Horizon Kinetics On S&P 500 Companies With Large Unfunded Pensions

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This section will focus on companies in the S&P 500 with large unfunded pension and/or Other Post-Employment Benefits (OPEB), specifically The Boeing Company (NYSE:BA), Caterpillar Inc. (NYSE:CAT), E I Du Pont De Nemours And Co (NYSE:DD), Deere & Company (NYSE:DE), The Dow Chemical Company (NYSE:DOW), Ford Motor Company (NYSE:F), General Electric Company (NYSE:GE), Hewlett-Packard Company (NYSE:HPQ), International Business Machines Corp. (NYSE:IBM), Kraft Foods Group Inc (NASDAQ:KRFT), Lockheed Martin Corporation (NYSE:LMT), Pfizer Inc. (NYSE:PFE), Raytheon Company (NYSE:RTN), AT&T Inc. (NYSE:T), Verizon Communications Inc. (NYSE:VZ), United States Steel Corporation (NYSE:X), and Exxon Mobil Corporation (NYSE:XOM).

Of that group, one can make a sharp division between those companies with unfunded plans that would have no difficulty funding them if required, and those companies for which funding might be somewhat problematic. For instance, one might place Exxon in the former category. It has a $17 billion benefit obligation in its U.S. plan, a $29 billion benefit obligation in a non-U.S. plan, and a $7.9 billion post-employment benefit obligation. As of December 31, 2011, according to Exxon Mobil Corporation (NYSE:XOM)’s Form 10-K, its U.S. plan had assets of $10.7 billion; its non-U.S. plan had $17.1 billion; and its post-employment benefits plan had $500 million.

As you can see in the accompanying Table 1, Exxon Mobil Corporation (NYSE:XOM) had a $7.9 billion in post-employment benefits obligation with $500 million actually deposited in the plan. To fund that obligation would require some really extraordinary rates of return. There is a total funding gap of $25.6 billion. However, Exxon has $40 billion of earnings power per year so, if needed, it could make substantial fund contributions.

Notably, Exxon Mobil Corporation (NYSE:XOM) uses a 5.5% discount rate on the value of its pension liability; therefore, these liabilities are the present value figures. They are not, by any stretch of the imagination, the ultimate liability, which will be much greater. Nevertheless, even given the much greater number which, incidentally, corporations choose not to disclose, Exxon probably would have very little difficulty funding it; such funding might impact earnings, which could be problematic for the stock, but not in an existential sense for the company. Incidentally, the company also assumes a 7.5% rate of return on funded assets. It’s difficult to imagine how such a rate of return can be achieved. Exxon also estimates that its longterm rate of compensation increase, that is compensation paid to employees, will be 5.25%, and that has some bearing on what the ultimate liability in the plans will be. Nevertheless, Exxon has the resources to ensure its pension earnings will be paid.

Other companies are perhaps more problematic. Lockheed Martin Corporation (NYSE:LMT), for instance, had an accumulated pension benefit obligation of $40.6 billion at the end of 2011. In addition, it also had a liability of $3 billion for post-retirement healthcare. At the end of 2011, the pension plan had $27.3 billion in assets and the healthcare plan had $1.7 billion in assets. Hence, the pension fund is $13.3 billion underfunded and the healthcare plan is roughly $1.3 billion underfunded.

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Rightly or wrongly, the discount rate used to calculate the liability is 4.75%. Using current interest rates, the discount rate probably should be lower. However, companies won’t be using a materially lower discount rate, because Congress has passed legislation, which the President is almost certain to sign, that will enable companies to choose a 25-year average of rates. If that weren’t the case, and companies were forced to continue the current practice of a two-year average, the liabilities would increase tremendously. Those increases would be balance sheet events for companies. Not wishing to cause more balance sheet events, Congress changed the rules.

Using the discount rate of 4.75%, the liability on Lockheed Martin Corporation (NYSE:LMT)’s pension would increase by $1.93 billion simply as a function of the discount rate used. That amount is approximately 7.06% of pension fund assets so, if the return on the pension fund assets were actually 7.06% per annum, the funding gap would stay the same. To narrow the funding gap without contributions, Lockheed would need a yet higher rate of return, much more than appears reasonable, given the currently available very low rates on bonds.

Full article via Horizon Kinetics

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