Issues

Pension Fund Disaster

United Airlines has just defaulted on $9.8 billion owed to 134,000
employees and retirees, the largest pension fund disaster in history.

Delta, Northwest, and Continental, with combined pension debts
of $11.4 billion, could be next.

Close on their heels are the pension funds of auto makers, auto
parts companies, and other major manufacturers.

The nation’s entire defined-benefit pension system seems
to be disintegrating.

Most people think the government
guarantees all the benefits. It doesn’t.

The very name of the government agency that covers pension funds
— the Pension Benefit Guarantee Corporation (PBGC) —
is a misnomer.

The ugly reality:

* The PBGC’s
maximum guarantee falls far short of the promised benefits for
tens of thousands of participants. If you retire at 65 and your
plan fails in 2005, the most you can get is $45,614 per year.

* If you retired at 55 and your plan failed in 2000, your maximum
benefit is far lower — only $17,397 per year.

* The PBGC does not cover health benefits. When the company files
for bankruptcy, you must go elsewhere.

*
The PBGC also doesn’t cover severance, vacation pay, life
insurance, and other nonqualified benefits.

* If
your benefits were increased within the last five years before the
pension plan is terminated, those increases are not fully covered.

* Spouses
may also be left in a lurch. Bethlehem Steel, for example, which
failed in 2002, had promised to make special cash payments to surviving
spouses. But once the company filed for bankruptcy, that program
was also terminated.

$100
Billion Deficit

As
you can see, the pension coverage that the government guarantees
is bare bones with no frills. And now, even this coverage is in
jeopardy unless Congress digs deeply into its already-shallow pockets
and dishes out more money — a lot more money.

The
PBGC reports that it’s saddled with 3,496 failed pension plans,
including those of huge bankrupt companies like Bethlehem Steel,
Kaiser Aluminum, Kemper, LTV Steel, McCulloch, National Steel, Polaroid,
TWA, and US Airways.

Consequently,
even before the PBGC takes over United’s pension fund, it
has almost $65 billion in debts. But it has only $40 billion in
assets, leaving it nearly $25 billion in the red.

The
far bigger problem is this: At the end of last year, 362 of the
companies in the S&P 500 had pension plans. And among these,
85% had deficits! Now, if many of these companies and their
pensions go under, the PBGC’s deficit will mushroom.

How
much could the PBGC potentially be responsible for?

A lot
depends on the value of the stocks that the pension funds invest
in. But even assuming the stock market doesn’t fall any further
from here, the total deficit among underfunded pension funds in
the U.S. is approaching $100 billion. And if the stock market falls
back to its 2002 lows, the deficit could be somewhere between $150
billion and $200 billion.

It’s
shaping up to be the greatest retirement calamity in our nation’s
history.

What
will be the impact on stock market investors? I see a double threat
…

Threat
#1
An Irresistible Incentive for
Companies to File for Bankruptcy

The
sad irony of the current system is that it gives companies a huge
incentive to file for bankruptcy.

If
they don’t file for bankruptcy, they’re stuck with the
sinking pension fund and can’t compete in their industry.
So if they want the government to take over the burden and stay
competitive, their ONLY choice is to march into bankruptcy court
and file for Chapter 11.

Result:
Shareholders get shafted and lose 100% of their investment. Bond
investors get some money back, but not much. Except for the receivers
and executives who continue to run the company, nearly everyone
loses.

Hard
to believe? Well, look at this recent history:

Back
in 2002, LTV Steel terminated its pension plan on March 31. About
eight months later, National Steel followed. Then, just two days
after that, came the biggest bombshell of all — the end of
Bethlehem Steel’s giant pension plan. Shareholders in all
three of the bankrupt steel companies were wiped out.

The
pattern: Soon after the FIRST major company in a battered industry
files for bankruptcy and dumps its pension plan, most other major
players in the industry do the same.

Is
this what’s going to happen now in the airline industry? For
an answer, consider this fact:

In
2002, Bethlehem Steel’s pension fund default was the largest
in history, sending shock waves throughout the financial markets.
Now, in 2005, United’s default is THREE times larger.

What
about the auto industry and the auto parts industry? What about
virtually all of the manufacturing companies in America with large
underfunded pension funds?

Clearly,
if you own their shares, the time to run for cover is now.

Threat
#2
Phony Earnings Windfall Turns into
Messy Earnings Cesspool

When
the stock market was surging and bond yields were higher, nearly
all these companies had fat surpluses in their pension funds. So
they used the surpluses to beef up reported earnings.

