Case Study: Ground Up Pension Improvements
December 1, 2010
Pensions continue to have a significant impact on corporate operations, with underfunded liabilities draining needed cash flow. In an effort to concentrate on the more complex strategic issues involved in managing a pension plan, many plan sponsors are outsourcing the investment management process to an outside cofiduciary partner, according to industry research.
Magnetek (Menomonee Falls, WI) has already shifted toward an outsourced investment management model for the pension plan. During its 25 years in business, the publicly traded manufacturer has become a leading international suppliers of digital power and motion control systems for the manufacturing industry.
“Our core competencies lie in the design and manufacture of power and motion control systems, not in actively managing financial asset portfolios,” says Marty J. Schwenner, vice president and chief financial officer at Magnetek. “That is not where our organizational strengths lie, but there is an entire industry of proven value-added partners who are focused on financial and investment management.”
In 2003, Magnatek was navigating a challenging financial and regulatory market. To further complicate matters, the company’s stock price had experienced a significant decrease due to one-time factors such as asset impairment charges, a lawsuit settlement and various divestitures.
At the same time, Magnetek was looking to maximize its opportunities for growth by ramping up R&D and increasing the size of its sales force. This meant that it was critical to control noncore costs.
When evaluating where the company stood at the time and where it wanted to go, it was critical to first identify expenses related to its pension plan. In the past, the pension plan had provided positive earnings, thereby helping the organization’s bottom line. Those earnings had now turned into an expense that was nearly triple what the earnings had been.
To manage the cost of running the pension plan, the company decided to freeze benefit accruals, resulting in an immediate decrease in the plan’s service costs. Freezing accruals also meant a projected decrease in the plan’s liabilities as they would no longer be growing. At the time, this move provided the company with financial relief in that it would not have to make pension contributions for the next five years. However, this also meant Magnetek was due to make an $18 million pension contribution in 2008.
“We could not be in a position where the pension plan interfered with our organizational goals of growing the business,” says Schwenner. “We needed to develop creative solutions for not only delivering this benefit to our employees who had earned it, but also having the financial flexibility and resources to invest in our business.”
Time Was of the EssenceLike many companies, Magnetek wanted its pension plan to be easy to manage, meet investment goals and adhere to regulatory obligations. And while the company had previously handled much of its investment management work internally, resources were needed in other places.
As a result, the organization decided to review its entire process for managing the pension and underwent a rigorous search process, looking for a firm able to step into a complex situation and deliver successful results.
In the end, Magnetek decided to shift to an outsourced investment management model and hired asset management firm SEI (Oaks, PA).
The outsourced model allowed for a reallocation of the time of internal resources to bigger-picture items, which was the most efficient solution.
Through its outsource model, SEI took on fiduciary responsibility for researching, selecting and monitoring investment managers that fit the ongoing strategies for the asset allocation set forth by Magnetek’s pension committee.
This setup allows Magnetek’s finance staff to focus on the organization achieving its short- and long-term goals, with the assurance that its pension plan is run and managed properly.
The Pension Expense SolutionEnsuring that the pension plan was funded without hurting the company’s growth efforts and sales budgets required a smart approach to managing the flow of cash into the pension fund. A key component was determining how to minimize the anticipated $18 million contribution that loomed in 2008.
In addition to manager oversight, SEI’s model provides clients with strategic advice around asset allocation decisions and their impact on the goals and objectives of the organization.
SEI’s team performed extensive modeling using Magnetek’s pension plan data as well as its financial statements and forecasts. Magnetek and SEI worked together in this process and identified several options for developing specific strategies that would align the pension plan with overall corporate finance goals.
“Previously, the pension had been managed in a vacuum outside of corporate finance objectives. If the goal was to make sure that the pension did not negatively impact corporate finance, the two had to become aligned,” Schwenner explains.
The end result was a custom funding strategy that required pension contributions of $4 million per year for a span of three years, starting in 2006. This strategy was designed to improve the plan’s funded status and would build up the credit balance over the course of the 10-year timeframe, thus removing the $18 million contribution spike in 2008.
The portfolio also was restructured with a goal of performing comparably to the company’s previous portfolio under expected market conditions, while aiming to decrease downside risk under poor market conditions. The new portfolio was designed to try to decrease volatility in the plan by increasing diversification at both the asset class and manager levels.
“From day one, the understanding was that we’re operating with not just the pension plan, but in a larger business context,” Schwenner says.
Today, Magnetek has a pension plan that is designed to efficiently sync with its corporate goals and requirements. With this model in place, Magnetek has more time and resources to focus on achieving its corporate objective of growing and expanding its business.