Pay up Solving the Pensions Puzzle

Continued low interest rates mean Germany's big firms are having to inject a record amount of cash to prop up pension funds, forcing many to consider new investment strategies.
It's not such a golden age for their ex-employers.

Many companies are profiting from the current low interest rates. Investors are plowing money into stocks and driving prices while cash is available at favorable rates.

But the flood of money comes with a downside, and this will become apparent when German companies submit their balance sheets this week.

The reason? Pension obligations have sharply spiked because of the low interest rates, requiring companies to considerably increase their reserves.

Experts at Mercer, the financial services consulting firm, assume pension obligations at the 30 German blue chip companies listed on the country's leading DAX market index increased by almost 25 percent last year to a record €373 billion ($423 billion).

This follows a noticeable drop in the actuarial interest rate, an estimate of the cost of future losses. Firms use this to discount long-term commitments to the pensions of their employees. The lower the rate, the higher the current value of pension obligations.

The result is a drop from about 66 percent to just 57 percent in funding ratios for pension funds.

“We assume that the DAX companies have lowered their actuarial interest rate, on average, by about 1.4 percent points,” said Thomas Hagemann, the chief actuary at Mercer Germany.

Taken together, this means a steep increase in pension liabilities to €68 billion, in addition to €4 billion from regular increases in commitments.

Yet while estimates of pension assets among the DAX-listed companies compiled by Mercer have increased by 8 percent to €214 billion, they’ve not kept pace with the growth of liabilities.

The result is a drop from about 66 percent to just 57 percent in funding ratios for pension funds, though the experts at Mercer say this is financially sound. “Hence there is no obligation or necessity for the companies to additionally fund their pension assets,” Mr. Hagemann says.

However, the low interest rates likely mean pension reserves need to be increased by as much as €56 billion on balance sheets. This represents the portion of the liabilities not covered by the pension assets.

2015-02-04 Higher burden-01

The increase won’t impact profits because the changes will not be charged to income, but they do diminish the equity position. So, despite generating larger net profits - totaling an estimated €75 billion in 2014 - the equity ratios of DAX companies probably worsened.

This was partially evident in interim financial statements released on September 30. Volkswagen increased its pension reserve fund from €21.8 billion to €26.5 billion in 2013, while Bayer increased its pot from €7.8 billion to €11.3 billion.

Despite record earnings, equity ratios decreased by more than one percentage point at Volkswagen and by about five points at Bayer.

Developments were even more dramatic at Lufthansa, where unfunded pension obligations rose by about 50 percent to €7.4 billion, while the airline’s equity ratio dropped from 21 to 15 percent.

The companies are ready to take greater risks. Carl-Heinrich Kehr, Investment expert, Mercer

Pension reserve funds at Thyssen-Krupp, the DAX company with the highest burden in relation to equity, rose by 11 percent to €7.15 billion. At the same time, just under €700 million in healthcare benefit obligations were cancelled, due to the insolvency of its U.S. subsidiary, The Budd Company.

In addition, the company implemented a capital increase, so its equity ratio improved by almost 9 percent despite greater pension burdens.

Companies are also responding to the low interest rate environment by altering the investment policies of pension funds. Although they profited from the fast rising bond prices in 2014, bond yields likely will be lower in the future. As a result, Mercer notes, asset managers at the companies are increasing stock purchases and embracing alternative investments such as real estate.

“The companies are ready to take greater risks,” says Carl-Heinrich Kehr, an investment expert at Mercer. He notes that they have already increased shareholdings from 29 to 31 percent, and alternative investments from 12 to 16 percent, in 2014. This trend, Mr. Kehr adds, is likely to continue in 2015.


The author is a Handelsblatt editor specializing in the chemical and pharmaceutical industries. To contact the author: [email protected]