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Lower Discount Rate, Longer Life Expectancies Burden Caterpillar Pension Plan

 Despite healthy growth of 7.8%, company took mark-to-market loss of $985 million on pension plan.

Heavy equipment maker Caterpillar Inc. said its US pension plans posted a healthy return of 7.8% in 2016. But a lower discount rate and improving life expectancies delivered a blow to the company’s bottom line.

In its annual report, the Peoria, Ill.-based manufacturer told shareholders that it took a mark-to-market loss of $985 million on its pension plans at the end of 2016. That compares to mark-to-market losses of $179 million in 2015, and $2.6 billion in 2014.

Caterpillar said its 7.8% return outpaced its expected performance of 6.9%. The robust results came despite a conservative asset allocation that favored fixed income over equities.

Caterpillar, one of the 30 members of the Dow Jones Industrial Average, said it lowered its discount rate for its US pension plans to 4% from 4.2%. For non-US pension benefits, the discount rate fell to 2.5% from 3.2%. The lower discount rates, of course, increase the plan provider’s pension obligation and future expense.

Another culprit for the latest markdown: longer life spans. Increasing longevity reflects improving public health, yet it also poses challenges for pension plans.

“As of December 31, 2016, the company adopted the new mortality improvement projection scales, which resulted in an increase in the life expectancy of plan participants and therefore an increase in our liability for postemployment benefits of approximately $200 million,” Caterpillar said in its annual report.

Caterpillar said it contributed $329 million to its pension plans in 2016 and $350 million in 2015. It expects to contribute an additional $610 million in 2017.

Caterpillar isn’t the only major company to warn shareholders that it’ll make large contributions to its pension fund in 2017. Pharmaceutical giant Merck said in its annual report that it will contribute $235 million to its pension plan this year. And General Electric plans to contribute $1.7 billion to its pension plan in 2017.

Such hefty outlays explain why many large employers have moved to reduce the generosity of their pension plans. GE’s pension plan is not open to new participants. In 2010, Caterpillar “froze” its defined benefit plans for some employees, meaning that the value of the benefit no longer is growing. Caterpillar will freeze the plan for the rest of its workers in 2019.

Instead of a traditional defined benefit plan, Caterpillar employees will get matching contributions to their 401(k) plans.

Compared to large public pension funds, private employer pension funds tend toward less aggressive asset allocations.

“In general, our strategy for both the US and the non-US pensions includes ongoing alignment of our investments to our liabilities, while reducing risk in our portfolio,” the company said.

For its US pension plans, Caterpillar’s asset allocation at the end of 2016 was 41% equities, 56% percent fixed income and 3% other assets. For non-US pension plans, the mix was 38% equities, 55% fixed income, 5% real estate and 2% other.

At the end of 2016, Caterpillar had $11.4 billion in its US pension plan and $3.9 billion in its non-US plan.

Caterpillar employed 95,400 workers at the end of 2016.

By Jeff Ostrowski