Low rates increase the actuarial value of pension obligations. The good news is that hardly any “sponsor” (the industry’s wording to speak of the corporate which has pension risks in its balance sheet) is taking seriously the sub-zero long rate context. So that those which write a pension provision avoid raising that provision at a cost to their equity base. Their risk ratios do not worsen as a result.
The bad news is that Central Banks do not provide a scenario whereby rates may be making a comeback, so that the grey area where corporates sit when assessing their pension actuarial value may not last forever.
To put things in perspective and for its total coverage of 463 issuers, AlphaValue computes total 2019 obligations (funded and not funded) at nearly €2tn with a €0.45tn pension deficit as a result. Shareholders’ equity (thus after the €0.45tn provision to meet that deficit) stands at c.€5.7tn, the market cap at €9.2tn and net debt at €2.3tn. Pensions in short remain a monumental issue.
The following chart shows pension trends for the AlphaValue global coverage. The paradox is that the absolute amounts seem contained since 2016 when it became clear that negative rates could no longer be excluded. That raises suspicions, indeed, of sponsors cavorting on the issue.
The €2tn in pension obligations is some sort of a gross debt, the value of which will swing with the discount rates used to NPV such long obligations. As a reminder, such “obligations” only refer to the “defined benefits” type of pension plans which most sponsors (companies) have tried to wind down to cap their risk. The net “debt” or pension deficit is the difference between the obligations and the money set aside (“plan assets”) to cover those risks.
Both items (obligations and plan assets) are a play on rates and return expectations. Low rates mean that obligations go up, but the value of plan assets tend to go up as well (while spot returns go down…). As pension risk is a set of complex accounting decisions on a wide number of retirement schemes across many geographies, how much of a zero rate outlook has been embarked onto the 2018 (and 2019) risk assessment is hard to gauge.
Assessing a pension deficit has no cash consequence as a rule, so that buying time is an affordable strategy and helps avoid cutting unduly into shareholders’ funds (pension deficits are provisioned and thus set against the equity).
The bulk of the 2018 pension deficits will be with Autos, Utilities, Banks and Insurance. The bulk of the pension obligations are with Banks, Oilss, Autos and Utilities so that any drive to match the lower for longer rate context will be particularly heavily felt in those sectors. As a matter of fact, those are the sectors where AlphaValue analysts project a surge in deficits.
The issue (and we are sorry to go into such technical niceties) is that AlphaValue is putting on an equal footing all pension risks by using standard discount rates which are currently way too high (see table) if one assumes that zero rates are a decade-long proposition
Assume for one split second that discount rates are down to zero and that rising employment in Europe leads to pay increases above 2%. Shareholders’ funds of the Autos and Utilities sector would suffer another heavy beating. Banks too. We still need to work out rough estimates in models which are all moving parts.
Founded in 2007, AlphaValue is the world’s leading provider of Independent European Equity and Credit Research. We provide comprehensive, unconflicted research-only (no execution, no corporate finance) coverage of c. 480 European mid and large cap stocks. We have an average of 46% of negative recommendations at any one time. Learn more at www.alphavalue.com