Pension deficit
AccountingThe excess of a defined benefit obligation over the assets held in the plan, treated as debt like in the bridge.
Also written: underfunded pension, net pension liability
A defined benefit scheme promises retirees a stream of payments, and the present value of that promise is the defined benefit obligation. Against it sits a pool of plan assets. Where the obligation is larger, the difference is a deficit, and it belongs in the bridge because it is a claim on the company's future cash that ranks ahead of shareholders and appears nowhere in EBITDA.
Only the deficit is added, not the gross obligation, because the plan assets are already earmarked against it. Adding the obligation gross while ignoring the assets is a common and large error.
Whether to add it gross of tax or net is a live disagreement. Contributions are generally deductible, so a deficit of 80 costs 60 after tax at a 25% rate, and many practitioners use that figure. Others argue the timing of the benefit is too uncertain to capitalise. Either is defensible. Not saying which you used is not.
The number itself is fragile in a way a bond balance is not. It is a snapshot at a reporting date resting on actuarial assumptions, and it is acutely sensitive to the discount rate because the obligation is long dated. The deficit also says nothing about the funding schedule, which is what actually consumes cash, so a large deficit spread over a long agreed recovery plan can be a smaller problem than a modest one falling due next year.
Worked example
An obligation of 230 against plan assets of 150 gives a deficit of 80, which becomes 60 if added net of tax at 25%.
Now move the discount rate. A scheme with a duration of about seventeen years sees its obligation move roughly eight and a half percent for a fifty basis point change, so a fall of that size lifts the obligation by close to 20 and, with plan assets unchanged, takes the deficit from 80 to about 100.
Nothing happened to the business in either case, which is why the deficit is checked against the latest actuarial position rather than lifted from a stale balance sheet.