Pension Funds -- the Next Shoe to Drop

Some of the country's biggest plans are underfunded, which will further erode earnings.
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As personal-savings accounts are starting to resemble piggy banks more so than treasure chests, pension income for workers lucky enough to have a defined benefit plan will become even dearer.

The problem is that every major pension fund, public and private, has been investing in the same risky assets that have crushed personal accounts and they, too, are now suffering losses that could lead to funding crises and, perhaps, government intervention.

Goldman Sachs' Global Markets Institute estimates that corporate defined benefit pension plans have fallen from being 108% funded at the end of 2007 to being 91% funded as of Oct. 13. This drop has led to a cumulative funding deficit of $115 billion. This means corporate defined benefit pension funds have lost $217 billion in 2008.

Pension funds are the biggest investors in the world. Calpers, the California Public Employees' Retirement System, had $253 billion in assets at the end of last year. By Sept. 30, assets had fallen to $213.5 billion, a loss of $39.5 billion, or 15.6%. And the numbers aren't even in for October, the worst month for equities.

The largest corporate fund is held by automaker

General Motors

(GM) - Get Report

. Weighing in at $104 billion in assets with obligations of $85.3 billion, it had a positive funding status of $18.7 billion as of Dec. 31, 2007. If we assume GM contributes and pays out similar amounts this year as it did in 2007 ($89 million in and $7.5 billion out, respectively) and we assume a return of minus 20%, which would beat the

S&P 500

, a rough sketch of the impending problem begins to unfold.

Even with conservative estimates of the 2008 plan-asset returns, the $18.7 billion surplus becomes an $8.1 billion deficit and the stock market may not pick up the slack any time soon. For a company with cash flow problems, this is a terrifying obligation on the horizon.

Many major corporate pension funds were already underfunded as of year-end 2007. When the massive losses from this year are taken into account, the difference between obligations and assets could cause a funding crisis that may take down already weak companies. (Corporate funds are not required to disclose funding status until yearend.)

Macy's

(M) - Get Report

, for example, has a plan that was only 70% funded, leaving it short by $980 million in 2007. Similar assumptions as those applied to GM leads to the underfunded amount jumping to $1.75 billion and the level of funding sinking to 46%.

If either of these funds were invested in any substantial way in the company's own stock, which is common in corporate plans, the losses could be substantially higher. GM shares have lost over 80% of their value this year, and Macy's is down 65.8%.

This problem is not confined to one industry. Relatively healthy companies have the same ax hanging over their heads.

ConocoPhillips

(COP) - Get Report

had underfunding of $1.14 billion at the end of 2007, leaving the plan only 73% funded, while

Viacom

(VIA.B)

is playing with fire, as it's able to fund only 58% of its obligation.

An underfunded pension fund erodes companies' bottom line. All private pension plans have to pay into a governmental organization, the Pension Benefit Guaranty Corp., or PBGC, which provides a form of insurance for employees covered by the plan. For a fully funded pension plan, the cost is nominal. Plans pay a premium of 0.9% on the amount underfunded. For a company whose deficit runs into the billions, it can be a crushing expense.

In addition, the company is also on the hook for the missing amount. The PBGC will only step in to manage a pension plan that is closing and is fully funded, or in the case of a bankruptcy.

Some companies have opted for stronger quarterly earnings rather than the proper funding of their commitments. Some assumed an average yearly return of as much as 9%, a short-sighted move.

Public funds, such as Calpers, and state employee and teacher funds nationwide most likely will have similar-sized shortfalls, requiring help from the states, whose reserves are already running on empty.

When looking for companies to scoop up at a discount, investors ought to scour reports for the time bomb of pension underfunding. ConocoPhillips, Macy's and Viacom are all rated "hold" by TheStreet.com Ratings, while GM is a sell. With pensions in peril, the ratings probably won't improve for some time.