GM's High-Performance Pension Machine

By Allan Sloan
Tuesday, April 10, 2007

There hasn't been much good news out of General Motors in recent years, but you'll be glad to know that at least one part of GM's U.S. operation is finally fixed: its pension funds. GM may be having a hard time turning around its auto business and getting its financial statements straight, but it's kicked butt in pensionland. In fact, GM's funds have done so well that the company has switched about $20 billion in pension assets to lower-risk bonds from higher-risk stocks. It's the equivalent of taking chips off the table after you've gotten ahead of the game.

Here's the deal. For reasons we'll examine later, GM's pension surplus increased by $9.6 billion in 2006. That gain would have made GM spectacularly profitable if pension results were part of companies' income statements, as some folks propose. I think that's a bad idea because pension returns distort results, which in turn would discourage companies from offering them. Not that they need much discouragement these days.

GM shows just how volatile pensions can be. In a mere four years, its U.S. funds have swung $35 billion, going from $17.8 billion underfunded (according to generally accepted accounting principles) in 2002 to $17.1 billion overfunded last year. To lock in those hard-earned gains, GM has switched investment targets in its $101 billion pension portfolio to just 29 percent stocks and 52 percent bonds from 49 and 32, respectively. (The other 19 percent is in real estate and "alternative investments" such as hedge funds.) Bonds are much less volatile than stocks, hence the change. "It's all about maintaining the funded status of your pension funds," GM's chief financial officer, Fritz Henderson, told me. "We want to take pension risk off the table."

How did GM go from the most underfunded corporate plans in the country four years ago to the most overfunded? By putting a ton of money -- $18.5 billion -- into the funds in 2003, most of which it raised in a giant bond issue. It wanted to fix its pension problems once and for all, which it did by getting above-market returns on that new money in what turned out to be an excellent investment market. GM has a stellar investment staff, and I've joked for years that it should dump the car biz and become a money manager. But who listens to me?

Although GM can't transfer the $17 billion surplus from its pension funds to its corporate coffers, it's using the surplus indirectly to help buy time for an auto turnaround. The pension funds absorbed several billion dollars in costs to help facilitate 34,000 early retirements last year as part of GM's huge cutback in its workforce. GM is also using its pension surplus to pick up part of its tab for the debacle at Delphi, the former GM parts division that filed for bankruptcy protection in 2005. GM expects to assume $1.5 billion to $2 billion of Delphi pension obligations as part of Delphi's planned emergence from bankruptcy protection this year.

Now let's crunch some numbers to see how GM ended up almost $10 billion ahead on its U.S. pension funds last year. (I keep stressing "U.S." because GM's non-U.S. pension funds are underfunded, but we're dealing only with the United States today.) Interest rates first. It doesn't make intuitive sense, but higher interest rates make pension-fund liabilities seem smaller than lower rates do. Here's why: Say you promise to pay someone $10,000 30 years from now. At an interest rate of 5.7 percent, which GM used in its 2005 calculations, that $10,000 liability three decades out goes on today's books as an obligation of $1,896. At 5.9 percent, the 2006 number, that liability is only $1,791. (GM doesn't get to choose its own discount number -- it uses a formula that's based on long-term interest rates.) The rate change's impact on GM's funds: about $1.6 billion.

Then there are investment returns. GM was projecting a 9 percent overall return last year but earned 15 percent. That added $5.4 billion to the surplus. Then there's everything else: an addition to the surplus by cutting back salaried employees' pensions, a charge from the aforementioned 34,000 early retirements and a variety of other stuff, all of which added $2.6 billion to the surplus. GM has now lowered its expected return on pension assets to 8.5 percent, but that doesn't affect the pensions' surplus.

And yes, there's a broader point I want to make. GM illustrates how volatile pension numbers can be. So remember not to panic when you hear about pension "crises" unless the plan's sponsor is about to go into bankruptcy. You should also remember that pension surpluses can disappear if markets crater. And one final point: GM shows that fixing a purely financial problem like pensions can be a lot quicker than fixing a complicated manufacturing business. Like cars.

Sloan is Newsweek's Wall Street editor. His e-mail address

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