Lower Discount Rate, Longer Life Expectancies Burden Caterpillar 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.

Never miss a story — sign up for CIO newsletters to stay up-to-date on the latest institutional investment industry news. 

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

The United States emerged the most-favored overseas market for Asian real estate investors in 2016, for the second year in a row. US investments attracted more than $25 billion of the total $60 billion that Asian investors, led by institutional investors, deployed in overseas real estate, according to CBRE. Chinese investors were the most active, accounting for $28 billion, or 47%, of the total overseas Asian real estate investment, the Los Angeles-based commercial real estate services firm reports.

Even as the Chinese government has put in policies clamping down on Chinese overseas investments, it seems Chinese investors are interested in diversifying their holdings. According to Yvonne Siew, executive director, CBRE Global Capital Markets, “With more scrutiny on cross-border capital flows and rigorous checks by the government which may lengthen the approval process, Chinese outbound real estate investment may moderate, gathering at a more sustainable rate. Instead of larger transactions, Chinese investors may simply opt for a higher number of smaller deals. Regardless, Chinese appetite for global real estate investment will remain solid but more cautious, with Chinese insurers and qualified asset managers being the active institutional investor class.”

The China Business Review expects that there will be short-term issues on the Chinese overseas commercial property investment front as a result of China’s capital controls. However, in the longer term, Chinese insurance companies and private equity funds have a supply of money that is available to meet the US demand for commercial real estate investments.

CBRE reports that the EMEA region – comprising Europe, the Middle East and Africa – was another favored investment destination, attracting 27% of the Asian investment. Asian investors were also partial to their own region, putting in 23%of the investments there, up from 21% in 2015.

Never miss a story — sign up for CIO newsletters to stay up-to-date on the latest institutional investment industry news. 

New York overtook London as the most favored metro area these investors favored in 2016, although the city’s share of the investment declined from 2015. Other metro areas the investors favored were Hong Kong, Seoul and Sydney. These top five metros attracted 37% of the Asian investment, compared to 42% in 2015, as the Asians diversified their investments more.

“Compared to 2015, more capital was deployed to alternative gateway cities in search of attractively priced opportunities. Places in Continental Europe, such as France and the Netherlands; Chicago, San Francisco and Washington in the US; and Vancouver in Canada, are now on more investor radar screens,” noted Robert Fong, Director of Research, CBRE Asia Pacific.

And while Chinese, Hong Kong, Singapore and South Korean investors continue to head up the list, India is also emerging as a capital source. Japanese capital also stepped up, with the United States a major draw for the Japanese. The commercial real estate services firm expects Japanese overseas real estate investment in 2017 to increase, coming off a low level in 2016.

Looking at preferred property types, the Asian investors favored office properties, which made up half of their total investment, especially going for office properties located in the “gateway” cities of New York, London and Hong Kong. Hotel properties also attracted interest. In fact, a Chinese investor’s purchase of a US hotel property was the biggest deal of the year, CBRE reports.

Asian investors also showed more interest in niche sectors such as student housing and healthcare, looking beyond the major commercial property types. In a first for the student-housing niche, Singapore investors got into three major deals in that property type. CBRE sees this interest in niche property types as resulting from a quest for higher yields and also “keeping in tune with demographic changes.”

By Poonkulali Thangavelu