Mini Case Study

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Mini Case Study

• General Motors Pension Plans

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Whats up (or really down) at GM?
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Things can only get better?
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More News July 2008

• GM suspends its 1 per share annual dividend
• First time dividend suspended since 1922
• Estimated to save 800M through 2009
• Also raise 2-4B through sale of assets
• Included in likely sales Hummer brand

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GM pension plan background

• Largest corporate DB pension plan
• Plan covers 452,000 retirees and spouses, plus
  195,000 active employees
• Company currently pays 7B in annual benefits
• Healthcare plan also leads to large outflows

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Perfect Storm for DB Plans Recently

• Market down ? plan underfunded ? have to increase
  contributions
• Interest rates down ? NPV of future pension
  obligations increases
• Mortality rates down ? NPV of future pension
  obligations increases

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How is GM affected?

• During 2002, GM contributed 5.8 billion to DB
  pension plan
• At end of 2002, GMs DB pension plan still 19.3
  billion underfunded (net income over 2002-2004
  8.3 billion)
• GM estimates one percentage point increase in
  rates ? liabilities fall 7B

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What did GM do to shore up pension plan?

• June 2003, GM has largest U.S. bond offering 13
  billion (10 billion earmarked to shore up DB
  pension plan)
• Raised additional 5 billion with sale of Hughes
  to contribute to pension plan as well
• GM will continue to make sizeable contributions
  to DB plan (18.5B in 2003 and 9B in 2004)
• What else can GM do to close the gap?

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What else is GM doing?

• Changed investment strategy
• In past, relied on investments in stocks and
  corporate bonds
• Now investing more in less conventional and
  riskier financial securities such as junk bonds,
  emerging market funds, REITs
• Counting on 9 return on investments

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How did market respond?

• Stock price continued to plummet
• Earnings have been disappointing
• May of 2005, SP downgrades both GM Ford to
  junk bond status
• Currently, GM has 35B in long-term debt, 19B of
  cash on hand, had net losses of -39B in 2007
• Going forward, more expensive to issue debt

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Who bears risk of GMs riskier investment
strategy?

• In part, YOU!!!
• PBGC Pension Benefit Guaranty Corporation,
  provides insurance to employees covered by DB
  plans (similar to FDIC for bank deposits)
• Cap of coverage of around 50,000 for single-life
  annuity
• Currently PBGC insures benefits for 44 million
  workers enrolled in roughly 30,000 plans

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How Does PBGC work?

• Firms pay premium into PBGC, however premium paid
  is not sufficiently tied to riskiness of
  pension-asset management
• PBGC currently faces shortfall (assets less than
  liabilities inherited)
• Mid-2004, U.S. corporate pension plans 280
  billion underfunded (somewhat better now)
• Roughly 2/3 of SP 500 have DB plan
• Airlines (like United) have added to PBGC woes

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Effects of DB Pensions

• Some companies like GM Ford have been
  downgraded by SP and Moodys because of concerns
  related to pension obligations
• Bankers also keeping an eye on DB pension
  underfunding
• If plan is underfunded, firm may have to reduce
  shareholder equity, which can violate debt
  covenants
• Firms like Delta and Cummins have had to pay off
  relevant debt or agree to higher fees because
  violating terms of loans
• Companies like Kellogg and Unisys were sure to
  have fluctuations in pension-funding status
  excluded from measure of net worth used by
  creditors

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What about PBGC going forward?

• Outlook is not rosy
• Experts estimate PBGC will continue to run
  increasing deficits and could run out of cash all
  together by 2020
• Why not just raise premiums for insurance it
  provides?
• Could ultimately require taxpayer bailout