Source "The Times" (added by Webmaster)
January 22, 2004
Finance and Accountancy Viewpoint
GM 'profits' from boosting its pension fund
By John Ralphe
GENERAL MOTORS, the world's largest auto-maker, reported solid 2003 results this week. The company is also the world's largest corporate pension fund, reflecting its history as one of America's postwar industrial giants in a highly unionised industry.
As a result of contribution holidays, falling equity markets and declining bond yields, GM's US pension plans have, unsurprisingly, been in deficit to the tune of $19billion at the end of 2002 on liabilities of $80 billion. GM has now announced that at the end of 2003 its main US pension plans had no deficit, after company contributions of $18.5 billion and 22 per cent asset returns during the year.
The stock market rewarded GM's stock price before Christmas, when it first revealed details of the pension improvement. But, have things really improved for GM's shareholders, bondholders or pension plan members? The 22 per cent asset returns of 2003 were offset by higher liabilities, a lower discount rate and a new labour contract. In addition, the annual cost of pensions means GM had to run hard just to stand still. Wiping out the deficit is not down to sparkling asset performance, but to GM's $18.5 billion contribution, without which the deficit would be virtually unchanged. Most of the cash was borrowed in the bond markets, so GM's net debt has increased dollar for dollar as the pension deficit was reduced. Since GM's net asset position is unchanged shareholders and bondholders are no better off.
What about the 700,000 US plan members? Unlike their cousins at Vauxhall UK, they are protected by the Federal Pension Benefit Guarantee Corporation; so if GM became insolvent their staff are no better off. The main, if unintended, beneficiary of full funding is the PBGC, which now has a lower liability. Full funding also helps those senior members whose pension is above the PBGC minimum.
Why has GM injected cash into its US pension plan, over and above the legal minimum? The likely answer lies in the shortcomings of US pension accounting. This recognises as operating income the "expected return on assets" - GM assumes a 9 per cent return per annum - multiplied by the pension assets at the beginning of the year.
Borrowing to boost pension assets at the beginning of 2004 increases profits. Even after interest charges on the debt, net profit and earnings per share are up at a stroke. But borrowing to inject cash into the pension plan has no economic substance; GM is just moving money from its treasury pocket to its pension pocket.
The profit from selling cars is slim and any boost to the 2003 net profit of $3.2 billion and earnings per share of $5.60 is material. The smoke-and-mirrors of borrowing to increase pension assets will raise 2004 net profit by about $550,000 and EPS by about $0.70. A lot easier than selling cars.
GM not only has an incentive to maximise its pension assets at the start of the year, but is under pressure to continue to justify a 9 per cent "expected return" applied to those assets. This seems generous in times of low inflation, especially with a third of assets in bonds. Simply reducing the expected return on its $110 billion of pension/healthcare assets reduces 2004 net profit by $1.1 billion or a third of the 2003 net profit figure.
To justify the 9 per cent return GM is shifting some of its pension assets to higher risk asset classes, up to $10 billion in "alternative assets". This move raises the stakes for investors; GM is not only continuing to take a huge bet on the equity markets through holding equities, but is also betting on the ability of its alternative asset managers to deliver superior, sustained performance without volatility. Alternative asset managers must spot opportunities and identify rich pickings.
Like it or not, holding equities against bond-like pension liabilities is risky. GM can only shrink the risk in its pension fund by cutting the asset and liability mismatch, shifting equities into matching bonds, which it has ruled out, since it would hit net profits by lowering the "expected return on assets".
US pension accounting gives the impression that a pension fund can have a higher expected return of equities with none of the risk. This seems to fool some of the people some of the time, but as GM will find out, it cannot fool all of the people all of the time.
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