Beware the Cost of Pension Possibilities

Implications: Unfunded pension and OPEB benefits (e.g., Other Post Retirement Benefits - health care) have little or no priority of claims in bankruptcy, in relationship to other forms of debt.  As political currents change, the possibility of radically changing this situation also changes.  (See source article.)  If pension and OPEB liabilities gain higher priority in bankruptcy, the imbedded risk in other forms of debt will increase.  This increase in risk will ultimately force higher required rates of return and thus lower values. Financial analysts need to be aware of this when pricing such debt and related equity.  

Analysis: When a company files for bankruptcy, the company's pension and OPEB liabilities have little priority of claims regarding debt.  It is only higher in priority to equity.  Thus pension/OPEB recipients, or their agents (e.g., unions, PBGC, etc.), are often left with little legal position.  An example is US Airways bankruptcy.

If legislation is passed to change the current law, two things may and probably will occur.  First, it will be harder to bring bankruptcy companies back as economically viable entities.  Second, pension/OPEB liabilities may force other forms of debt to bare higher default risk.  This higher default risk will mean lower values for such debt.

The bottom line is simple for financial analysts.  The pension/OPEB risk currently born by employees could be shifted to holders of other forms of debt and equity.  This has significant implications for valuations.