security. Annuitization is an incentive for corporate sponsors to contribute to their plans to raise them to full-funded status faster than they ordinarily would in order to qualify for annuitization.
For example, General Motors had no pension funding requirements for 2010 through this year, while contributing only $31 million in 2009.
In addition, GM has offered the salaried plan retirees a choice. They can ensure they receive the full present value of their pension benefits by taking a lump sum, and possibly leave something to their heirs, or they can ensure they won't outlive or outspend their benefits by taking the annuity.
Companies moving pension obligations to insurance companies could give those liabilities stronger protection than the status quo. In fact, GM's U.S. plans would have likely been dumped on to the PBGC had it not been for the Department of Treasury-led bailout and reorganization of the company under bankruptcy protection in 2009.
Those enormous liabilities would have worsened the PBGC's underfunding. That event might have jeopardized the full pension benefits of the retirees in the U.S. salaried plan because the plan was underfunded.
In addition, in managing annuities, insurance companies can use risk-reduction techniques, such as reinsurance, that are not available to the PBGC.
Pension management has to become more creative because of the massive obligations in relation to the size of the companies. That imbalance could drive more annuitizations. GM has $134.2 billion in worldwide pension obligations, underfunded by $25.4 billion, while its recent market capitalization is only $30.7 billion.
Ford Motor Co., Boeing Co. and Exelis, among other corporations, also have large imbalances, according to an Aug. 6 Moody's report, “Pension Terminations: No Free Lunch.”
PBGC trustees — the secretaries of the departments of labor, treasury and commerce — need to step up their leadership and promote creative options to PBGC protection, which will help improve corporate and PBGC finances in the long run, while still protecting pension benefits.
More consideration should be devoted to the greater role that state insurance guaranty associations might have in pension security, and the risks that implies for those state programs.
While the PBGC will no longer insure those GM obligations, Marc Hopkins, PBGC spokesman, noted in an e-mail: “State guaranty associations provide coverage for people who receive pension benefits through insurance companies like Prudential.”
There is another reason to pursue annuitization: it reduces uncertainty as to the size of liabilities to companies, as well as the PBGC, from factors such as low discount rates.
The annuitization is not a panacea for GM. It reduces the company's underfunding by $1 billion, but leaves GM with most of its pension underfunding and attendant corporate financing problems as well as the PBGC exposure.
But even that reduction can be deceptive. A GM financial presentation on June 1 showed its U.S. salaried plan's funded level has been highly volatile, fluctuating for example, between nearly 130% funded in 1999 to its current status of 92% funded. Now GM won't have to deal with that volatility risk for the annuitized obligations.
A sensitivity analysis in Boeing's 10-K report, to take another corporate plan sponsor, shows a 25-basis-point increase in its discount rate used for valuation would decrease its projected benefit obligations by $2.1 billion, while a 25-basis-point decrease would increase its PBO by $2.6 billion.
An Aug. 6 Milliman Inc. report shows the funding deficit of the 100 largest corporate pension plans at $533 billion, a record since it began tracking the 100 largest U.S. corporate defined benefit plans 12 years ago.
Annuitization isn't a final answer. Significantly underfunded plans are not candidates.
In derisking retirement obligations, companies have to weigh the cost of deals like the Prudential transaction against the continuing costs of overseeing their pension plans as they do now. Ford and Boeing, for instance, have concluded their own derisking strategies are a better way than annuitization.
As for the viability of the group annuity market, megatransactions like the GM deal are a new frontier for U.S. insurance companies. But the Moody's report concludes there “is ample insurer capacity to absorb the market demand for annuities.”