by Marc Bastow | February 6, 2013 7:00 am
It’s one of those line items on balance sheets and notes to financial statements that investors never seem to read, but one that corporate CFOs can’t keep their eyes off: pension costs.
Fed Chairman Ben Bernanke’s low-interest rate environment is helping companies borrow money at inexpensive rates, but those same low rates are killing companies with the (slowly going-away) defined pension plans[1] as they either pour money into sagging pension plans to bolster them, or are forced to take charges against earnings due to pension shortfalls.
The reason is simple: Companies must incorporate a “discount rate” in a present-value calculation to determine future pension liability (in essence, how much the company will pay out over time to retirement plans). The lower the discount rate (typically pegged to corporate or Treasury bond yields), the higher the future liability cost; companies must account for any shortfall between monies set aside for the payout and the “estimated” future costs.
It’s a simple concept, but it causes some difficult realities, according to a Wall Street Journal report[2]:
Those are some significant, scary numbers. And with the Fed telegraphing low rates through 2016, future defined pension costs won’t see much in the way of relief. That means companies will have to work through the shortfalls, meaning either cash out of pocket or charges cutting into profits.
In either case, the situation can lead to serious problems for both investors and company retirees.
Keep in mind that unfunded pension liabilities in the billions of dollars helped contribute to the enormous difficulties faced by Ford and General Motors (NYSE:GM[9]), as former workers looked to the companies’ coffers for long-ago-promised retirement payments … and neither company had enough set aside to deliver.
With interest rates expected to remain low for the near future, investors would be wise to look through pension liability information found in quarterly and annual reports. Pay close attention to existing deficits (if any), as well as mentions of possible changes required to estimates of future costs. Also look at cash balances, which will give you a sense of whether the company can close the gap that way, and remember that slim profit margins won’t provide much wiggle room for additional pension expenses incurred.
Shortfalls require action. Don’t get caught uninformed!
Marc Bastow is an Assistant Editor at InvestorPlace.com. As of this writing, he was long VZ.
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