A retired couple
Remember those defined-benefit programs through which companies promised a certain amount every month to retirees? The market crash may be dealing that already waning concept a final, fatal blow. A new report from Goldman Sachs' Global Markets Institute illustrates that massive equity losses have resulted in S&P 500 companies' pension funds, which had been overfunded at the start of the year, fading so fast that they are now underfunded as a group. Instead of holding 108% of the assets they were promising to provide to retirees, they now hold just 91% (and falling).
As the appropriately dubbed "Pension Palpitations" report details, the S&P 500's pensions are now collectively underfunded by at least $115 billion. The problem stretches far beyond the finance sector. Five of the companies with the highest dollar amount of pension underfunding, according to the report, are Raytheon (underfunded by $1.6 billion), Johnson & Johnson ($1.5 billion), ExxonMobil ($1.4 billion), Macy's ($980 million) and Alcoa ($950 billion). "This is affecting the broad swath of companies that make up the fabric of what we call the 'real economy,'" says Mark T. Williams, a risk-management expert and finance professor at the Boston University School of Management.
With the stock market shedding more than a third of its value this year, pension funds at big companies have been battered beyond recognition. What looked like safe stowaway spots where corporations securely tucked away assets for their employees' retirements now look like roller-coaster funds. In addition to sending shivers up the spines of employees who count on that income, the problem also threatens to haunt the bottom line at many major firms. Williams says some may be forced to consider mergers to accumulate bigger asset bases or may have to sell off strategic assets.
"In the past, the IBMs and GEs of the world have not had to worry about underfunded pensions," says Williams. Now, though, successful firms with undervalued obligations may have to accumulate additional cash, amid the credit crunch, just to prop up their pension accounts. That's in part because evolving accounting standards — including those established in the Pension Protection Act of 2006 — prevent companies from getting too far underwater on their obligations to retirees. Public pensions have also been hit hard. State and local governments' pension funds support some 27 million Americans, and many have lost a fifth of their value this year. Virginia's retirement fund and California's Calpers have each fallen 20% in just the past four months. The pain is both broad and deep.
Focused on long-term growth, corporate pension funds tend to lean heavily on stocks. More than 60% of S&P 500 firms' holdings at the start of the year were in equities. Those firms that bet most aggressively on stocks have been especially hard hit. For example, about 80% of Harley-Davidson's pension assets were invested in equities at the end of last year. Johnson & Johnson's (79% equities) and Exxon's (75%) funds have also been bruised. But the pension pain may be most acute for smaller outfits, some of whose obligations amount to more than 100% of their market capitalization. That category includes companies like Circuit City, whose obligation now amounts to 336% of its market capitalization, OfficeMax (271%) and Goodyear (170%).
Where will all this lead? Companies that haven't done so already will likely move even more swiftly toward defined-contribution plans in place of defined benefits, because doing so reduces the potential scale of their future liabilities. The shift means firms will assure you, the employee, of how much they are putting into your retirement fund instead of promising how much you'll end up with. That latter amount will depend on how your investments perform rather than on the scope of your employer's pledge. "When my father was working, he knew what he would retire on," says Williams. "Now the market risk will be borne on the shoulders of employees."