Bankruptcies and underfunded pension plans are painful not just for pensioners but for investors too. Pension plan underfunding is one company risk indicator that an investor should examine closely. Underfunded pension obligations that become too onerous may cause a liquidity crisis in a weakened company and may be a catalyst for bankruptcy. Companies are obligated to make up pension underfunding with extra catch-up payments, which can harm the company's chance of survival. Westlaw's Bankruptcy Risk: Pension Underfunding in Overdrive describes the difficult situation in some of Canada's best-known companies like Air Canada and AbitibiBowater.
Recently, Rob Gerlsbeck at MoneySense evaluated the status of pensions at 181 public Canadian companies in The Top 22 Pensions in Danger. His table (which can be downloaded as a spreadsheet for further sorting and filtering) uses two very useful figures to assess pensions in danger: the percent underfunding (pension plan liability vs pension assets) and the Altman Z-score, which estimates the risk of near-term bankruptcy using accounting figures. This table can help an investor screen in, or out, potential investment targets.
The Altman Z-score is a reasonably reliable predictor of company bankruptcy according to the Wikipedia article on the subject but extensive lists where the calculation has been done are not readily available to the online investor. Investopedia's Z Marks the End walks through the example of how the Z-score foretold of trouble at WorldCom and discusses limitations of the metric. To do one's own Z-score calculations, there is an online calculator at CreditGuru, or one can build one in a spreadsheet with the formula. The required accounting data is found in company financial reports.
The crash of 2008 hit pension plans hard through lowered values of the shares which comprise much of the assets of such plans. The recession added to stress on company operations and drove some famous names like GM and AbitibiBowater into bankruptcy. There has been modest recovery in pension solvency during 2009 along with the stock market but the federal pension regulator, the Office of the Superintendent of Financial Institutions, said that the average solvency of the 400 plans it monitors rose only from 85% in December 2008 to 88% in June 2009. This is still lower than any other point since 2003.
Averages cover a wide range of individual company situations, from the desperate like Extendicare REIT, to the extremely solid like Corby Distilleries, as the MoneySense table shows. Further digging may also reveal a different picture, such as the fact that Zarlink's pension plan, though unfunded and described as in danger by MoneySense, has been protected in other ways as CanadainFinancialDIY writes. Investors, like pensioners, need to monitor this risk hot spot when buying or selling stocks.
Disclaimer: this post is my opinion only and should not be construed as investment advice or recommendations.