Underfunded defined benefit pensions need careful management over next two years, ratings agency says

Companies with underfunded defined benefit (DB) pension schemes, tied to the final salary of employees, will need careful risk management and are especially vulnerable to fluctuating conditions in the eurozone over the next two years, according to ratings agency Standard & Poor's.

There has been a fall in long-term bond yields, which are used to calculate the rate that pension funds use when calculating their liabilities, Standard and Poor's said in a statement.
Based on that fall, DB scheme liabilities will have increased by between 11 and 18%, or €58 and €93 billion (US$65 and $104 billion) in 2014. Decreased long-term inflation expectations only partly offset this, the agency said.

Standard and Poor's analysed the funding position of the 50 European companies that it rates as most exposed by their pension plan deficits. At the end of 2013, this group had pension fund liabilities totaling €527bn. That, compared to assets of €356bn, meant that on average they had a funding deficit of just over 30%, the agency said.

Despite good investment returns of 8%-12% on plan assets on 2014, the fall in long-term yields, together with the degree of underfunding and the mismatch between pension fund assets and liabilities will see "substantial growth" in pension deficits for many companies for 2014, and targets for plan returns will need to be lower for 2015, Standard & Poor's said.

Effective risk management is vital in managing companies' credit risk exposure, and potentially mitigating impacts on their credit metrics, Standard & Poor's said.

"We would expect plan sponsors to continue exploring options such as lowering pension benefits by freezing pensionable salaries, capping future pension increases, increasing the retirement age, and closing plans to new and even existing members," the agency said.

"The challenge for companies in coming years will be how to rein in plan deficits in the new post-quantitative-easing low interest rate environment in Europe. This will become a more material credit consideration where defined-benefit plan deficits are significant, as under our criteria we include existing plan deficits on a tax-adjusted basis in our calculation of adjusted debt," said Standard & Poor's credit analyst Paul Watters.