The world does not lack for discussion about the risks of maintaining very low interest rates for a very long time. Monetary policymakers have addressed the potential for a sudden spike in inflation and stoking asset bubbles in recent weeks, for example.
But a growing number of global companies face a different risk: Pension obligations are at an all-time high. As bond yields have fallen, discount rates fell, too, which increased estimated corporate pension liabilities. And in a low-yield environment, companies haven’t been able to earn as much on fixed-income securities within their investment portfolios, meaning there is less cash available for pensions.
While pension funding is always based on forecasts of interest rates, employee longevity, and other factors that only become clear in the future, a company’s present-day funding status can affect present-day investors. Companies with large pension deficits may be forced to shore up their plans, which can have an immediate impact on earnings, cash flow, and stock valuations, and may even put dividend payouts at risk.
Credit Suisse’s Investment Solutions & Products team recently cautioned investors to look warily upon companies with underfunded liabilities worth more than 5 percent of market capitalization or an underfunded pension liability of any size and a discount rate assumption of more than 4 percent.
