European Companies Underestimate Pension Obligations

The pension deficits of Europe’s major listed companies – some 430 – were underestimated by €300bn in their last full year reports with some of the largest gaps at UK banks, according to AlphaValue, a pan-European independent equity researcher.

AlphaValue’s research reveals the most underestimated funded obligations, in value terms, were those of Lloyds, The Royal Bank of Scotland (RBS), British Airways, Siemens, Barclays, RD/Shell, HSBC, GlaxoSmithKline (GSK), BT Group, ING and EDF. In percentage terms, AlphaValue believes there are 31 firms with obligations underestimated by 40% or more and above €1.5bn.

Conventional estimates of pension deficits (measured through corresponding provisions) for Europe’s largest listed companies grew by 22% to €280bn. But there is an additional €300bn – equivalent to 9% of the total shareholders’ equity of the European companies analysed by AlphaValue – that has been unrecognised, most notably through the use of high discount rates.

The basis of the miscalculations, believes AlphaValue, is through companies underestimating wage inflation and overestimating the opportunity cost of money (discount rate).

AlphaValue believes that some companies, particularly those that are UK-based, attempt to keep the lid on pension obligations by minimising projected rates of future salary increases and maximising the discount rate. In 2008, the average wage inflation rate declined to 3.6% from 3.7%, and the average discount rate increased to 5.57% from 5.38% (4.9% in 2006). This 30bp improvement in the ‘spread’ may look insignificant but it is not when applied to €1.1 trillion of obligations. A rough indication is that this 2008 ‘spread’ saved European corporates about €51bn in extra provisioning.

Pierre-Yves Gauthier, director at AlphaValue, said: “More than one-third of 2008 pensions obligations – some €1.1 trillion – are recorded at UK companies, as this is where the largest companies operate with the largest defined-benefit commitments. The bulk of the ‘non-accounted-for’ pension deficit is also with UK corporates, especially the banks, as they use rather high discount rates compared with non-UK peers. A number of companies have made sharp corrections in their valuations over the last few quarters. However, difficult market conditions make it even more important that more consistency be found across European corporates on the use of coherent discount rates in particular.”


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