Now,
with big deficits in their pension funds, it’s having the
reverse effect.

To
better understand how this happened, go back to the late 1990s and
early 2000s.

That’s
when many major companies legally jury-rigged their books to transfer
the surpluses in their employee pension funds to their own earnings
statements, exaggerating their profits or covering up their losses.

Verizon
Communications, for instance, had multi-billion dollar losses in
2001. But just by adding in its projected pension fund gains exceeding
$2 billion, the company was able to magically report a net profit
for the year of $389 million.

Eastman
Kodak lost tens of millions in 2001. But by including its projected
$100-million-plus profit from its pension fund, the losses were
magically transformed into a $76 million profit.

Another
company that lost tens of millions in 2001 was TRW. But by adding
in a $100-million-plus projected gain in its pension fund, it transformed
the huge loss into a $68 million profit.

Honeywell
International’s loss of $99 million in 2001 would have been
several times greater. But the company minimized the loss by counting
the projected pension fund gain of hundreds of millions on the corporate
bottom line.

The
Most Absurd Accounting Gimmick of Our Time

In
the ensuing years, when the market turned sour and the value of
their pension funds sank, you’d think these companies would
have given up their accounting gimmicks.

But
no! Archaic accounting rules allowed them to blindly assume that
the stock market would rise to new highs and continue rising for
years to come. So they continued grabbing still more money
from the employees’ kitty.

An
example I cited in my 2003 book, Crash Profits, illustrates
the utter absurdity of these maneuvers:

Let’s
say that a company has $100 million in its pension fund and it projects
an annual return of 10%. That gives it a projected $10 million return
per year.

But
now, let’s say that the company has a bad year in the stock
market and the pension fund suffers unrealized losses of 5%. How
much do you think they’d have to deduct from the company’s
profit statement?

If
you said $5 million (5% of $100 million) your answer would be perfectly
logical … but actually wrong. According to GAAP — Generally
Accepted Accounting Principles — the company could spread
out the unrealized losses over, say, 10 years or some similar time
period.

So
you’d think the company would have to at least deduct one-tenth
of the $5 million — or $500,000 per year, right? Wrong again.

Remember,
they were assuming a rising stock market and projecting gains of
$10 million each year. So they could take that $10 million projected
yearly gain and reduce it by the half-million-dollar amortized loss
from the stock market decline. That’s $10 million minus a
half million — which equals $9.5 million!

Result:
Although the pension fund suffered an actual loss of $5 million,
the company could actually report a PROFIT of $9.5 million! But
it was a total fiction. And now, the day of reckoning with the truth
has arrived.

Today,
companies with these large underfunded pension funds have just two
choices: File for bankruptcy or allow their pension funds to be
a perennial drag on earnings. Either way, the pension fund disaster
will drive their share prices down.

Some
Protective Steps You Can Take Immediately …

* If
you hold shares in companies with big pension fund liabilities,
get out as soon as you can.

* The
pension fund disaster is both big and widespread. It’s bound
to drag down the Dow and the S&P 500, where most of the large
pension problems are concentrated. So seriously consider reducing
your exposure to companies in these indexes even if they don’t
have pension fund problems of their own.

* Put
the proceeds into a money fund that invests exclusively in short-term
U.S. Treasury securities or equivalent, such as our affiliate’s
Weiss Treasury Only Money Market
Fund.

* If
you’re concerned about retiring without a health plan, I recommend
a solid Medicare Supplement (Medigap) policy. Just make sure to
(1) find a reliable insurer, (2) buy only the coverage you truly
need, and (3) save on premiums by shopping around. For $49, Weiss
Rating’s Shopper’s
Guide to Medicare Supplement Insurance will help you accomplish
all three goals by giving you a personal report that’s tailored
to your individual circumstances. Enter some basic personal information
online, run the customized report and download it instantly.

* If
you’re a participant in an underfunded pension plan, it’s
obvious that you can’t count on the federal government to
cover all your benefits. Plus, if the value of the stocks and bonds
they own go down, the problem will only get worse. To protect yourself,
consider hedging — for example, by buying put
options on the most vulnerable stocks.

Good
luck and God bless!

martin Pension Fund Disaster
Martin
D. Weiss, Ph.D.
Editor, Safe Money Report
President, Weiss Research, Inc.
eletter@weissinc.com

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