Pension Fund Demands and Firm Sustainability
2008 Stock Market Crash
Robert C. Jinkens, PhD, CPA
University of Florida, Gainesville
The 2008 stock market crash had a significant impact for firms with defined benefit pension
plans. The 23 Dow Industrial Average companies with December 31st year ends, on average were
underfunded approximately 5 billion dollars each and they are in greater jeopardy of going bankrupt
than other firms.
The upheaval on Wall Street has deluged public pension systems with losses that government
officials and consultants increasingly say are insurmountable unless pension managers
fundamentally rethink how they pay out benefits or make money or both.
Within 15 years, public systems on average will have less [than] half the money they need to pay
pension benefits, according to an analysis by Pricewaterhouse Coopers. Other analysts say
funding levels could hit that low within a decade.
After losing about $1 trillion in the markets, state and local governments are facing a devil's
choice: Either slash retirement benefits or pursue high-return investments that come with high
The problem isn't limited to public pension funds; many corporate pension funds have lost so
much ground that they are also pursuing riskier investments. And they, too, could end up a
taxpayer burden if they cannot meet their obligations and are taken over by the federal Pension
Benefit Guarantee Corp (Cho, 2009).
Prior to the stock market crash of 2008, I could have retired. Now I cannot. I believed we (the
investors) were facing a structural change in the stock markets. For younger people this might not be a
problem, but for people close to retirement age this could be a devastating disaster. While younger
people may be able wait the many years it may take for stocks to increase in value to a stable level,
older people do not have this option, and although the market has increased since the 2008 crash, older
people may be afraid to risk reinvestment with what they have left.
When people lose their entire retirement, the next thing they do is ask themselves, “What
happened, and what to do next?” This leads to several questions that can be investigated. What
happened? What can be done to undo the damage? What are other investors doing? Were all people
damaged the same? What can people with defined contribution pension plans do? What can people
with defined benefit pension plans do? Could firms with defined benefit pension plans now be
underfunded since pension fund investments have probably decreased? What will these firms do? Can
these firms continue to exist?
I have chosen to try to address the last question. What will firms with defined benefit pension
plans do? If the underfundings were sufficiently large, could such underfundings force firms to declare
bankruptcy? Since many of us as investors have diversified our portfolios, I will limit the study to market
As the literature review will show there is a trend for firms to avoid defined benefit pension
plans. They have converted to: (a) defined contribution plans, (b) “cash balance” plans (explained in
literature review), (c) frozen plans (explained in literature review), (d) or they have chosen to terminate
their plans. Firms’ objectives seem to be to avoid the cost and associated risk of pension plans, but not
all firms will be able to eliminate their pension plans. They may have binding contracts which prevent
them from changing or terminating their pension plans. For the firms which must continue with their
existing pension plans will the possible required funding increases cause them to go bankrupt?
In a study funded by the Center for Retirement Research at Boston College, Munnell et al.
(2003) found that because of there being a bull market from 1982 to 2000 pension contributions
virtually disappeared. Kapinos (2008) found during this same time period, that some firms converted
their defined benefit pension plans to “cash balance” pension plans and some even terminated their
A “cash balance” pension plan is similar to both a defined contribution pension plan and a
defined benefit pension plan. In a “cash balance” pension plan the employer sets aside an agreed upon
sum of money into an investment account. The fund balance, principal plus earnings (or less losses), is
paid to the employee at retirement. The money might actually be put into a fund or it might be only a
ledger entry as if the money had been put into a fund. At retirement, the benefits can be paid as an
annuity or in one lump sum. The amount which the employee will receive at retirement depends upon
how much the investment account earns (or should have earned if it were not 100% funded). There is
no risk to the employer if the fund decreases.
In a defined benefit pension plan, however, the amount the employer is obligated to pay the
employee at retirement is not based upon how much is in the account, but is based upon the
employee’s service to the employer, e.g. 80% of the employee’s last year’s wages. Thus, if the
investment account did not earn enough to pay the agreed upon amount to the employee at
retirement, the employer would be obligated to fund the deficiency (United States Department of Labor,
The distinction between “cash balance” and defined contribution pension plans is that the
amount paid in a “cash balance” plan is essentially known (It is the amount set aside or theoretically set
aside plus its earnings.), whereas the amount that will be paid in a defined benefit plan is not known
(The benefits are based upon unknown future determinants.). Defined Benefit plans could require
In a defined contribution pension plan, the employer pays an agreed upon amount into an
investment account. The employee owns the investment account as soon as he or she becomes vested.
All risks of ownership are the employees.
From 2000 to 2007, Munnell et al. (2007) found that defined benefit pension plans were
declining in the private sector and that the rate of decline was accelerating. They attributed the
accelerating rate of decline to the “perfect storm.” The “perfect storm” refers to declining stock market
values and declining interest rates. The result was that some firms were underfunded, which led to
some firms choosing to freeze their pension plans. That is, new employees were not allowed to join
current pension plans, and funding might stop for existing employees. The firms which tended to freeze
their plans where: those with high credit balances relative to their income, those with substantial legacy
costs (large proportion of retired participants collecting benefits relative to the total number of
participants), and those with low funding ratios. The article’s authors concluded that more firms with
these characteristics would freeze their plans in the future. [During the 2000 – 2007 “perfect storm”
The Dow Jones Industrial Average was initially 11723, then dropped to 8235, and finally increased to
14164, a 21% increase, or a compounded amount of 2.4% per year.]
