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Corporations in the U.K. have become grimly familiar with watching stock markets go down, then down some more. London's FTSE 100 index has fallen about 48% from its all-time high at the end of 1999 — and about 9% just in the first month of 2003. Obviously, the most painful dip for any company is one in its own share price. But when market bears roam as widely and fiercely as they have for nearly three years, they can harm even firms whose own shares are doing well.

Why? Because in the U.K. almost half the work force subscribes to a corporate retirement scheme — the highest of any E.U. nation. Those funds are overwhelmingly invested in equities, and when the markets tank, firms are hit hard. How hard? Last month, a study by investment bank Morgan Stanley estimated that in 2002, the pension liabilities of companies in the FTSE 100 grew from $330 million to over $108 billion in a single year.

The corporate pension deficit is causing havoc. U.K. companies with billions in obligations to workers are panicked over losses and confused about how to respond. And investors are fast learning that pension liabilities can reduce or even eliminate the profits of the world's largest corporations.

Fortunately for the employees involved, companies do not have to plug the holes overnight. The shortfalls are in obligations that stretch far into the future. "We have years to address this," says Ross Cook, a spokesman for British Telecommunications (BT), a company whose pension-fund deficit is currently calculated at about $2.63 billion. But experts say the shortfalls should raise alarms about the long-term solvency of some schemes, and serve as a red flag to funds that continue to invest heavily in equities. In 2001, equities constituted 71% of the assets held by U.K. pension funds. Asks Allan Cook, technical director of the Accounting Standards Board, "Have they taken a risk which is ultimately very serious? Once you've made a loss, how do you get it back?"

During the bull market of the '80s and '90s, equity investment proved a bonanza for corporate pension schemes. In 1997, says the U.K.'s National Association of Pension Funds, some plans were doing so well that 34% of schemes took "contribution holidays," using stock-market returns to cover their liabilities. As late as last year, 24% of plans were still doing so.

Those were the days. One of British Airways' (BA) pension funds, worth about $5.7 billion, currently has a deficit of more than 6% of its value, a shortfall for which BA currently sets aside an additional $40 million annually. For its part, BT must contribute an additional $330 million annually to cover its pension-fund deficit — which eats into profits.

As a way to stem the flow, some U.K. employers have stopped offering plans that promise retirees a fixed benefit: in the private sector, 30% of such plans have closed to new entrants. (Newer schemes are much less certain, and place all the risk with the employee rather than the employer: what workers take out at retirement depends on how their investments perform.) Experts remain unconvinced that such moves will solve long-term problems. "That solution is a very slow burn," says Raj Mody of U.K. actuaries Hewitt, Bacon & Woodrow. "All you're doing is addressing past promises."

Much of the current furor over U.K. pensions grew out of a recently introduced accounting standard, FRS 17, which requires U.K. firms to disclose their pension-fund assets and liabilities. Some fund managers note that FRS 17 numbers differ from longer-term actuarial calculations, and complain that the annually reported standard is short-sighted; after all, should equity markets grow for a sustained period, the current shortfalls could be erased. In the Netherlands, corporate and industry occupational pension schemes have lost about 44% on their equity investments. But, says Ophélie Mortier, a funds expert with Pragma consulting in Brussels, the strategy of Dutch funds "is to outlast the slump, then take advantage of what they believe will be significant growth." Some U.K. funds are also sticking to higher-risk shares, rather than moving to lower-risk bonds (and risking being out of the market when equities recover). Says John Birch, secretary to BA's pensions schemes: "Over the long-term, equities will outperform bonds." Other E.U. nations with escalating pension bills are nudging their populations toward private-sector retirement funds. Jana Adler, a German mother of two, has signed up for a private pension scheme, but she's not venturing near the stock market, calling it "too risky." Others are more resolute. In 2002, French carmaker PSA Peugeot Citroën introduced a private scheme for some employees. The fund only began investing in October, so it has managed to avoid some hard stock-market hits. But European workers must be hoping that the new schemes take note of what is happening in the U.K., and learn some timely lessons.

• JENNIE JAMES/London
• The bear market may force a rethink on U.K pensions practice