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Stocks With Pension Funds Losing Worth: CN Rail

February 09, 2009 | About:
Saj Karsan

Saj Karsan

21 followers
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 (CNI).

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.

Saj Karsan

www.barelkarsan.com

About the author:

Saj Karsan
Saj Karsan founded an investment and research firm that is based on the principles of value investing. He has an MBA from the Richard Ivey School of Business, and an undergraduate engineering degree from McGill University.

Rating: 3.3/5 (7 votes)

Comments

kbodawala
Kbodawala - 5 years ago
Some things to consider about Defined Benefit Plans vs. Defined Contribution plans. Defined Benefit plans are more riskier becasue the assets and liablitites are owned by the plan sponsor. So if the plan liabilities exceed the assets then the sponor (company) must make up the plan underfunding. To really evaluate the plan you must go beyond just its asset allocation look at the following also:

1. Average age of employees

2. Companies ability to pay for plan underfunding thru operations.

3. Formula used in arriving at Pension Benefit obligation.

This is very critical since the discount rate used to discount its obligations can greatly understate obligations (high rates understate obligations). Also rate of return assumption used on assets (high rate will lead to overvaluing future assets).

4. Assumptions in empolyee pay rate growth also factor in since the formula used for payout is based on employees average pay over the last few years of his worklife.

A decline in current asset values may not mean much if the company has a young workforce and can make its obligations to its current retirees thru operations. However, it maybe be very important if the age of workers is old and the impending retirement of a large portion of its workforce coupled with losses from current operations will leave the company having to deficit finance its obligations.

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