FT: Why lower rates mean higher liabilities

Why lower rates mean higher liabilities

When Daimler used €2.5bn of the cash on its balance sheet to top up its pension fund last December, it rather took the market by surprise. But the move by the German carmaker, while unusual, reflected another unintended consequence of the flood of cheap money from the European Central Bank. Many companies’ pension deficits have widened significantly because the discount rate used to value pension liabilities has fallen in tandem with interest rates.

Lufthansa is also suffering from this unwelcome side-effect of the low interest rate environment. Earlier this month, the airline said the deficit in its defined benefit pension scheme had risen by more than 40 per cent since December, and is now more than €10bn. Lufthansa wants to scrap DB pension arrangements for employees but has yet to negotiate a less onerous scheme with unions. Its pilots have gone on strike repeatedly to protect early retirement benefits.

Similarly, the deficit in Siemens’ pension plan rose to €11bn at the end of March, from €9.6bn at the end of December. At BASF, the chemicals manufacturer, pension provisions more than doubled to €9.6bn in the first quarter, compared with a year earlier. Standard & Poor’s, the credit rating agency, estimates that a 50-basis point change in discount rates adds a whacking €1.85bn to BASF’s liabilities.

It is not just pension fund trustees in Germany that are feeling the pain. Standard & Poor’s estimates that, in 2014, the sharp fall in long-term bond yields increased the post-retirement benefit obligations of the top 50 companies it rates in Europe by 11 to 18 per cent. It is predicting a further widening of scheme deficits this year. Even at the end of 2013, pension schemes at these 50 companies were underfunded by 30 per cent, or nearly €200bn.

Pension deficits are not debt in the conventional sense, and many companies face no statutory requirement to set aside financing for them. Nor have S&P or Moody’s downgraded any company’s credit rating because of a widening of its deficit. S&P believes, however, that if interest rates remain low, pension deficits will become a more material negative factor over the next two years. More companies, in that case, may have to follow Daimler’s lead.