Raytheon-UTC merger could spawn pension heavyweight

The combined company that will materialize from the announced merger between Raytheon Co. and United Technologies Corp. will be among the largest U.S. corporations in terms of retirement plan assets.

The combined company, which will be called Raytheon Technologies Corp., will have to deal with how to approach its $90 billion-plus in retirement plan assets, a staggeringly high number that represents the most retirement plan assets to result from any corporate merger.

Robin Diamonte, chief investment officer of Farmington, Conn.-based UTC, would not comment on the merger, but said in an email that the company has had two significant integrations into its defined benefit and defined contribution plans in the past. Its 2012 acquisition of aircraft-components maker Goodrich Corp. and its 2018 acquisition of aerospace company Rockwell Collins added about $5 billion and $8 billion in retirement assets in those deals, respectively.

"In both cases, you start by looking at the combined liability profile of two companies, then understand the priorities of the sponsor (cash flow, pension expense, volatilities, debt threshold levels, etc.) and then build a suitable asset allocation policy," Ms. Diamonte said. "Once you have the policy, you decide on the best investment managers from the two funds and reallocate. In the past we have used a transition manager to help reduce market impact and minimize costs."

Using that process, Ms. Diamonte and her staff were able to merge both Goodrich and Rockwell Collins' DB and DC plans into UTC's plans within several months of the closing of those acquisitions.

Whether UTC and Waltham, Mass.-based Raytheon's plans will merge or remain separately managed remains to be seen. According to the companies' June 10 joint news release, the deal is expected to close during the first half of 2020, pending shareholder and regulatory approvals. Some shareholders, including Pershing Square Capital Management CEO William Ackman, have expressed concern regarding the deal.

As of Dec. 31, Raytheon Co. had $25 billion in defined benefit plan assets, according to the company's most recent 10-K filing, and as of Dec. 31, 2017, the company had $19 billion in defined contribution plan assets, according to its most recent 11-K filing.

As of Sept. 30, United Technologies Corp. had $26 billion in defined benefit plan assets and $24 billion in defined contribution plan assets, according to Pensions & Investments data.

After the merger closes and the combined company is ranked No. 4 in U.S. corporate retirement plan assets according to Pensions & Investments data, staffers face a unique set of opportunities and challenges when deciding whether to merge those plans.

Ron Barin, New York-based senior adviser at River and Mercantile Solutions, said in a telephone interview that he has been worked on both company mergers and separations in his capacity as a corporate plan sponsor executive.

From 2008 to 2018, Mr. Barin was vice president, chief investment officer, pension investments at Alcoa Corp., and from 2000 to 2008 he was senior director, pension investments at Pfizer Inc.

The first step in analyzing a potential merger of plans, Mr. Barin said, is deciding which pension group is in charge, and what that personnel is going to look like. Or whether they will blend the two staffs.

"You also look at the profile of the plans," Mr. Barin said. "Are they open or are they closed? Are they frozen? What are the funded statuses of the plans? I know UT is probably in the 90% range, and Raytheon is probably in the mid-70s, so there's a pretty large difference in funded status."

According to United Technologies' and Raytheon's most recent 10-K filings, the companies' defined benefit plan funding ratios were 93.3% and 75.9%, respectively.

Looking at the liability profile, if a sponsor has an open plan, that profile is going to be longer than if you have a frozen plan, Mr. Barin said.

UTC has both open and frozen DB plans, while Raytheon's plans are closed.

"Then you have to look at really the objectives of the investment strategy," Mr. Barin said. "What the investment beliefs are."

Mr. Barin said the new pension staff must conduct an asset-liability study and then come up with a new strategic asset allocation.

"You then analyze your external lineup, for one, to see if there's any overlap (between the two plans) to see if you have the right investment managers," Mr. Barin said. "Because you have a higher (asset size), there should be an opportunity for more fee savings."

Mr. Barin was involved in merging plan assets when Pfizer acquired Warner-Lambert in 2000 to become the second-largest drug company in the world.

The merger of the companies ultimately resulted in the forming of a master trust structure while the plans themselves remained separate. The major challenge with that merger, Mr. Barin said, was that the Pfizer and Warner-Lambert plans had different custodians.

"I think Warner-Lambert used Mellon and Pfizer used Northern Trust, and that actually created a lot of complications with merging assets, so it wasn't as clean as it could have been. There were performance reporting issues that created a lot of complications," Mr. Barin said.

One unique characteristic of the UTC-Raytheon merger is that UTC is already spinning off its Otis and Carrier businesses before merging with Raytheon, setting up some unique challenges, Mr. Barin said.

In 2016, while Mr. Barin was at Alcoa Inc., that company split off into Alcoa Corp. and Arconic Inc. (the latter of which itself announced earlier this year it is splitting into two companies). That represented an interesting challenge, he said.

Because the newly separated companies each had fewer assets following the separations, they were charged higher fees by external managers.

"What we tried to do was argue it wasn't under our control to split the assets," Mr. Barin said. "You should consider both Alcoa and Arconic's assets when you figure the fees."

That, however, did not work, he said.

How to manage the investments of merged companies' retirement plans is only one challenge for staffers.

In general, there is no clear-cut answer whether companies that merge should combine their retirement plans, said Bruce Cadenhead, New York-based partner, global chief actuary-wealth at Mercer, in a telephone interview.

However, he said, Pension Benefit Guaranty Corp. premiums have been increasingly dictating companies' approaches on merging plans.

The fixed rate, which is measured per participant, is currently $80 in 2019. The PBGC's variable rates are determined by the funded status of a plan and is currently $38 per $1,000 of underfunding.

Regarding variable rates, Mr. Cadenhead said the similarity of defined benefit plans' funded status can determine whether merging the plans is prudent.

"A consideration would be whether you have plans that are at the PBGC premium cap, because if you're at the premium cap, it means you have a large amount of unfunded vested benefits," Mr. Caldenhead said. "If you have one plan in that situation and another plan that is well funded, then does it make sense to merge?" The premium cap for 2019 is $541 times the number of participants, according to the PBGC's website.

Mr. Cadenhead said regarding fixed-rate PBGC premiums, companies that merge will analyze how many employees may be participants in multiple plans. Merging the plans may be wise in this case since each of those single employees count as multiple participants and thus the company must pay multiple premiums.