In October 2003, a leading finance magazine published an upbeat interview with the pensions manager of Kodak’s £800 million UK pension scheme, in which he disclosed details of the plan’s new and daring asset strategy. The scheme, he explained, had invested 35% of its
assets across 40 hedge funds with just 2% remaining in equities.
It was a new
and different approach, with the ambitious aim of out-performing run-of-the-mill, bog
standard, equities “by around 2%”.
In fact, the whole portfolio had been carefully set up to be diversified and intelligent, seeking additional asset returns.
Light at the start of the tunnel
it was a picture of success: “Kodak produced a positive return of 12.1% making it the best UK scheme within the WM2000. Last year it
produced a top-decile performance by restricting its losses to -3% against a peer group average of -14%” said the article.
In 2004, the UK pension scheme’s property portfolio also duly appreciated in value.
Back then, it is fair to say, it was all looking good.
So much so, that
the parent’s 2003
annual report (p31) proudly proclaimed:
significant funding requirements in relation to its defined benefit pension plans
in 2004.”
That was then…
Today, however,
as the embattled US Kodak parent finds itself in the dark room of Chapter 11 insolvency, its
badly under-funded UK pension scheme is learning a bitterly painful lesson.
For whilst Kodak’s US high command insists that it is “business as usual” in Europe, the glaring harsh
reality is that it is highly uncertain, to say the least, whether the UK pension plan will
find the £440 million deficit it requires in order to make all the payments due to its present and future pensioners over the remaining life of the scheme. Kodak UK is unlikely to have sufficiently deep pockets.
How did it all go so wrong?
Kodak failed in 2003 to consider the potential problem of rapidly rising pension
liabilities. At the time, the pension scheme manager said:
alpha to cover liabilities. Instead, we have taken a diversified approach.”
The pension scheme’s management team was plainly fully aware of the risk of unfunded liabilities and believed it had come up with a game plan.
Nor was the new investment strategy impetuous and unconsidered. As the article
pointed out: “[The pension scheme manager] has evolved his
strategy over time.”
And this was no
renegade embarking on an unsupervised frolic of his own: “[He]
has involved his trustees at every stage.”
No. The tragedy
for Kodak is not that the trustees
and pension plan managers et al failed to think about the problem. It was, quite
simply, that they failed to implement the correct solution.
By way of evidence, and in
contrast, just eight weeks later, in early December 2003, a similar sized UK pension
plan, Friends Provident Pension Scheme, did
successfully
implement a hedge and, in so doing, protected the FP Scheme from its
principal predator: the Collapsing Real Yield (CRY!).
The CRY!
beast of terrifying ferocity. It has ripped (and is currently ripping) the
beating hearts out of defined benefit pension plans around the globe, pushed
pensioners by their hundreds of thousands closer to the cliff-edge of old age
penury, and stolen the golden years from an entire cohort of the vulnerable
elderly.
The CRY! is
ruthless. It propels pension liabilities skywards without a second thought. It
drives the present value of pension
plan obligations up into the stratosphere, miles beyond the reach of almost any
asset performance. It draws no distinction between private sector and public sector
workers.
Between the years
of 2003 and 2012 (present day) the CRY! has eviscerated pension plans, brutally
exposing those who clung doggedly to the belief that the CRY! was a chimera, a
bubble, a mirage, and therefore failed to fight fire with fire. The CRY! is now exacting a
terrible price.
Kodak,
tragically, fell into that category. It is a reasonable assumption that in 2003 their pension scheme supremos in Hemel Hempstead (UK) and Rochester (US), considered the risk of the CRY! but, along with many other pension plans, it seems they did not
implement the anti-CRY! solution.
Put simply, in
2003 Kodak faced three risks:
One: The risk of the Collapsing Real Yield! That is,
the risk of sharply falling long
term interest rates, coupled with simultaneous rising inflation. This toxic combination would cause Kodak’s pension
liabilities to rise uncontrollably; if the CRY! came to pass, the pension plan
would be in serious trouble.
Two: The risk of their newly diversified “growth” assets failing
to perform the heroic growth targets demanded of them. This would result in
insufficient assets to match the CRY!-ravaged liabilities.
Three: The risk of Kodak (UK) pension scheme’s
sponsoring corporate far away in Rochester, NY, becoming insolvent and leaving the
UK pension plan with no external means of support. If, in the nightmare scenario, Risks
One, Two and Three all materialised, the pension plan would be cast headlong into the
UK’s Pension Protection Fund along with an unquantifiable number of other
failed pension plans.
Given those risks, it would have been prudent to comprehensively hedge the scheme. But from the size of the deficit today, the signs are that they did not. My hunch is that in the final analysis, Kodak just did not believe that the
Collapsing Real Yield would materialise.
Further, they could not conceive that their carefully-crafted diversified alpha-seeking asset strategy would be insufficient to meet the onslaught of the CRY!.
Nor did they anticipate the US mothership becoming
insolvent mid-way through its agreed pension contribution schedule.
Certainly,
they never dreamed for a second that ALL three
events would occur. But they have.
It is a perfect storm.
Disastrously for Kodak, Risks One and Two have
been materialising ever since that interview back in 2003. The Kodak
UK pension plan’s liabilities are now a stunning £1.6 billion whilst the assets
are, apparently, a mere £1.2 billion. The CRY! helped to wipe out £440m(!) of assets.
Risk Three materialised
last Thursday.
Game Over.
Ironically, in the 2003 interview, the pension scheme manager made the point that he had “taken care to consult his sponsor’s
corporate treasury department. ‘Which
is only right. After all, the support of the sponsor is the biggest asset we
have.’”
Take-Aways
So what are the
key lessons from all this?
The Sponsoring Corporate can become insolvent.
This can occur despite oft- repeated assurances to the contrary from the
sponsoring corporate. Super-advanced technology
is obsoletizing (new word) established iconic platforms and processes. Kodak somehow
missed the digital camera revolution (despite having invented the digital camera)
and got
blown away by more nimble competitors. They’re not the first and they won’t
be the last.
to predict the markets and betting the farm that killer risks (such as the CRY!) won’t materialise, is a costly error.
If your assumptions, predictions, prognostications and assorted gambles turn out to be wrong, there will be
irreversible problems for the pension plan. Instead, you should implement a risk
management strategy. There is no alternative.
It is mystifying why, although Parliamentary and Congressional
hearings are routinely held to consider the sudden collapse of other financial organisations, pension
plans that fail are assumed to be “victims of a series of unfortunate
events”.
pension plan ends up with materially fewer assets than liabilities and a bust sponsor? Who
was asleep at the wheel? What was the advisors’ advice? Where was the Kodak global pensions risk management strategy? Why did the Corporate
not take action earlier? What did it choose to spend its cash on instead? Why
did the pension scheme’s trustees not bang harder on the CEO’s door whilst there was still money in the pot? What was the
Pensions Regulator doing?
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