12 April 2010

Why Did GM and Chrysler Keep Their Pensions?

Unlike every other major company in history that has go bankrupt in recent history, General Motors and Chrysler kept their defined benefit pension plans in place.

Airlines and just about all other major companies that have gone bankrupt, terminated their pension plans, let the Pension Benefit Guarantee Corporation pick up unfunded liabilities, and started defined contribution plans.

This is because a defined benefit plan shifts a great deal of investment risk from the employee to the company. If a defined benefit plan is underfunded, which it typically will be during bear markets because its liabilities don't change in value much and its investments lose value, then the company has to put in more money at precisely the time when its bottom line is likely to be hurting. Absorbing investment risk from individuals is fine if you are a well capitalized insurance company selling straight annuity and life insurance products, and is not a very good idea when you are a manufacturing company with highly cyclic sales that is hanging on for dear life. A defined benefit plan is a significant contingent liability and form of leverage that isn't obvious on the face of the balance sheet.

Defined benefit plans also give workers an expectation of lifetime employment and an intense financial incentive to stay employed with the firm as long as possible, because this will not only allow the employee to continue to earn a wage, but will contribute an ever increasing amount (through a "normal" retirement age where the marginal benefits of additional work dramatically decline) to that employee's pension.

This makes voluntary early retirement incentives for employees, which are the main alternative to mandatory layoffs, very expensive, because early retirement is much more expensive for a worker who is close to retirement in a defined benefit plan than it is for a worker who is close to retirement in a defined contribution plan. This makes the job of scaling back operations for the two companies, which both have to do so and are likely to have to cut more in the future, more difficult.

Surprisingly, both companies actually had somewhat overfunded defined benefit plans at the time of their bankruptcies (assets which are not available to creditors), so it probably wouldn't have cost the federal government anything if the plans had simply been terminated at the time of the bankuptcy. Retirees did take a deep hit in the bankruptcies and were major creditors of both companies who have traded company debts to them for equity. But, the losses were from no PBGC guaranteed liabilities to retirees like retiree health insurance.

Now, the government faces the risk that there will be far bigger unfunded pension obligations in the future, and an increased risk that its investment in GM and Chrysler will be rendered worthless. The federal GM bailout investment looks likely to be repaid this year, and the federal government will still own valuable stock in the company, although this could change if a defined benefit plan liability that could have been eliminated in bankruptcy without undue controversy outstrips the ability of GM to meet its obligations.

But, the federal government has already lost its bailout investment to the tune of about $5 billion in the Chrysler bankruptcy, and the large stockholdings that the public has in Chrysler are more likely to become worthless as its sales have not turned around as GM sales have post-bankruptcy and it shows no signs of making a profit soon.

Essentially, labor, in insisting that the defined benefit plans stay in place in the bailouts and bankruptcies has made a big bet that the defined benefit plan liabilities won't pull GM and Chrysler under. This will mean a handsome reward for workers if the companies do survive, which is hedged by a federal PBGC guarantee. But, this has put the companies themselves at a far greater risk of future failure and has put the federal government at a far greater risk of having to make a big PBGC payout if one of these companies fails later.

No comments: