Worries about pension deficits just won't go away. Despite a big rally in the stock market, most companies in the S&P 500 have seen their pension deficits expand even further this year, meaning even bigger cash contributions could be necessary and earnings could take another hit as a result. What's more, companies continue to assume very high rates of return on their pension assets, suggesting that the quality of corporate earnings will remain poor in 2003. David Bianco, head of the valuation and accounting group at UBS Investment Research, believes that S&P profits will be overstated by about $2 this year because long-term asset assumptions are too aggressive. Thomson First Call is currently looking for the S&P 500 to post earnings of $52.10 this year. Here's what's going on. Companies treat pension contributions from workers as if it were income that they can invest in the financial markets. When times are good, pension assets typically expand, but when financial conditions turn south, companies can lose money on their investments. Pension accounting rules require that firms contribute money to their pension plans if they are deemed to be sufficiently underfunded, and big contributions to these plans can act as a drag on earnings. But wait, hasn't the stock market moved higher this year? Yes, but at the same time interest rates have moved to multidecade lows, and interest rates help to determine the present value of future pension liabilities. For example, let's say company XYZ has to pay an employee $20,000 per year in 20 years. If interest rates are very low, at say 2%, the firm would need $13,459 today to cover the expense. But if rates were higher, at say 8%, the firm would need just $4,290 to cover. The upshot of this is that while pension assets have increased this year, low interest rates have raised liabilities even more. The aggregate pension deficit for S&P 500 firms stood at a record $239 billion as of the end of May, according to Bianco, who estimates that this will increase to $278 billion by the end of fiscal 2003.