Many companies offer pension funds to employees as a tool for attracting and retaining workers. Some of these pension funds are called “Defined Contribution” plans, since the employer and/or employee kick in a defined amount into an account every period, and the employee owns whatever is in that account when he leaves. The other type of pension fund is called a “Defined Benefit” plan. When it’s the benefit that’s fixed (or defined), rather than the contribution, the shareholders are on the hook for a set benefit when the employee retires, no matter what happens between now and then.
As one may imagine, “Defined Benefit” plans are more risky for shareholders. If returns on the plan’s assets are strong, shareholders make money. In a time like this, however, assets in pension plans are taking a plunge, and shareholders are on the hook to make up the difference. Consider CN Rail (CNR).
In last year’s annual report, CNR disclosed that it held $16 billion in assets specifically to pay for its obligations under its “Defined Benefit” pension plan. Since then, the S&P 500 is down almost 50%. CNR also disclosed that it aims to hold 53% of plan assets in equities, suggesting that its pension plan will have dropped by $4 billion in the last year by considering the equity drop alone (i.e. ignoring real-estate and other components of the plan assets).
While some investors may believe the market will rebound by the time these obligations have to be paid, others may have a more dire outlook and believe this to be a permanent loss. Whatever the investor’s position may be, it is important that he understands and is aware of any pension obligations a company may have. For CNR, this $4 billion swing represents 20% of the company’s current market cap, making it no small point.