Pensions
Depending on the contract a sponsor is able to negotiate with an insurer, and the risk both are willing to assume, given 10-year Treasury bonds of 2.95% and annuity rates not much higher, adds at least 17% to current corporate underfunding. The median discount rate for liabilities is currently 5.9% for the S&P 500. Such a rate is unachievable in today’s marketplace.
The 8% median investment assumption adds another 8%-12%
Some of the difference is made up though higher salary assumptions ( currently 4%) and lower turnover assumptions.
You will be hearing and reading much more on this issue towards the end of the year and should be expected to negatively impact those impacted companies. Pension accounting does not impact the amount of periodic pension cost reported on the income statement, but it does impact the reporting of comprehensive income. As such, we make the appropriate adjustment based on, in my estimation, an actuarial sound policy.
Please see our related articles on pensions and free cash flow implications of underfunding:
- Pension Facts: Why The Hit to Earnings and Cash Flow Is Upon Us
- Pensions-Buyer Beware
- CNBC Strategy Session – Underfunded Pensions Earnings Bombshell
- CNBC’s Herb Greenberg – Underfunded Pensions are Red Flag for Investors
- The Next Shoe to Drop?
- The Other Shoe – Part 2
- With 3-, 5-, and 10-Year Stock Returns Negative: Why Are Pension Funds Assuming 8% Returns?
Disclosure: No positions
Kenneth S. Hackel, CFA
President
CT Capital LLC
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If you are interested in learning how to analyze the pension plan, including plan accounting, effect on earnings, cash flow, financial structure and valuation, order “Security Valuation and Risk Analysis” out this fall from McGraw-Hill.
