Keeping retirement plans funded could be a bigger problem than companies anticipate.
Low returns on defined-benefit pension plan assets represents a significant economic challenge to companies, one that could siphon cash and, potentially, affect ratings, according to a new report by Fitch Ratings.
Fitch looked at European firms worried about how changes to International Accounting Standards relating to pensions, and determined that these changes would not affect the economics of the plans, only their financial reports. By contrast, low returns on assets could lead to significant underfunding, requiring cash injections from sponsor companies.
The authors of the report, “Fitch: Returns not Accounting Real Threat from European Pensions,” write, “December 2007-December 2011 data from the UK’s Pension Protection Fund shows an average annual increase of pension plan assets of around 3.6 percent – much of which will have been accounted for by company contributions above payments rather than asset returns.”
Fitch compared this with the return assumption used in 2007 by BT Group, which has the country’s largest DB plan, of 6.4 percent, and concludes that the difference in the two growth rates for the UK corporate sector as a whole, represents GBP113 billion of additional funding that companies needed to cough up.
Adding insult to industry, the accounting change will force companies to calculate their expected asset returns using the same rate that they use to discount their liabilities. While the underlying asset/liability situation won’t change, the reported shortfall in funding will in many cases increase.