GM: Who’s Next? Answer: At Least 1,300 More
There are at least 1,300 companies, whose defined benefit plans are, according to our analysis, overstating their funded status; meaning, they are exaggerating their cash flows and understating their true leverage.
The biggest fault is in their choice of an appropriate discount rate used to convert expected benefits to their present value. As the assumed discount rate changes, the impact on the pension benefit obligation (PBO) is substantial: Decreases in the rate, which is the crux of our analysis, produces significant increases in the liability. The recognition of the change in value is, however, deferred on reported financial statements. If these gains and losses reach a sufficient magnitude with respect to the PBO and market value of plan assets (10%), they are gradually amortized and recognized as part of pension expense (the so-called “corridor” method.) In reality, however, the analyst should currently recognize the liability, which is not being presently done by any firm we are aware of.
GM, which will report its next valuation in October, will need to significantly raise its estimate of the underfunded status of its plans. Unfortunately, they are just leading the way.
Please see our related articles on pensions and free cash flow implications of underfunding:
- You Ain’t Seen Nothin’ Yet!
- Pension Facts: Why The Hit to Earnings and Cash Flow Is Upon Us
- CNBC Strategy Session – Underfunded Pensions Earnings Bombshell
- 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.
