Financial Analysts Beware: The Rules of Pensions Are Always Changing

Implications: 1)  The PBGC increasing the amount of insured benefits for qualified, defined benefit plans is a normal, annual event. 2)  Ignoring the impact of this increase on firm valuation can be problematic. 3)  Financial analysts, following mature and declining industries and firms, must pay particular attention to this increase due to solvency and liquidation issues. 

Analysis: Each year, the Pension Benefit Guaranty Corporation (PBGC) revises the maximum pension it will guarantee. This year the limit was increased from $49,500 to $51,750, or a 4.5% increase. This annual escalation is normal and to be expected.

What is important to realize is the impact of this increase. The PBGC's goal is that all defined benefit plans meet all pension promises. However it only insures such promises up to a limit. All promises above this limit are uninsured. If a firm, with an underfunded defined benefit plan, gets into a solvency problem, the PBGC can place a lien on the firm's assets up to the insured amount. All amounts above the insured limit are general creditors. Thus, as the limit increases, the financial implications for valuation also increases.

The PBGC is responsible for adequate funding of all qualified, defined benefit pension programs in the U.S. When a pension fund is well funded, an increase in the limit has very little impact. However when a firm's pension fund is not well funded, the PBGC can have a significant impact on the firm's operations and possible liquidation. 

Financial analysts need to be cognizant of this fact, particulary for mature and declining industries and firms.  The valuation of such firms can be altered by the PBGC's claim.