Download Corporate Earnings Hit by Rising Pension Liabilities

September 13, 2011
SEPTEMBER 13, 2011, 4:10 PM ET
Corporate Earnings Hit by Rising Pension Liabilities
While historically low interest rates have been a boon to companies looking to raise cash, those same rates
could hit companies with the double whammy of increasing pension liabilities and reduced asset values.
The recent broad decline in interest rates, a reaction to market turmoil in August, has put pressure on corporate pension obligations. That’s because the current value of such liabilities is determined using a discount rate
based on long-term interest rates. When that rate falls, the liability rises. At the same time, a drop in equity
markets has reduced the value of corporate investments, increasing the gap between pension assets and liabilities, thus double-teaming the hit to corporate balance sheets.
“Everything is going in the wrong direction,” said Kevin Wagner, a senior consulting actuary at Towers Watson.
He noted that this year’s trend is reversing gains in 2010, when strong markets helped companies reduce their
pension funding gaps. He said funding levels for U.S. corporations have dropped about 7% for the year.
“It’s going to be a problem for everybody,” said Aldo Pagliari, CFO of Snap-On Inc. He said the discount rate
that Snap-On uses to value its pension obligations fell to 5.0% in August, down from 5.3% at the end of last
year. The drop amounts to an increase of Snap-On’s obligations by $49.2 million. The company had pension
liabilities of $244.4 million at the end of 2010, according to its annual report, down from $252.5 million in 2009,
but up from $204.6 million in 2008.
According to a report by research firm Credit Sights, a drop in discount rates will hurt company earnings in
2012. “The impact of lower pension discount rates is likely to be just one more source of earnings pressure that
companies will be experiencing as they report their results early next year,” said the report.
Investment consulting firm Milliman Inc. said in a report on Tuesday that the projected liabilities of the 100
largest corporate defined pension plans rose $33 billion in August alone, to $1.521 trillion from $1.488 trillion at
the end of July.
The increase in liabilities was caused by a drop in the discount rate tracked by Milliman to 4.96% from 5.12%
in July.
J.P. Morgan analysts highlighted the issue on Tuesday, issuing a report that said defense contracting firm
Lockheed Martin’s earnings would suffer from rising pension costs. “Our [pension] expense assumption for
2012 is increasing from $300 million to $800 million on a 75 basis points decrease in the discount rate and an
assumed actual return on assets in 2011 of 0%,” said the J.P. Morgan report, according to a story from Marketwatch’s Christopher Hinton. “We are now assuming a 2013 [pension] expense of $415 million.”
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