German companies will likely continue to feel the pain of increasing pension liabilities on their balance sheets if interest rates continue to fall and inflation doesn’t decrease.
Under the International Financial Reporting Standards (IFRS), if interest rates continue to fall, there will be a significant increase in obligations, and persistently high inflation would continue to lead to sharp increases in liabilities and cash flows for inflation-linked commitments due to the long payout periods of most pension plans, Lutz Specht, partner at consultancy BDO said, commenting on pension liabilities numbers published with pension buyout group Vedra Pensions.
Inflation in Germany rose to 3.7% in December 2023, and by 5.9% for the year on an annual average basis compared with 2022, according to the Federal Statistical Office. The Bundesbank’s forecast for the inflation rate is currently 2.70% for 2024.
With the moderate increase in average discount rates, instead, the valuation of pension obligations under commercial law could ease slightly in the next few years, he added.
German companies are already bearing a higher level of liabilities on their balance sheets due to the combination of inflation and higher interest rates.
Corporate pension obligations have already increased by around 17% at the end of 2023 compared with the previous year, mainly due to the discount rate under IFRS falling on average by around 0.5 percentage points, and the consequences of inflation, which continues to be above long-term pension trends, according to figures published by Vedra Pensions and BDO.
Many companies will have to face once again uncertainty with regard to their pension obligations in the current reporting season, both firms said.
Vedra Pensions and BDO conducted an assessment of the expected valuation of pension obligations of German companies in the current economic environment. The analysis showed that inflation continues to affect balance sheets and cash flow, especially in the case of inflation-linked pension benefits.
“This picture once again illustrates the risks of pension obligations, which, in contrast to other forms of liabilities, entail both balance sheets and cash-flow volatility for companies,” said Tilo Kraus, managing director of Vedra Pensions.
He added: “Compared to previous years, both the development of interest rates and the development of inflation were equally negative for companies.”
A large part of an estimated €650bn in pension provisions in Germany is directly linked to inflation, meaning that an overall increase is likely to be in the high double-digit billions, according to the figures.
Risk transfers of pension liabilities can help to protect balance sheets and cash flow planning against such fluctuations, the firms added.
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