PIMCO to Pensions: Get Real on Liabilities

Investors need greater disclosure along with more aggressive and realistic strategies for addressing rising pension liabilities sooner rather than later, PIMCO's Christian Stracke says.

(January 28, 2013) — Companies should provide more information on both sides of their pension balance sheets while using realistic assumptions, Pacific Investment Management Company (PIMCO) advises.

“As corporate treasurers get ready to publish their 2012 annual reports, we ask for one New Year’s resolution: get real on pension liabilities,” PIMCO’s Christian Stracke writes in a whitepaper. “Creeping pension liabilities are an increasing source of concern for credit investors and full disclosure of the risks surrounding them is what credit investors need to regain confidence in the most affected issuers. A few companies have stepped forward in recent years with some admirable improvements in their disclosures, but in general the information available to investors is still far from what we need.”

According to Stracke, credit markets penalize issuers for lack of disclosure. “Yes, companies can generally keep some investors in the dark for a while, and enjoy lower spreads in the short term as a result of limited disclosures. Ultimately, though, credit investors wise up to the problem and in the end are forced to assign a steep uncertainty premium to issuers,” he writes.

Companies should know (and disclose) not just the pension liability under certain normalized assumptions, but also how volatile the pension liability could be over time, PIMCO’s paper outlines. “Because companies’ ability to make cash injections into pension plans is generally negatively correlated with the size of the required cash injection from one year to the next, the volatility of the liability is a critical factor in credit analysis,” Stracke asserts. More disclosure on the duration of liabilities could help significantly with that goal. Stracke also concludes that a common refrain that we hear from management teams is that companies already disclose so much information that any more would simply be too much to handle, especially complicated actuarial information on pension liabilities. “This is simply wrong…As with many new areas of disclosure, there could be a transition during which there may be some short-term volatility in stock prices and credit spreads, but robust engagement of the investor community to educate analysts on the disclosure could keep this transition period short,” he writes.

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The paper concludes: If investors obtain clearer disclosure along with more aggressive and realistic strategies for addressing rising pension liabilities, “companies should enjoy lower credit spreads (and, ultimately, a lower equity risk premium) by giving investors confidence that the pension problem is settled.”

PIMCO’s report follows follows a study from the Edhec-Risk Institute, which said that while investors were aware of pressures on public and private pension systems in Europe, a closer look into how each nation measured their liabilities uncovered some surprising results. “Due to the variety of national systems, obtaining a clear view of pension liabilities is not straightforward,” the study said. To demonstrate, the institute used a uniform discount rate to measure each member state in the European Union’s public pension obligations as a percentage of 2010 GDP. “Ultimately, the values for public pension liabilities that Edhec-Risk Institute has calculated can lead to solvability analyses that are substantially different from those habitually taken into account by rating agencies or investors, ” the study noted.

Click here to read PIMCO’s full paper.