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Prepare for the Looming Pension Crisis

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Recently, workers with employer-sponsored 401(k) plans have taken it on the chin. The bear market has hurt anyone who invested their 401(k) money in stocks, and many employees who invested too much in their employer's stock have seen huge losses.

401(k) plans have behaved so badly that many are now calling for significant reform, or even these plans' outright abolition. Yet before you decide that worker-controlled retirement plans can't stand up to real pensions, here's some bad news: Underfunded pensions could well be the last straw that moves the U.S. into a brand-new financial crisis light-years beyond what we've seen so far.

Employers have gotten hurt, too
A recent study from Standard & Poor's indicates that America's retirement safety net is in worse shape than many probably thought. Even as companies have seen their own share prices plummet, and had to cut costs through layoffs and pay cuts, they've also seen many of the investments they've made toward meeting their pension obligations get slammed.

As a result, the overall shortfall among pension funds has grown substantially. According to Standard & Poor's, those companies in the S&P 500 index have only $1.1 trillion in assets to meet estimated future obligations worth $1.4 trillion in current dollars. That shortfall comes to a little more than two years' worth of earnings for those 500 companies.

Moreover, the problem is widespread. A report from Wilshire Associates found that 92% of the 323 companies in the S&P 500 with traditional defined-benefit pensions were underfunded. The median funding ratio was just 73.3%, indicating that the amounts by which these plans fall short are generally quite significant.

What it means for investors
At the very least, pension shortfalls could force companies to divert earnings to increase pension reserves, forcing them to take charges against earnings. That could disappoint investors, although savvy companies that take the opportunity to bundle one-time charges into already subpar quarterly results might effectively keep their full impact under the radar.

Pension shortfalls could have a much greater effect on companies that are already feeling the strain of the recession on their balance sheets. Take a look at the financial condition of some companies the report cites as having shortfalls:

Company

Pension Shortfall

Cash Less Long-Term Debt

2008 Profit/Loss

ExxonMobil (NYSE: XOM  )

10,999

24,994

45,220

General Motors (NYSE: GM  )

25,499

(26,783)

(30,860)

Kraft Foods (NYSE: KFT  )

2,004

(18,110)

2,901

Time Warner (NYSE: TWX  )

363

(32,957)

(13,402)

CBS (NYSE: CBS  )

1,486

(6,577)

(11,673)

Southwestern Energy (NYSE: SWN  )

13

(539)

568

Hershey (NYSE: HSY  )

19

(1,487)

311

Source: Capital IQ, a division of Standard and Poor's. Numbers in millions as of financial statements for Dec. 31, 2008.

Not all of these companies are in terrible shape. Companies like ExxonMobil and Hershey could fund their shortfalls with just a fraction of their 2008 earnings. Others, such as GM, face the triple whammy of big debt, huge earnings losses, and major pension shortfalls. Investors can only expect bad news to get worse for these companies and their stocks.

Not just in the stock market
Moreover, the problems go well beyond the private sector. State and local governments, large colleges and universities, and other public pension systems have lost unprecedented amounts during the bear market, creating a potential trillion-dollar shortfall that could go well beyond their ability to raise revenue to remedy the situation successfully.

A collapse of the public pension system could overwhelm local economies that are already struggling to survive, even with huge inflows of funds from the federal government. A cascading loss of confidence could make the recession we've seen thus far look like a walk in the park compared to the real depression that could follow.

Investors who think the worst is behind us need to pay attention to the implications of pension shortfalls. It will take a major readjustment in workers' expectations, as well as corporate financing of pension obligations, to overcome this huge challenge -- which could very well become the next major financial crisis.

For more on preserving your retirement:

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Fool contributor Dan Caplinger has dealt with his own retirement savings for years. He doesn't own shares of the companies mentioned. Kraft Foods is a Motley Fool Income Investor selection. Try any of our Foolish newsletters today, free for 30 days. The Fool's disclosure policy plans to survive any crisis.


Read/Post Comments (8) | Recommend This Article (13)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On April 23, 2009, at 2:31 PM, clanza875 wrote:

    I fail to understand how this is going to bring america down. So they're underfunded by 300B thats less than half of the original TARP and close to what AIG has gotten so far.

  • Report this Comment On April 23, 2009, at 7:24 PM, holosys wrote:

    "It will take a major readjustment in workers' expectations."

    That is the problem. Greedy corporate CEO's and boards expect employees to lower their expectations so they can continue receiving multi-million dollar pay packages, obscene gold parachutes, and fat bonuses they do not deserve.

    While high level executives are stuffing their personal domestic and overseas bank accounts and buying property all over the world, they expect employees to make major readjustments.

    Employees need to demand laws to stop high level theft by lazy executives. I cannot name a major company where its CEO and his cohorts are not hoarding cash so they can spend the rest of their lives consuming excessively at the expense of working people. Think about it, the next depression is meaningless to those who can vacation in Europe luxuriously even if the rest of us starve to death.

