By Vipal Monga; The Wall Street Journal ~ Jun 19, 2012

The many big companies looking to gain control over their yawning pension-fund obligations are finding there are no quick fixes.

Earlier this month, General Motors Co. said it would pare its pension obligations for retired white-collar workers by billions of dollars, in part by offering them a lump-sum payout, instead of continuing payments. GM also said it would hand responsibility for the retirees’ pension plan off to Prudential Financial Inc. by buying a group annuity contract; it said that wouldn’t change the plan’s payments.

GM’s approach followed Ford’s announcement this spring that it would reduce the size of its pension plans by offering to pay lump sums to about 98,000 white-collar retirees and former employees.

Those moves may help the auto makers reduce the volatility of their pension obligations, which rise and fall based on factors such as interest rates and the life expectancy of retirees. But few other companies are expected to follow suit, pension experts say, because they would run the risk of having to pay a bigger lump sum now than they would in the future if interest rates were to rise.

If interest rates were higher, says Bob Collie, chief research strategist at Russell Investments, companies would need fewer assets in their pension funds to cover future pension liabilities than they do at the today’s low rates. “If you made a $100 lump-sum payment today, if interest rates went up in a year, you’d only have to pay $90,” he said.

According to the actuarial firm Milliman Inc., the 100 largest corporate pension funds, in terms of assets, had a combined shortfall of $356.96 billion at the end of May, more than double the $163.27 billion deficit recorded a year earlier and the third-largest on record—and that was after contributing $55.09 billion in 2011 to narrow the gap. Last year’s contributions were down 8.7% from $60.33 billion in 2010, but almost five times the $12 billion they contributed in 2000.

Changes in pension laws that took effect this year reduced the cost of making lump-sum payouts, giving companies a reason to explore them. To determine how much to pay out, companies use a so-called discount rate to calculate the present value of their future liabilities. The lower the rate, the bigger the payout required.

Previously, companies had to use rates based on Treasury bonds to calculate lump-sum payouts. Now, they can use corporate bond rates, which are higher, effectively reducing the size of the lump sum.

“A very large portion of our client base is considering the expanded use of lump sums,” says Matt Herrmann, head of the retirement risk-management group at consulting firm Towers Watson. He said companies are trying to determine what the likely acceptance rates would be for any lump-sum offer, whether it makes sense to consider making such offers when interest rates are so low and how to structure the offers administratively.

Market conditions, however, have made lump-sum payouts too costly for most companies, according to John Ehrhardt, a principal at Milliman. Because interest rates are so low, “you’re getting rid of your liabilities when they’re at their all-time high,” he says. Milliman data show average discount rates at the end of May were 4.56%, just off their record low of 4.53%, set last October and November.

“The pace at which companies do this is going to slow down,” says Russell Investments’ Mr. Collie. “Some may decide to hold back.”

Michael Moran, a pension strategist at Goldman Sachs Asset Management, says the lump sum and annuity strategies have been tried before, but the sheer size of GM and Ford’s obligations and the money needed to meet them makes them unique.

“It’s pretty overwhelming,” he says, referring to the size of Ford and GM’s pension obligations relative to their market capitalizations. GM has projected global pension obligations of $134.3 billion, four times its $33.56 billion market capitalization, Milliman says. Ford’s projected $73.98 billion obligation is almost double its $39.46 billion market cap.

Mr. Moran characterized GM’s response as “aggressive,” and says it may be pursued only by companies that have a very large exposure to their pension plans.

Ford said it won’t be able to predict the total cost of its lump sum until it knows how many retirees will accept the offer. GM, through its lump-sum offer and annuity purchase, will be paying roughly $29 billion to remove $26 billion from its balance sheet, or an 11% premium.

Daniel Ammann, GM’s chief financial officer, said in a June 1 conference call with analysts that lessening the risk and volatility in GM’s pensions made the premium worthwhile. “As a result of reducing the volatile and debt-like pension obligation, The company’s overall financial flexibility is enhanced, and we will be less exposed to the funding volatility and calls on cash we’ve experienced in the past, which in turn will improve our flexibility to deploy our cash for alternate uses,” he said.

A spokesman for Ford said the lump-sum strategy was part of its goal of reducing risk in its pension plans, and having them fully funded by mid-decade.

Companies with pension plans have been under extreme pressure since the fourth quarter of 2008, following the bankruptcy of investment bank Lehman Brothers, when the aggregate pension deficit widened to $269 billion by year end from $6.7 billion at the end of September.

Given the currency crisis in Europe and slow growth in the U.S., few expect changes anytime soon in the toxic combination of low interest rates, which increase a company’s pension liabilities, and weak stock-market returns, which hurt the value of pension-fund assets.

Milliman’s Mr. Ehrhardt said that rising interest rates eventually will reduce pension liabilities and an improving stock market could help boost asset values, which raises the possibility of simply doing nothing today. “The other thing is to ride it out,” he said. “Sooner or later, interest rates are going to have to bump back up,” he says.