After 2000, firms continued converting to “cash balance” pension plans rather than keeping
defined benefit pension plans (D’Souza et al., 2008). Such firms were large, less profitable, and had
workforces close to retirement.
Interestingly, Franzoni and Marin (2004) found in the before mentioned “perfect storm,” bear
market, that investors overpriced firms with severely underfunded pension plans relative to those which
were not underfunded. Their proposed explanation was that “investors do not anticipate the impact of
the pension liability on future earnings and cash flows, and they are surprised when the negative
implications of underfunding finally materialize.”
What happened in 2008?
Substantial falls in the value of defined benefit plans and marked deterioration in their solvency
now threaten the integrity of the whole institution. At the same time, public confidence in the
defined contribution system has been seriously undermined with increasing numbers of people
facing the consequences of poor returns through hardship in retirement. Worldwide, the value of
pension funds in 2008 amounted to $22 trillion down from $27 trillion the previous year (Watson
Wyatt 2009). The results for 2009 are bound to be worse. The apparent inability of many pension
funds to adequately respond to the credit crisis and global recession are significant failures of
governance that could have ramifications for a generation (Clark & Urwin, 2009). [During 2008
The Dow Jones Industrial Average plummeted from a high of 14164 to a low of 6547, a 54%
decline in less than one year.]
For those firms with contractual Defined Benefit Pension plans are they sufficiently funded?
This leads to the first hypothesis to be tested:
H1: Firms with contracted Defined Benefit pension plans are underfunded.
This creates a second question. If firms are underfunded, how severely are they underfunded?
This leads to second hypothesis to be tested:
H2: Firms are so severely underfunded that the underfundings will force them into bankruptcy.
To test H1 and H2, 23 companies will be examined both before and after the 2008 stock market
crash. Financial ratios and descriptive statistics were calculated for 2006 and 2008, before and after the
market crash. The ratios and statistics included analysis per Beaver (Beaver, 1966), and Altman (Altman,
1968). The analyses included: (a) Cash flow to Total Debt, (b) Net Income to Total Assets, (c) Total Debt
to Total Assets, (d) Working Capital to Total Assets, (e) Current Ratio, (f) Altman’s Z, and (g) Pension
The data came from Compustat. The 23 companies analyzed were those of The Dow Jones
Industrial Average with December 31st 2006 and 2008 year ends1.
Results and Conclusions
Table 1 shows the results of calculating the precedingly mentioned ratios and statistics. As
predicted the pension funds of the sample companies are significantly underfunded, on average
$4,988,800,000 per company. Also as predicted, according to Altman’s Z score the companies are more
in jeopardy of going bankrupt. Although Cash Flow to Total Debt (here Total Liabilities) has increased,
this would not have been possible if the firms had funded their pension plans. It should also be noted
that net income as a percentage of total assets has significantly decreased. The changes in Total Debt to
Total Assets, Working Capital to Total Assets, and Current Ratio are not a concern at the present time.
3M Co, Alcoa Inc, American Express Co, AT&T Inc, Bank of America Corp, Boeing Co, Caterpillar Inc, Chevron Corp,
Coca-Cola Co, Du Pont (E I) De Nemours, Exxon Mobil Corp, General Electric Co, Intel Corp, Intl Business Machines
Corp, Johnson & Johnson, JPMorgan Chase & Co, Kraft Foods Inc, McDonald’s Corp, Merck & Co, Pfizer Inc,
Travelers Cos Inc, United Technologies Corp, Verizon Communications Inc.
Ratio/Statistic 2006 2008 Change %
Cash Flow to (647.8) -0.0036 1,348.4 0.0058 0.0094 263%
Total Debt (a) 182,108.0 232,412.0
Net Income to 9,316.8 0.0405 7,340.4 0.0263 -0.0141 -35%
Total Assets 230,321.0 278,831.0
Total Debt to 182,108.0 0.7907 232,412.0 0.8335 0.0429 5%
Total Assets 230,321.0 278,831.0
Working Capital to 3,529.9 0.0153 4,687.3 0.0168 0.0015 10%
Total Assets 230,321.0 278,831.0
Current 23,582.2 1.1760 25,533.9 1.2249 0.0488 4%
Ratio 20,052.3 20,846.5
Altman's Manufacturing 1.2158 1.5242 0.8067 0.9875 -0.5367 -35%
Z - Average Other 1.8325 1.1683
Pension 817.0 (4,171.8) (4,988.8) -611%
(a) Total Liabilities used instead of Total Debt
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Cho, D. (October 11, 2009). Steep Losses Pose Crisis for Pensions: Two Bad Choices for Funds:
Cut Benefits Or Take Greater Risks to Rebuild Assets, The Washington Post. http://washingtonpost.com.
D’Souza, J. D., Jacob, J. & Lougee, B. (September 2008). Cash Balance Pension Plan Conversions:
An Analysis of motivations and Pension Costs. AAA 2009 Financial Accounting and Reporting Section
Franzoni, F., & Marin, J. M. (2004). Pension Plan Funding and Stock Market Efficiency. Journal of
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Munnell, A. H., & Soto, M. (December 2007). Why Are Companies Freezing Their Pensions?
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