As General Motors transforms into a very healthy automaker with world-class products, operations, and profit margins, it has been and continues to be burdened by some of the largest pension obligations among all U.S. companies. Luckily, it is taking control of the pension obligations, thereby freeing up cash to invest in the business and develop future models and technology.
Last week, the company said that it has noticed a significant improvement in its obligations thanks to rising interest rates used to calculate the cost of future payments to retirees. Simply put, rising interest rates decrease today’s cost of pension-related promises in the future. In other words, pensions obligations that have been stockpiling for years can shrink without cash outflows by The General.
The development is fortuitous for GM, as it should theoretically allow the automaker to spend and focus more on its core business of innovating, designing, engineering, building, and supporting the world’s best cars, trucks, and SUVs in the long term, rather than worrying about funding pension obligations. This situation results in a more colorful outlook for The General, which is just entering its global product offensive by getting ready to roll out a slew of all-new or highly-refreshed products over the next 2-3 years while earnings better-than-expected profits.
Over the years, General Motors (along with cross-town rival Ford) have spent heavily in trying to fulfill their pension obligations — something that has become one of the companies’ most challenging issues. At the end of 2012, GM had a pension plan shortfall of $27.8 billion, while Ford’s stood at $18.7 billion.
“We’ve made good progress since the end of last year from a pension-funded position perspective, given the rise in interest rates that’s clearly helped our overall funding position,” said GM CFO Dan Ammann. During a conference call with analysts, Mr. Ammann also mentioned that the stronger fund “gives us more rather than less flexibility.”
This year, GM isn’t required to make any contributions to its U.S. pension funds, but will pay in roughly $900 million anyway. Last year, GM initiated a plan where it would spend $4.5 billion to transfer salaried retirees to a group annuity managed by a unit of Prudential Financial. GM forecast that the annuity, along with the lump-sum buyout offers to 42,000 retirees, would shave $26 billion from its pension burden.
And according to GM’s 2012 annual report, an increase of 1 percentage point in the discount (interest) rate sheds an astounding $8.76 billion from the present value of the automaker’s U.S. pension obligation. According to some analysts, GM may be able to cut its pension shortage by 24 percent to $21 billion. But the current value of promised future payments is only a part of the total pension situation, as the investment return is also a major component in assessing the heath of a plan. But the basic principle still stands: the less time and other resources GM has to dedicate to figuring out and fulfilling its pension obligations, the more it can do what it does best: make great automobiles.
As an aside, an interesting by-product of rising interesting rates is the greater cost of credit for the consumer, which may act as a deterrent to car-buying. So as GM’s overall pension obligations shrink thanks to rising interest rates, sales of its vehicles (and those of competitors) could begin to drop off. But that’s a lesson in economics for another day.