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How pension risk affects corporate behavior

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SmartBrief is partnering with Big Think to create a weekly video spotlight in SmartBrief on Leadership called “VIP Corner: Video Insights Powered by Big Think.” This week, we’re featuring Jonathan Nus, senior director of S&P Ratings Services.

After the Pension Protection Act was passed in 2006 and once pension deficits were moved on to companies’ balance sheets, there was a change in corporate behavior toward pensions, says Jonathan Nus, S&P Ratings Services’ senior director.

Now, pension deficits are considered similar to debt in S&P’s analyses and pension obligations are usually companies’ second most significant financial obligation, after debt, he says. “And just to give you some perspective, in many recent studies that we’ve done where we’ve looked [at] credits across our entire rating spectrum, across various industries which are pension heavy as well, we find that pension deficits add nearly 20, sometimes 30% to a company’s reported debt levels,” Nus adds.

Nus says that defined benefit pension plans should be viewed from the perspectives of business risk and financial risk. When it comes to business risk, companies should consider their competitiveness compared with their peers and the relation of the pension plans to their cost structures. “Many companies are managing both the liability and the asset side of the equation together in a much more holistic way,” he says. “And those companies that are managing both the liability and asset side of the equation are minimizing much of the volatility and noise that ultimately affects their balance sheet and their capital structure.”

When it comes to financial risk, S&P looks at pension plans as deferred compensation plans in which employees are creditors to their employers, which is why they consider pension underfunding as a “debt-like obligation,” according to Nus. And since the plans ultimately affect companies’ cash flows, S&P adjusts the cash flow, leverage and profitability metrics to reflect the status of the pension plans, he adds.

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