Now, thanks to the pension freeze, the employee pension plan no longer has any expense: In the years since the freeze was announced, the gains from curtailing benefits have added nearly $3 billion to IBM’s income.
GM also took advantage of low interest rates to lock in a bigger liability. When the automaker announced in 2006 that it would freeze the pensions of 42,000 U.S. salaried workers, it blamed its troubles on “legacy costs,” including pensions for its U.S. workers. The move wiped $1.6 billion from GM’s pension obligations.
How costly were the pensions of GM’s workers at the time? The pension covering nearly 700,000 U.S. workers and retirees had a $9 billion surplus and was adding $10 billion to its income calculations. The executive pension was another matter. The $1.4 billion in executive legacy liabilities for an unknown number of executives generates an expense that hurts GM’s bottom line each year. GM has often claimed that its U.S. pension plans add about $800 to the cost of each car made in the United States. But it doesn’t say how much of this cost is for executive legacy liabilities.
A MERCANTILE DECISION
It’s possible that the widening retirement gap is just an unintended by-product of a trend to reduce benefits and enhance executive pay. But at some companies, the disparity was deliberate. In 1996, the pension committee of the board of directors of Mercantile Stores met at the exclusive Union Club in New York City to vote on some critical changes in their retirement plans. The chain of department stores in the Midwest and the South had a pension plan covering 21,000 employees and retirees. The pension plan wasn’t a burden: It had a surplus of about $200 million. The average pension of the retired cashiers and clerks was $138 a month, and employee turnover was so high that many workers never qualified for a pension anyway.
But the company was in financial trouble, and the pension plan was one place to look for relief. Benefits consultants pondered the situation and concluded that pension cuts would be appropriate. Why? Because the Mercantile pension plan was more generous than those of other retailers, the consultants said. At the same time, the consultants concluded that the executives’ pensions weren’t “competitive” with others in the industry. To resolve this supposed imbalance and bring Mercantile’s retirement benefits in line with those of its peers, the board voted to reduce the pensions of low-paid workers and boost executive pensions. Two years later, Dillard’s Inc., a Little Rock, Arkansas–based retailing chain, bought Mercantile, terminated the pension plan, and captured the surplus.
Towers Perrin, the consulting firm that helped Mercantile with these kinds of decisions, merged with Watson Wyatt in 2010. Now called Towers Watson, the global consulting firm continues to help the largest companies in the United States, Canada, the United Kingdom, the Netherlands, and Germany shrink retiree benefits and boost executive pay and pensions.
Towers Watson practices what it preaches. Its employees have a cash-balance pension plan, while top executives have a supplemental pension with all the bells and whistles that have been stripped from rank-and-file pensions, including a generous formula based on final pay, which spikes in value in the later years, and the ability to retire at sixty with full benefits. The company reimburses executives for their FICA (payroll) taxes and “grosses up” the payments (i.e., it pays the taxes on the tax payments). When top managers depart, the company uses an unusually low interest rate, 3.5 percent, to calculate their lump-sum payouts, which results in a larger payment. In fiscal 2010, the executive pension liability for the combined company stood at $627 million, 32 percent of the total pension obligation. The company also paid out $496 million in “discretionary compensation,” i.e. bonuses, of which most, or all, went to executives.
UNDERSTATEMENT
Like many public pension plans, executive liabilities have been growing quietly behind the scenes, producing a mounting obligation, much of it hidden. Even when a company owes its executives billions of dollars, it can be almost impossible to tell because of the way companies bundle all their pensions together in securities filings.
When companies mention executive pensions at all, they typically use terms that only pension-industry insiders would recognize, such as “nonqualified obligations” and “unfunded defined benefit pension plans.” Comparing the obligation and cost of executive pensions to regular ones is possible only at the few companies that actually break out the figures (like GE) or provide enough clues to enable a determined researcher to back the figures out of the totals.
Executive pensions are like public pensions in another critical way: The liabilities are often lowballed. So even if one is able to identify the current liability for executive pensions, the figure may provide an unrealistic view of what the company will ultimately pay out, for a variety of reasons, including the way they are calculated.
Like most public pensions, executive pensions are calculated by multiplying years of service and pay—the formula many private employers have abandoned for regular employees because the benefits grow steeply in the final years. With pensions based on final pay, an individual has a big incentive to make sure the final pay is as high as possible. A firefighter or police officer, for example, might work hundreds of hours in overtime in their final years on the job, a move that might add $50,000 a year to a pension.
Executives do essentially the same thing, with bigger payoffs, and have a variety of ways to boost their pay—and thus their pensions—by millions of dollars prior to departure or retirement. One way is to simply change the definition of “pay” to include more types of compensation. ConocoPhillips included “certain incentive payments” when it totted up CEO Jim Mulva’s pension in 2008, which increased it by $9.5 million and brought it to a total of $68 million. The same year, a $6 million pay increase for Merck’s chief executive, Richard T. Clark, pushed his pension from $11.9 million to $21.7 million.
Awarding a substantial bonus to executives who are on the verge of retirement or departure can also generate a huge pension windfall. One of ExxonMobil’s two supplemental pension plans for executives calculates executive pension benefits using the three highest bonuses in the five years prior to retirement. A well-timed bonus can make a big difference. A $4 million bonus to CEO Rex Tillerson in 2008 pushed the total value of his pension up by $8 million in a single year, to $31 million. “By limiting bonuses to those granted in the five years prior to retirement,” the company states blandly in its proxy filing with federal regulators, “there is a strong motivation for executives to continue to perform at a high level.” It also encourages top management to make some shortsighted decisions, because a large award can lead to bigger pension benefits for the rest of their lives.
Awarding additional years of service, a practice that compensation watchdogs have perennially snapped at, is alive and well. PG&E, the giant West Coast utility, awarded its CEO, Peter Darbee, an additional five years, which boosted his pension 38 percent to $5.2 million in 2008. The company said it was doing this because it felt that his pension was less generous than what other executives were receiving. This kind of peer pressure drives executive pay and pensions steadily higher. That same year, the compensation committee of Constellation Energy awarded its chairman and CEO, Mayo Shattuck, an additional 2.5 years of service, boosting his pension by $10.3 million, a 97 percent increase.
Executive pensions have another characteristic that has been widely criticized in public pensions: Employers have an incentive to boost the benefits and hide the growing (unfunded) liability. In contrast, when it comes to rank-and-file pensions, employers have an incentive to inflate the liabilities and cut benefits.
Using unrealistic (and sometimes undisclosed) assumptions to estimate the executive liability can shrink it substantially. Some companies assume that executive salaries don’t rise; others, like Towers Watson, calculate the executive obligation using an unusually high discount rate, 7.5 percent in 2010, which results in a lower reported liability.
Companies can delay reporting some of the liability by waiting until the executive is headed out the door to apply some feature that inflates the total payout. A small change in the interest rate used to calculate a lump sum payout, for example, can increase a pension by millions of dollars.
In 2008, Goodyear Tire & Rubber adjusted the interest rate and compensation assumptions it used to calculate top executives’ pensions, which increased chief executive Robert Keegan’s pension by $6.3 million, to a total of $17.5 million. (The company earlier credited him with eighteen additional years of service, which has
