Thursday, July 23, 2009

Sears Holdings Bails out Delphi. Yes, that's correct.

It seems Eddie Lampert and Sears Holdings will have to pay for the Delphi pension bailout.

First, the news of Delphi.
The Pension Benefit Guaranty Corp. agreed to take on $6.2 billion in pension liabilities from bankrupt auto supplier Delphi Corp., putting in place a key piece in the bailout of the car industry but renewing pressure on a government agency facing huge burdens as more companies fail.

The pension rescue is the PBGC's second-largest ever, ranked by dollars, after that of United Airlines in 2005, which totaled $7.5 billion. As a result, the government will take over payments for 70,000 workers and retirees that Delphi says it can't afford under its restructuring plan.
How does this impact Sears? From Lampert's March 06 Letter. (Read the bold if you are in a hurry)

I thought it would be useful to share my thoughts on the status of Sears Holdings’ pension plan funding and more generally on the pension plan issues that the American economy is now confronting.

Sears Holdings has a very significant pension plan obligation. The Company’s current estimated U.S. pension liability – which includes both the Kmart Employee Pension Plan and the Sears Pension Plan – is roughly $6.1 billion (applying a 5.5% discount rate) and the combined pension assets are about $4.3 billion, which leaves a pre-tax shortfall of about $1.8 billion. While $1.8 billion is certainly a large number, there are three points I want to make about it:

§ First, the estimated pension liability (of Sears Holdings or of any company) is very sensitive to interest rates. A pension is a promise to pay benefits in the future. To estimate (in today’s dollars) what that promise represents, these projected future benefits are discounted back to today’s dollars using current interest rates. The lower the interest rate, the higher the estimated pension liability – and with interest rates currently near historic lows, the estimated pension liability for all companies is relatively high. If interest rates rise in the future, however, estimated pension liabilities will decline: in Sears Holdings’ case, we expect that a one-percentage-point increase in interest rates would reduce our plan’s liability and funding shortfall by approximately $750 million.

§ Second, Sears Holdings has the financial capacity to meet this pension obligation (as one can see based on our current cash position). Further, we are very focused on appropriately managing this liability to meet our obligations over time by conservatively managing the asset portfolio, and not using the portfolio or assumptions related to it to improve earnings, to chase better investment performance, or to do anything else that is disconnected from the goal of meeting the pension obligation.

§ Third, and most importantly, Sears Holdings is committed to honoring this obligation and has demonstrated that commitment. In bankruptcy, for example, Kmart could have attempted to “walk away” from its pension obligation like some other companies have. But it did not, instead opting to honor its obligation to associates and retirees. Over the past three years, moreover, Sears and Kmart have contributed $1.4 billion to their pension plans.

Because a pension is by its nature a long-term obligation, Sears Holdings’ intention is to fund our pension obligations in a measured, disciplined manner, much like the way most people pay for their homes through mortgages. Recent events, however, have complicated matters. As you know, a number of companies have defaulted on their pension plan obligations, and this has prompted two significant legislative changes. First, the premiums assessed by the Pension Benefit Guaranty Corporation (PBGC), which is in essence a government-mandated pension plan insurance program, are increasing. Second, pension funding relief rules, which were enacted because interest rates were at historic lows and would have threatened the liquidity of many companies, were allowed to expire.

The net result of these changes is a significant increase in pension costs for those companies – like Sears Holdings – that have pension plans. The annual PBGC premiums Sears Holdings pays will increase by nearly 60 percent, and we, like many other companies, will be required to increase our pension contribution by hundreds of millions of dollars over the next few years. And we still don’t know where the costs caused by legislative changes will ultimately end: a number of measures are pending in Congress and each would have onerous consequences to companies with defined benefit plans.

There are at least three problems with the recent wave of pension reform efforts. First, while the desire to ensure that retirees are protected if their former employer defaults on its obligations is an admirable and characteristically American one, the system for funding that pension insurance is outdated. Under the current system, the costs of providing that PBGC insurance are borne only by a subset of American businesses, namely those that offer (or have in the past offered) defined-benefit plans. This may have seemed sensible in an era when offering a defined-benefit plan was the norm for American businesses, but given the tendency in recent decades of employers to avoid the liabilities and regulations associated with defined-benefit plans, this system results in the burden of pension insurance being placed entirely on older companies, like Sears and Kmart, and not on more recently established companies. We are not against new competition; in fact, we welcome new competition as a way to force us to be more relevant to our customers. We believe, however, that if policymakers are going to attempt to redress the broad, structural problem of pension plan default in a way that burdens older American businesses and favors newer firms, then that policy decision (and its consequences to the American business landscape) should be made explicit and fully debated.

Second, even among companies with pension obligations, the PBGC premium increases are applied across-the-board, without regard to whether a company’s pension plan funding is manageable or precarious. Accordingly, a company like Sears Holdings, with a large market capitalization and significant cash flow relative to its pension liability, is being forced to “bail out” other companies that (for whatever combination of reasons) have not been as successful managing their pension obligations. This is very different from a traditional insurance program, in which premiums are adjusted for risk and a company is rewarded for good behavior. (Some have proposed that premiums should relate to a company’s credit rating, but if that is to be the measure then there also needs to be a more fair and consistent evaluation by the credit rating agencies of Sears Holdings’ strong cash flow and credit statistics, as I mentioned above.)

Third, pension regulations today do not allow companies to recapture assets from plans that are (or become) overfunded. Under current law, if a company’s pension plan becomes overfunded, i.e., if the plan’s current assets exceed the present value of the future obligations, then additional contributions by an employer are not tax-deductible and are not capable of being recouped by the company. Instead, those assets become trapped. This creates a powerful disincentive that discourages employers from fully funding or over-funding their pension plans. This surely is an unintended result and is ripe for a legislative solution. Because of this trapped-asset risk, the sensitivity of the obligation to interest rates, and the long-term nature of the obligation, we believe that pensions should be funded in a measured, disciplined manner.

The net result of the current system, with its shortcomings, is that a company like Sears, which has been a responsible steward of its pension plan, is being burdened with a 60% increase in PBGC premiums, not in order to address any risk associated with Sears, but rather to make up for the difficulties of other companies. Meanwhile, our competitors that do not offer defined-benefit plans do not share this burden, even though the problem is a broad and structural one.

Pension funding is one of the most important, complex, and vexing issues facing American workers and businesses today. At Sears Holdings, we understand and believe that a company should manage its pension plan and fund its pension obligations in a way that provides a high degree of certainty that the obligations will be met. We also understand that the pension system in America, including the funding of the PBGC, needs to be fixed. But imposing additional costs on long-established firms, like Sears and Kmart – especially on those that have acted responsibly in managing their pension obligations – while allowing a competitive advantage to companies that have not been around long enough to have provided defined benefit plans or that have not managed their plans well, is a controversial way to address this problem. Before policymakers decide the best way to address this problem, the issues, the potential solutions, and the consequences for American business should be debated fully, frankly, and fairly.