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 …
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.
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 D. Weiss, Ph.D.
Editor, Safe Money Report
President, Weiss Research, Inc.