Pension Liability
AdvancedA pension liability is the obligation a company records for retirement benefits it has promised to employees under a defined benefit pension plan, measured as the gap between the value of the promised benefits and the assets set aside to pay them.
In a defined benefit plan, the employer promises a set level of pension, often based on salary and years of service. It must estimate the present value of these future payments, called the benefit obligation, using assumptions about life expectancy, salary growth, inflation and a discount rate.
The company compares this obligation with the value of the plan's investments. If the obligation is larger, the shortfall is a pension deficit, shown as a liability on the balance sheet. If the assets are larger, there may be a surplus.
For example, if a company's pension obligation is valued at 500 million and its plan assets are worth 420 million, it reports a net pension liability of 80 million.
Pension liabilities can be large and volatile. Small changes in the discount rate or life expectancy assumptions can change them significantly. Analysts often treat pension deficits like debt when valuing a company. Many employers have closed defined benefit plans and moved to defined contribution plans, which do not create this liability.
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