Pensions: How the turnaround in interest rates relieves companies of 105 billion euros

Rising interest rates are a challenge for many companies. There are various reasons for this: The higher interest rates make loans more expensive and devalue future earnings. This is because the cash flows of the future must be converted to their present value (“discounted”) using a higher interest rate. Many assets, such as real estate, can also lose value in this way, which puts a strain on balance sheets.

This effect was largely behind the recent banking turmoil, for example at the Silicon Valley Bank (SVB) in the USA, which had to sell long-dated government bonds with price losses after money outflows. The bonds had lost value due to the rise in interest rates. All of this is currently relevant because interest rates have been rising rapidly since the beginning of 2022. The European Central Bank (ECB) and the US Federal Reserve recently raised interest rates again.

But the turnaround in interest rates also has a positive side for companies. Large companies in particular have to plan a lot of money for their later company pensions. The higher the interest rate rises, the easier it is to bear these future burdens. Once a year, the management consultancy Willis Towers Watson (WTW) examines in detail how the pension obligations in the Dax are doing. Now she has presented the new study “Dax Pensionswerke 2022”.

Interest rate changes have an immediate impact

This shows the gigantic relief effect: with 308 billion euros, the 40 Dax companies had to book around a quarter fewer pension obligations. Compared to the previous year, the total fell by a whopping 105 billion euros. The obligations reflect which benefits – in particular pensions – companies have to pay to their current and future company pensioners. Companies have to set aside provisions for these obligations.

Behind the billions in relief is the massive increase in international actuarial interest rates. According to the study, it is currently 3.74 percent and has therefore more than tripled within a year. Interest rates have not been as high as they are now for almost ten years.

What you need to know about this: According to international accounting standards, which are decisive for most companies, an interest rate that is tailored to the maturity of the obligations is applied. Interest rate changes have an immediate effect. According to the German Commercial Code, on the other hand, a multi-year average interest rate would be used, which dampens the development.

“The year 2022 was characterized by extraordinary economic conditions: the Ukraine war, the energy crisis, fears of recession, the rapid increase in inflation, rapid, sharp interest rate hikes by the central banks, and great volatility on the capital markets,” says Hanne Borst, Head of Retirement Germany at WTW and co-author of the study. It is gratifying that the companies were able to “robustly manage” their pension schemes.

In total, the DAX companies employ 4.1 million people worldwide. The total balance sheet total of the companies is almost six trillion euros. On average, pension obligations account for around seven percent of the balance sheet total. The highest absolute amounts are achieved by Volkswagen (EUR 42.2 billion), Siemens (EUR 27.9 billion) and BASF (EUR 21.7 billion).

Billion dollar losses in pension assets

In order to assess the stability of the pension schemes, one must look not only at the pension obligations but also at the pension assets. The formation of such assets is not mandatory in Germany, unlike in other countries. However, most Dax companies use special pension funds. This allows them to reduce the pension provisions on their balance sheets. The pension assets are not shown in the balance sheet, but only appear in the notes. In order for assets to be recognized as pension assets, they must be managed in accordance with strict requirements. It must be earmarked and invested separately from the rest of the company’s assets. Creditors have no access. The part of the pension obligations that is not covered by such assets must be covered by other company assets.

The massive rise in interest rates was also reflected in pension assets in 2022. It collapsed by 17.8 percent to 245 billion euros. That is the blemish of the positive interest effect. At 42 percent, most of this money is invested in bonds. Their price falls when interest rates rise. Stocks only represent 19 percent, real estate accounts for six percent. The rest (33 percent) is distributed among other investments, including reinsurance, cash, infrastructure investments and private equity.

Many of these investments, not just bonds, react negatively to rising interest rates. “Last year there were only a few investments that brought positive returns,” says Johannes Heinz, Head of General Consulting at WTW and another study co-author. Overall, a clear decline was noticeable. Adjusted for currency effects, it amounted to 56 billion euros.