August 11, 2015 / 6:23 PM / 2 years ago

Buffett's biggest deal casts light on pension burden

Berkshire Hathaway CEO Warren Buffett plays bridge during the Berkshire annual meeting weekend in Omaha, Nebraska May 3, 2015.Rick Wilking

NEW YORK (Reuters) - Growing pension obligations at Precision Castparts Corp PCP.N, which Berkshire Hathaway has agreed to buy for $32 billion, highlight an issue that large U.S. corporations still face, almost a decade into a low-interest rate environment.

Berkshire's boss, Warren Buffett, has himself highlighted rising pension cost as an area of concern for the American economy. Back in 2007, Buffett said in a letter to shareholders that S&P 500 companies should not expect above-average returns on their pension investments, as many companies publicly assumed at the time.

Obligations to retired workers pose an increasing risk to corporate bottom lines as investment returns in recent years have not consistently kept up with cost increases at most U.S. pension plans.

The industrial company Berkshire bought on Monday has been no exception, but the pension issue is not enough to raise alarm for Berkshire investors.

"It could raise its costs a bit, but for a company of this size, it's not significant," said Brian Reynolds, chief market strategist at New Albion Partners in New York.

Precision Castparts' pension promises to pay $2.84 billion to its more than 10,300 participants, but was underfunded by $615 million of as of March 29, the end of its most recent fiscal year. That level of underfunding was up 61.8 percent from the prior year.

PRECISION CASTPARTS' PENSION

If Precision Castparts' pension costs continue to rise quickly, they could limit the new business's ability to contribute to Berkshire's operating profit in coming years, but no one is predicting a major headwind.

Still, its recent history shows how hard it can be for pension plans to meet their stated goals.

Over the past five years, Precision Castparts' return on pensions came close to its projections but never quite met them, according to company filings. Its return on plan assets averaged 7.46 percent, but that performance has been uneven. It earned 10.2 percent for fiscal 2015, but just 4.5 percent the prior year.

According to Precision's most recent 10K filing, it assumed a long-term return of 7.75 percent for its U.S. retirement plans and 7.25 percent for its non-U.S. plans in fiscal 2015. It expected to assume the same returns for fiscal 2016.

Since Precision Castparts' fiscal 2015 returns were solid but did not keep up with obligations, its funding deficit jumped.

With stock markets flat and bond yields down so far in 2015, a 7.75 percent target could be out of reach.

“We are fully compliant with PCBG funding requirements, ERISA guidelines and are mindful of our fiduciary responsibilities to the beneficiaries of the fund,” Precision said in a statement.

Berkshire did not immediately respond to requests for comment.

ROCKY JULY FOR U.S. PENSIONS

To be fair, many U.S. corporations, even Berkshire, saw the funding status of their pensions deteriorate last year due to a jump in obligations and historic low interest rates, according to a consulting firm Milliman.

Companies can address underfunding by adding more cash, asking for deferrals, issuing bonds, or finding other ways to finance pensions - all of which add to risk and the cost of doing business.

Pension funding deficits worsened in July among the 100 biggest U.S. corporate pensions Milliman tracks as bond yields fell on worries about Greece's debt and Chinese stock market turmoil. A sustained drop in bond yields raises the amount of cash a pension requires to ensure it meets future payouts.

In its most recent regulatory filing, Precision Castparts said it plans to contribute $51 million in fiscal 2016, up from $34 million from fiscal 2015. That comes to 35 cents a share, or about a 3-percent drag on earnings-per-share for Precision Castparts, according to Thomson Reuters data.

When the Federal Reserve raises interest rates, it would support higher bond yields, helping Precision's and other U.S. pensions to reduce their funding deficits, said Zorast Wadia, principal and consulting actuary at Milliman.

Reporting by Richard Leong; Editing by Nick Zieminski

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