Business

The Pension Paradigm Shift: Corporate America's Surplus Surprise

In a remarkable story of fiscal turnaround, Eastman Kodak Co., which dominated the photography industry for much of the 20th century, has seen its pension investment team's savvy financial strategies transform a significant deficit into a billion-dollar boon. Over a mere seven years, their bold investments in hedge funds and private equity metamorphosed a $255 million shortfall into an eye-opening $1.1 billion surplus. This astonishing financial feat has afforded the storied company a potential windfall in an era of tumultuous attempts at reinvention, ranging from ventures into cryptocurrency to forays into pharmaceuticals during the Covid-19 pandemic.

At the beginning of March, Kodak announced plans to transfer its pension management to an external firm, sparking curiosity about how it may leverage these newfound assets that nearly triple its market valuation.

A Nationwide Trend of Unexpected Pension Prosperity

Kodak's situation is but a microcosm of a broader phenomenon across the landscape of corporate America. Many companies are witnessing their old-guard defined-benefit pension plans transform from financial burdens into surprising sources of wealth. In a robust financial market buttressed by ascending interest rates, the outlook for these pensions has improved so dramatically that they now present as rather fortuitous nest eggs.

According to Mercer, a partner at a consulting firm, this represents a historic opportunity. Indeed, Mercer's most recent analysis reveals that as of February's end, companies within the S&P 1500 Composite Index boasted a combined surplus of $137 billion— a staggering turnaround considering the collective $500 billion deficit just a few years prior in late 2016.

Public Vs. Private Pension Contrasts

The revitalized status of these corporate pensions presents a stark contrast to the enduring deficiencies plaguing many public pensions, which sustain teachers, firefighters, police officers, and other government workers' retirements. Among corporate workers in the U.S., the retirement savings paradigm has shifted toward 401(k) plans, relinquishing the fixed benefits provided by earlier pensions and casting a cloud of financial unpredictability over future retirees. Larry Fink, CEO of BlackRock Inc., underscored the severity of the emerging retirement crisis in his yearly missive to investors, highlighting the alarming transition from financial security to uncertainty.

The Complex Quest to Utilize Surplus Funds

Despite the apparent abundance, it is not anticipated that the surplus from these generous defined-benefit plans will be dispensed directly to retirees. They are more likely earmarked for wider corporate objectives. While the notion of diverting these extra funds to other expenses seems straightforward, it is entangled with hefty federal taxes, potentially escalating to exploitative heights when state and local taxes are factored in.

It is theoretically feasible for corporations to extract pension funds for expenditures such as stock buybacks, but the prohibitive tax implications render such maneuvers imprudent.

Alternative Avenues to Capitalize on Pension Surplus

Corporations do have several tax-wise strategies to put their pension surpluses to work. One approach involves augmenting benefits for pension plan retirees or folding the surplus into a newly established plan that covers beneficiaries from the previous one.

On a more inventive note, some companies are employing their surpluses as strategic assets in mergers and acquisitions (M&A). This involves the potential consolidation of pension plans, which could most effectively allow the surplus from one to alleviate the underfunded status of another.

IBM's Pension Strategy: A Model of Innovation

A prime illustration of strategic surplus management is provided by International Business Machines Corp. (IBM), which combined its pension plan with a substantial $3.6 billion surplus with another plan. The move ingeniously utilized the surplus to counteract the approximate $550 million in yearly payments to that plan, securing IBM a prolonged reprieve from further contributions and liberating funds for alternative corporate uses.

This type of prudent financial planning is becoming a focal point for many companies re-evaluating their pension strategies, particularly regarding the disposition of surpluses.

The Rise of Pension Risk Transfers and Outsourcing Pension Management

Another strategy gaining traction for managing surplus is the pension risk transfer, a transaction where companies offload pension responsibilities to insurers. In anticipation of such deals, companies often initial engage professional money managers to oversee their pension assets.

This can lead firms to partner with outsourced chief investment offices (OCIOs), which are evolving as a favored option due to the managerial and regulatory complexities of pension plans. Companies invest significantly to manage these plans, covering HR costs, investment manager fees, and steep obligatory contributions to the Pension Benefit Guaranty Corp. (PBGC), the U.S. entity safeguarding private retirement funds.

The Outsourced CIO Landscape

The top global players in outsourced money management include Mercer, BlackRock, Russell Investments, and Goldman Sachs, with Mercer at the helm boasting around $420 billion in assets under management, closely followed by BlackRock with $400 billion and Russell with $375 billion. Goldman Sachs, itself managing approximately $250 billion, clinched a landmark mandate of almost £23 billion from BAE Systems Plc's pension plan in the autumn preceding.

These firms not only assist companies in investing their portfolio assets but also facilitate the kind of risk transfer deals that firms like Kodak are potentially deliberating and that are becoming more common with each passing year.

A Flourishing Future for Pension Risk Transfers

Goldman's annual corporate pension study indicates that 2022 marked a decade-high peak of $48.3 billion in risk transfer deals, with 2023 embarking on a robust commencement characterized by several multi-billion-dollar transactions. A recent example includes the UK insurer Prudential assuming responsibility for Shell Plc’s $4.9 billion U.S. retiree plan and Verizon Communications Inc.'s $5.9 billion initiative covering tens of thousands of retirees.

Overall, it is anticipated that the majority of U.S. corporations with surplus pension plans will explore risk transfer options in the following couple of years, primarily because a surplus diminishes the necessity for additional company contributions to complete the deals. As expressed by Sean Brennan of Apollo Global Management Inc.’s Athene, this represents the pinnacle of pension risk mitigation.

Insightful Reading on Pension Management Challenges

For further understanding of the complexities and challenges in managing pension funds, the QuickTake: Why Slow-Burn Pension Crisis Is Getting Harder to Fix[^1] provides valuable perspective on this critical issue.

[^1]: Why Slow-Burn Pension Crisis Is Getting Harder to Fix

Conclusion: The Dawning of a New Pension Era

The transformations occurring within corporate pensions reflect the dynamic nature of finance within the modern business landscape. What was once viewed as a financial encumbrance is now being recognized as a potent corporate asset—subject to innovative and strategic management. As companies navigate this new terrain, their choices will not only affect their financial health but also the retirement security of employees for years to come.

The encouraging state of these pension funds stands in contrast to the crisis warned of by investment magnates, but also presents a silver lining—a signal that with strategic financial management and foresight, even the most daunting fiscal challenges can be turned into opportunities.

(Bloomberg) - The dismantling of Eastman Kodak Co.’s internal pension investment team, as surprising as it was for their success in generating substantial profit, reflects the wider transformation happening within corporate pensions across America. The group, after successfully turning a deficit into a significant surplus, has constructed a potential treasury for the erstwhile industrial titan as it ventures to re-establish itself in a rapidly changing commercial environment.

As with Eastman Kodak, the renaissance in pension funding status across the S&P 1500 stakes a claim to be a defining point for the pension landscape and its role in wider corporate strategies. The practical challenge rests in how companies can strategically exploit these surpluses for M&A activities, benefit improvements, or complex risk transfer deals. However, as the market and regulatory landscapes continue to evolve, the ingenuity and creativity of companies in directing their pension finances will be instrumental in defining this new era of corporate pension management.

To tread further into the intricate world of pension management and strategic decision-making, visit the original Bloomberg article exploring Kodak's use of its surplus funds Kodak Explores Tapping Pension Fund’s $1.2 Billion Surplus.

©2024 Bloomberg L.P. The information herein highlights the shifting dynamics of pension funds within corporate entities and the innovative strategies being implemented to manage these assets for future growth and stability.