Ford CEO Alan Mulally has turned around the automaker through excellent management decisions. Photo credit: Ford Motor Company.
I recently wrote a brief article regarding Ford Motor Company (NYSE:F)‘s underfunded pension plan and how low discount rates have played a role in creating a huge obligation for the company. At the end of 2012, with discount rates at low levels, the company left an underfunded pension plan to the tune of $18.7 billion – larger than Ford Motor Company (NYSE:F)’s automotive debt of $15.8 billion. What most people don’t understand is how quickly this can turn around as rates rise.
Break it down
As discount rates rise, obligations decline – simple right? But that doesn’t put into perspective how much or how fast this can happen. For General Motors Company (NYSE:GM), which has a pension plan underfunded by a staggering $27.8 billion, an increase of one percentage point in the discount rate would cut $8.76 billion from its obligation value, according to Automotive News. A similar rate increase would reduce Ford Motor Company (NYSE:F)’s obligation by $5.2 billion – more than it has paid into the fund in the last two years combined.
In Ford’s second-quarter conference call and presentation it was very clear that management is happy with how its underfunded pension plan has been progressing this year. The reason is that Ford has witnessed a 70-80 basis point rise in discount rates this year. An increase toward the high end of that range would reduce Ford Motor Company (NYSE:F)’s pension gap by 42%, down to $10.8 billion by the end of this year, said Matthew Stover, an auto analyst with Guggenheim Securities, according to Automotive News.
While that’s very promising, that’s only part of the equation. On the other side of the equation, Ford Motor Company (NYSE:F) is putting more cash into the fund than it has previously. In 2011, it put in $1.1 billion, and it increased the amount to $3.4 billion last year. Both amounts still pale in comparison to the $5 billion in planned contributions this year (much of that $5 billion will consist of voluntary or excess payments).
Consider that through the first half of 2013 Ford has paid in $2.8 billion, of which $2 billion was paid voluntarily. Meanwhile, General Motors Company (NYSE:GM) isn’t required to make any contributions to its pension plans this year, and will make a voluntary payment of just under $1 billion – still far behind Ford in tackling the problem with voluntary payments.
In addition to adding more capital into the fund, Ford Motor Company (NYSE:F) is also exercising a pension buyout strategy this year. Essentially, it’s offering some retired employees a choice to take a lump sum, and it already has completed about 60% of expected settlements, according to Ford’s second-quarter presentation.