  • Report this Comment On April 23, 2009, at 11:47 PM, WishToRetire wrote:

    These pictures give the word trillion a sense of its real (i.e. scary) meaning

    http://www.pagetutor.com/trillion/index.html

  • Report this Comment On April 24, 2009, at 1:36 AM, paultaut wrote:

    YRC wordwide has just received permission to delay Pension contributions. That's Yellow Freight.

    Truckers are suffering across the country. Its not their fault, its ours. I we don't buy, they don't ship.

    Who forced us to buy a home we couldn't afford, SUV's and Hummers, a family of 4 with 4 cars, a vacation home sitting idle for most of a year, speculating on Condos yet to be built, Big screen Plasmas which used more electricity than 2 refrigerators and cost more than 2 refrigerators.

    Did someone force us to buy a New Cell phone everytime an "improvement" was made or buy a new Ipod/Iphone/IMac/Ianything just to keep up with our friends. Did we care that Ball players were being paid Millions or that the poor Movie Stars had to go on strike to make extra Millions.

    We envied the lifestyles of the "Rich and Famous" by watching TV shows about them. We did not care then.

    Now, when the rubber finally meets the road, they are the crooks and criminals. We have to blame someone else, never ourselves.

  • Report this Comment On April 24, 2009, at 9:09 AM, hal5840 wrote:

    Americian's are their own worse enemy. We have become use to buying everything on credit and as a society are very wasteful and demanding.

    I believe the entire pension system needs to be looked at especially at the government level. The government workers receive a pension that is 80% of their ages at time of retirement. Wouldn't we all love that. We as taxpayers are funding these pensions yet we have nothing to say. At what point does the government get it that they can't keep spending. They can tell private industry how to reduce cost but they can't reduce cost. I really don't understand why more people have not come down on the government at all levels to start controlling cost. When any government says they have to layoff people because they don't have the tax revenue they are not telling the entire truth. Their is not one person that believes that their is not waste in government. It's about time we begin contacting our elected officals and tell them that they need to reduce waste.

  • Report this Comment On April 24, 2009, at 12:09 PM, fattanker wrote:

    hal5840

    Please feel free to look up the pension policies for tha majority of government employees. Pay and benefit information is availlable on-line for any government position. I'm one and I am not aware of the great deal you described. (Congress excluded). Mine certainly has nothing to do with age. Pension plans generally pay on a formula based on time in service and pay at retirement.

    I fully agree that the public should get to see and voice opinions about compensation matters for the government. (We work for you, lest some of my peers forget) I also agree that these obligations should be funded through the budget, as any government obligation should be.

    However, if you want to attack government waste, it should be for three reasons:

    1. excessively large programs (too many employees for the task)

    2. unnecessary programs (not useful, or outside of the scope of the federal government)

    3. not feasible at this time (not entirely funded within the annual budget)

    Limiting your solutions to these areas, and not focusing on the wages and benefits of individual employees offers a more constructive approach to government fiscal responsibility. Attacking individual wages and benefits will result in lower incentives for decent, competent folks to take those jobs.

    Why would I process tax refunds for $10/hr when I can pre-audit them for a comercial tax filer for $15-20/hr? Why would I drive trucks for the Army for $28k/yr (80-100 hours/per week in hazardous conditions) when I could drive commercially in a comfortable, safe environment where I exert more control over my hours and pay.

    The answer lies in the entire pay/benefit package that the government can offer. Stripping those away forces people to the commercial sector leaving the government with the folks that generally couldn't make the cut. (I'm not saying this doesn't already occur in some areas)

    To bring this back to the inflation topic, we really need to pressure the government to prioritize and focus on the tasks that are necessary and stop spending that money we don't have on optional endeavors.

    Nothing would restore a vote of confidence in the dollar more than passing a balanced budget for a change, especially one with a surplus, specifically directed toward paying down the national debt.

  • Report this Comment On April 24, 2009, at 2:24 PM, jag99 wrote:

    I suppose the author does not support M2M changes either...it is the same problem...the pension funds shortfalls are estimated using a today liquidation value...that's not real life...what were the shortfalls when the market was 6200 DJ ? what will they be when its at 10,200 ?

  • Report this Comment On May 06, 2009, at 6:56 PM, diditbad100 wrote:

    What will the shortfall be when the DJIA goes back down to 5,000 or lower? Scary question! Good thing that the market is headed in the right direction, I hope it keeps going up! Other considerations are how much will companies lose if the market stays down for a long period of time? The company I work for is doing well, but cash on hand is invested in the market.

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Dan Caplinger
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Dan Caplinger has been a contract writer for the Motley Fool since 2006. As the Fool's Director of Investment Planning, Dan oversees much of the personal-finance and investment-planning content published daily on Fool.com. With a background as an estate-planning attorney and independent financial consultant, Dan's articles are based on more than 20 years of experience from all angles of the financial world.

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