Beware of pension-plan optimism

By Michael Brush

At a glance, corporate pensions might appear to be climbing up off the mat.

After all, just a few years ago companies in the Standard & Poor's 500 Index ($INX) had pension plans underfunded by $203 billion. Now that shortfall has shrunk to $77 billion.

But don't be fooled. Pension plans are getting healthier for one big reason: rising stock prices. But just because stocks have been rising for the past four years doesn't mean the trend will last.

"Everyone is talking about how pension plans are healthy now," says David Zion, an accounting expert who follows pension issues for Credit Suisse. "But wait a minute. We just saw this movie a few years ago."

Zion is referring to the fact that the stock-market rally of the late 1990s helped S&P 500 companies boast a $239 billion overfunding of pensions -- until the subsequent market meltdown made that surplus go poof. When that happened, companies in the S&P 500 had to increase their annual pension contributions from $10 billion in 1999 to $71 billion in 2003.

Another stock-market slide almost certainly would create similar problems. The question is, which companies look most likely to lose if that happens?

Big plans, big risks

One way to find companies with looming problems is to compare the size of their pension obligations with their market capitalizations. The bigger the imbalance, the bigger the risks. At Ford (F, news, msgs), for example, promised pension payouts are nearly five times the value of the company. Last year, pension promises were $75.8 billion worldwide, compared with a recent market cap of $16.1 billion.

Unisys (UIS, news, msgs) and Goodyear Tire & Rubber (GT, news, msgs) stand out as other S&P 500 companies with the biggest imbalances, with pension promises nearly two times their recent market caps (see box).

 Promises, promises

Company	Marketcapitalization	Promised pensions*	Pension as a %of market cap
Ford	$16.1 billion	$75.8 billion	471%
Unisys	$3.2 billion	$7.2 billion	225%
Goodyear Tire & Rubber	$4.47 billion	$8.2 billion	183%
*Projected benefit obligation at the end of 2006 for all current and former employees, excluding health-care benefits

Source: David Zion, Credit Suisse

These numbers don't mean companies haven't actually set aside enough to cover their pension obligations. Unisys, for example, says that as of the end of last year its U.S. pension plans were "significantly funded" and that its foreign pension plans were less underfunded than they had been a year earlier. (Specific numbers will come out soon in its annual report.)

Such numbers, however, do show how vulnerable the companies are to stock-market volatility. The larger the pension plan, the bigger the risk that a shock to the market could push the plan deep into the red and force the company to bail it out.

When you own the stocks of these companies, you're making a bet on the stock market as a whole, not just the company. If the market goes down, the impact on these particular stocks can be multiplied by the sheer size of the pension obligations.

"Are you comfortable with that?" asks Zion. "Maybe you would rather own companies that take risks in their core businesses."

Ford's U.S. pension plans were recently overfunded by around $1.2 billion. But worldwide, its pension plans were underfunded by $8.1 billion. That's already big, but it's a number that would increase sharply in a market pullback. Here's why: Given the strong stock market last year, Ford probably has around $70 billion in pension assets. About 70%, or around $49 billion, of that is in stocks, Zion says.

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