Essay on Pension and Benefit Obligation

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RETIREMENT BENEFITS ANALYSIS

Why Are Pensions Important?

Benefits at Retirement
Pensions
Other Post Retirement Benefits

Role of Estimation

Determining Retirement Costs

Contributions

Determining Plan Obligations

Determining Plan Assets

Funding Status

Pension Plan Disclosures

Analysis of Retirement Plans
Common Size
Funding

Underfunded Pensions

WHY ARE PENSIONS IMPORTANT?
Societal Implications of Retirement Benefits

Social Significance – Who is responsible for the elderly?

Government?
Former Employer?
Family?
Individual?

Financial Significance – Some pension plans are larger than the corporation. The full pension liability is not recognized on the balance sheet.

Career Significance – You should understand pension benefits before accepting a job.

WHY ARE PENSIONS IMPORTANT?
Pension Analysis Issues

Pension amounts are earned, but not paid until later. When should the expense be shown on the income statement?

How should amounts owed to future retirees be shown in the financial statements?

How do we know if a pension plan is healthy?

WHY PENSIONS ARE IMPORTANT?
Impact of Retirement Benefits
On Corporations

From 2010 Annual Reports
(in millions)

Corporation
Corporate
Liabilities
Pension
Obligation
Post-
Retirement
Obligation
General
Motors
$101,739
$128,157
$9,919
Ford
Motors
$166,435
$70,032
$6,423
Dow
Chemical
$46,946
$21,158
$2,095
Sears Holding (+Kmart)
$15,654
$7,024
$589
Kimberly-
Clark
$13,662
$5,658
$796

BENEFITS AT RETIREMENT

Two kinds:

Defined Contribution – employer makes periodic payments into employee controlled account prior to retirement.
In US, governed by §401(k) of the Internal Revenue Code
Employee holds assets in special accounts
Employee usually has flexibility regarding where invested
Some plans allow for both employer and employee contributions
Benefits are typically taxed when withdrawn
Withdrawal prior to 59½ is subject to 10% penalty
Withdrawals are required by 70½

Defined Benefit – employer makes payments to employee after retirement
Funds are placed in a third party trust
Payments typically determined by a formula based on years of service and salary

Who uses what? Of 150 large corporations (PwC 2005):

91% have defined contribution plans
48% have defined benefit pension

BENEFITS AT RETIREMENT
Postretirement Benefits

If offered, benefits will be in the form of:
Medical Plan
Dental Plan
Life Insurance

Note: 53.0% of large American companies have retiree health plans

BENEFITS AT RETIREMENT
Trends

Percentage of workers in defined benefit pension plans at medium and large employers

1980 – 84%
2003 – 33%

Source: Fortune June 26, 2006, p. 86

ROLE OF ESTIMATION

Pension analysts and actuarial scientists make assumptions and estimates for the following key factors: • Discount rates

• Inflation rate

• Salary growth

• Expected return on plan assets

• Retirement rates

• Mortality rates

• Expected contributions

STRAIGHT FROM THE 10-K
Role of Estimation
Ford Motor

Assumptions and Approach Used.

We base the discount rate assumption on investment yields available at year-end on long-term bonds rated Aa- or better. In the United States we use the Moody’s Aa long-term bond yield as the initial indicator of these yields

Our inflation assumption is based on an evaluation of external market indicators.

The salary growth assumption reflects our long-term actual experience, the near-term outlook and assumed inflation.

The expected return on plan assets assumption reflects various long-run inputs, including historical plan returns and peer data, as well as inputs from a range of internal and external advisors for capital market returns, inflation and other variables, adjusted for specific aspects of our strategy.

The
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