"However, in most cases the deteriorating funding position is expected to have a limited short-term impact on companies' cash funding requirements, and, assuming assets recover in the medium term, should not fundamentally change the nature of what remains a long-term liability. The devil is in the detail, however, and Fitch will continue to look beyond headline numbers for specific companies to determine the existence and extent of any additional cash flow demands."
While Fitch recognises pension obligations are debt-like and computes pension-adjusted credit metrics to take this into account, once it has been established that a pension deficit is potentially a significant credit issue, Fitch explores in more detail the cash flow impact of such a deficit.
While there will no doubt be pressure from some quarters for companies to increase pension deficit funding, in reality the practical consequences of the falling asset values will, in the short term at least, be limited by a number of factors.
In the UK, for example, negotiations between pension scheme trustees and sponsoring employers take place on a triennial basis, following full actuarial valuations. While in some circumstances this process can be accelerated, employers will have to address the real prospect of liquidity constraints and their own solvency (the 'employer covenant' in UK pensions terminology). This suggests they will strongly resist additional demands for additional cash by pension scheme trustees, and have their own constrained liquidity to use as a bargaining tool. Fitch believes they seem likely to get some support in this stance from The Pensions Regulator, which in recent pronouncements has emphasised a measured response by trustees to the current crisis. In guidance to trustees issued in October 2008, it suggested the current recession, and associated increase in deficits, may result in 'longer recovery periods being proposed, recognising the emerging pressures on company cash flows and thus affordability.' The market had interpreted the Regulator's previous guidance on recovery periods as suggesting a period of no longer than 10 years in most circumstances, with many plans having a shorter timescale.
Longer, potentially end-loaded recovery plans are likely, and Fitch expects to see sponsoring employers using a variety of measures to either put off paying cash into plans or to reduce the liability. The former includes the provision of contingent assets and transferring non-cash assets such as property to the pension scheme. These can affect other creditors' recoveries in the event of a default. The current downturn may also give more pressured employers the additional leverage they need to negotiate reduced pension benefits, scheme closure to new members or the cessation of further pension accruals for existing members, reducing their eventual liability.
In Germany, the other European jurisdiction where significant pension scheme deficits are often found, legislative arrangements for defined benefit pensions still favour unfunded schemes (i.e. where the employer simply pays pensions to former employees as they fall due). While this is generally the case, German legislation allows for plans to be funded voluntarily in a number of ways, including contractual trust arrangements (CTAs), or other, insurance-type, structures. While CTAs typically bear no statutory requirement to maintain any given funding level, there may in specific cases be additional factors which do generate some pressure - for example previous agreements with works councils on funding levels.
While Fitch believes it unlikely, for most companies, that higher reported pension deficits in 2009 will lead to rating-material increases in pension contributions in the short term, there is the potential that in specific circumstances an increased pension deficit could be at least a contributory factor to a wider problem - therefore the agency will continue to investigate the implications of pensions funding at an individual issuer level as appropriate.
