In the bipartisan federal budget bill signed into law last November, Congress acted for the third time in four years to give corporate pension plan sponsors relief from funding requirements for underfunded plans.
In the same bill, Congress authorized a sharp increase in the premiums that plan sponsors — especially the vast majority whose plans are underfunded — must pay to the Pension Benefit Guaranty Corp. (PBGC)
The congressional give-and-take parley means that plan sponsors, which already had to consider an array of factors in setting plan-funding strategies, have a weighty new one on their plates.
For any particular underfunded plan, the question for its sponsor is whether to use the funding-relief mechanisms to reduce the minimum annual amount it must contribute to the plan under PBGC regulations. That choice would keep contributions low, but it would impose what’s in effect a heavy tax on underfunded liabilities in the form of PBGC premiums. It also would, in effect, “kick the can down the road” — plan sponsors will, after all, have to fully fund their plans eventually.
(The funding relief first was included in the Moving Ahead for Progress in the 21st Century Act (MAP-21), a 2012 law governing federal surface transportation spending. The relief was expanded by provisions of the federal budget bills enacted in 2014 and 2015. In each case, pension plan sponsors were granted leeway to use a 25-year smoothed interest rate in calculating future plan liabilities, which would be much lower than if they used the prevailing, historically low market rates.)
Instead of keeping contributions low, a plan-sponsoring company could choose to ramp up its contributions and thereby rein in its PBGC premium payments, which had been rising even before the most recent federal budget ratcheted them up much higher. That, though, would involve using cash that then would be unavailable for other corporate purposes.
“Companies are looking at their capital structure and trying to decide whether there’s an opportunity or rationale to fund their plan above the minimum required contribution in order to pay a lower premium, which is just like a tax,” says Ari Jacobs, global retirement solutions leader for human capital consulting firm Aon Hewitt. “Is it the right thing to do from a funding standpoint? An available cash standpoint? How does it compare to other uses of funds for M&A, stock buybacks, dividends, or whatever?”
Also up for consideration: whether the matter could be addressed from a debt-issuance standpoint. General Motors announced in a Feb. 23 regulatory filing that it would issue $2 billion in unsecured debt this year to be specifically allocated to a contribution to its pension plan for hourly workers. The debt consists of long-term notes, with $1.25 billion due in 2036 and the rest in 2046.
GM’s hourly-worker plan was underfunded by $10.4 billion at the end of 2015, comprising about half of its total pension underfunding. Cumulatively, the company’s pension plans are the second-most underfunded of any U.S. corporation, according to Russell Investments. (See chart, above.)
The strategy of borrowing to fund pension plans is not new, although it tends to come in and out of vogue. Still, GM’s move has attracted a lot of attention in the pension arena, because the company was not required to make the contribution that the debt will fund.
“In the past when we’ve seen this, it’s been reactionary to required contributions as opposed to an elected contribution,” says Bradley Smith, a partner at NEPC, an investment adviser that has pension-sponsor clients with plans totaling $237 billion in assets. “That’s why it’s newsworthy.” (GM is not an NEPC client.)
Opinions on GM’s strategy from such experts are uniformly positive.
“The PBGC premium is dead money,” says Bob Collie, chief research strategist, Americas institutional, for Russell Investments. “It doesn’t reduce your deficit, so it operates just like a tax. Every time the premium goes up, it shifts the balance toward making sense to fund your plan. Now, it depends on what your borrowing cost is, your tax situation, and other complexities, so it’s a case-by-case calculation.
“But in the generic calculations we’ve done, there’s a strong case for considering doing what GM is doing. We think that for a lot of plans, it is a positive calculation in terms of net present value. To us, the math is overwhelming. We’ve been talking about this happening for a year.”
Collie is expecting other underfunded plans to follow in GM’s path, not only because of the math, but because sponsors of the largest corporate pension plans are often “first movers” on strategy. For example, in 2012, General Motors, Ford Motor, and Verizon Communications launched a trend of offering lump-sum buyout settlements to groups of pension plan participants that is still playing out today.
Aon Hewitt’s Jacobs says the borrowing strategy “makes tremendous sense” for investment-grade companies. “Borrowing costs are low, and you avoid the PBGC tax. I expected this to be a bigger wave than it has. I think there are still a lot of organizations that don’t want to risk overfunding because they think interest rates are going to go up,” which would which allow plans to fund up without a cash infusion from the sponsor.
But that hesitancy is less relevant with regard to fixed-income investments. Indeed, NEPC’s Smith said the debt-issuance strategy will be sound only for plan sponsors that de-risk the investment.
And that’s exactly what GM intends to do. All $2 billion of the borrowed funds will be going into fixed-income instruments, according to Dhivya Suryadevara, the company’s vice president of finance, treasurer, and CEO of its GM Asset Management unit.
However, Suryadevara adds, the savings on PBGC premiums is more “icing on the cake” than the primary reason for the debt-fueled contribution to the pension plan.
“It’s more about risk management,” she says. “We tend to look out a few years at what our non-operating calls on cash are going to be. Understanding that we’re in a cyclical business, we want to make sure we’re able to meet those even during a downturn.”
GM currently expects that it will not have to make significant mandatory contributions to its U.S. pension plans for the next five years. “If you pre-fund it, it pushes that mandatory contribution out a bit further,” Suryadevara notes. “In the process, we’ll also be able to save on the PBGC premiums.”
She adds that while GM will look on a regular basis at issuing additional debt to fund pension contributions, it’s not known whether or how often it will actually do so.
There are two elements to the PBGC premiums that plan sponsors pay. First, there is a flat-rate, per-participant fee that has been rising steadily since 2006. It was $57 in 2015, is $64 this year, and will continue to rise until it hits $80 in 2019, after which it will be subject to annual inflation adjustments.
That’s not what companies are concerned about. There’s also a variable-rate premium that is a percentage of a plan’s unfunded liabilities, currently capped at $500 per year per participant. It was below 1% for many years but began rising in 2014 and for 2016 is approximately 3%. The variable rate also will keep rising until 2019, when it will reach 4.1%.
For plan sponsors with a poor funded status, premium bills will be huge. A letter sent to the PBGC last November, signed by more than 100 companies, expressed outrage at the steep increases.
“Every additional dollar that employers must pay to the PBGC is one less dollar that can be used to fund participant benefits, expand businesses, create jobs, or grow the economy,” the letter said. “Rather, these premium increases foster economic uncertainty, hamper investment, endanger jobs, and constrain economic growth.”
Further, the companies griped, “PBGC premium increases also create an unfair playing field among employers, as only the employers that voluntarily provide defined benefit pension plan benefits face this tax burden.”
Still, the many companies that have taken advantage of the funding relief mechanisms introduced in the past two years have only themselves to blame for finding themselves in a deeper, more highly taxed hole to climb out of with respect to funded status. And in doing so they played right into the federal government’s hand.
“When the relief in MAP-21 was introduced, it was a reaction to the [then-recent] financial crisis, intended to help companies contribute less money to their plans because they had so many other needs for their cash,” says Collie. “The last two rounds of relief were both part of budget acts, which makes it very clear that the intent was to reduce tax-deductible contributions as a way to increase tax revenue and use that in budget-balancing calculations. The rationale for the relief was pretty blatantly political.”
Photo: John F. Martin for General Motors