The expectation of quantitative easing by the European Central Bank (ECB) will likely cause an increase of 11%-18% – between €58 billion and €92 billion – in reported European pension liabilities in 2014 for the 50 most exposed companies that we rate in Europe. This is because the sharp fall in long-term corporate bond yields was only partly offset by a drop in long-term inflation expectations.
Underfunded defined-benefit (DB) pension schemes with deficits greater than 10%-15% appear particularly vulnerable to the ECB’s monetary policy. These DB plan deficits will become a more material negative credit factor over the next two years as a result.
The reason is that our adjustments to reported debt include unfunded pension deficits. For instance, pension deficits for these 50 companies have increased adjusted debt by 30%-40% in recent years. Therefore, the challenge companies now face is reining in these growing deficits and mitigating any potential impact.
At present, we expect liabilities to climb even further in 2015 – assuming the reduction in long-term corporate bond yields to below 1.5% holds – making effective risk management an immediate priority. Companies need to continue managing their pension risk exposures carefully to mitigate any further negative impact to their creditworthiness. To this end, we expect plan sponsors to explore options such as lowering staff pension benefits by freezing pensionable salaries, capping future pension increases, increasing the retirement age, and closing plans to new (and even existing) members.
Looking ahead, the medium-term risk remains that quantitative easing achieves nothing more than an environment of stagflation in Europe. The combined effects of weak growth, low bond yields and rising inflation could create a toxic mix for already struggling DB pension schemes.
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