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Pension Fund Demands and Firm Sustainability


          2008 Stock Market Crash

            Robert C. Jinkens, PhD, CPA

                  Visiting Scholar

          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

risk only.


        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?

                                            Literature Review

        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

pension plans.

         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

additional funding.

         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


                                              Data Collection

        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.

                                                                 Table 1

 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


            Beaver, W. H. (1966). Financial ratios as Predictors of Failure. Journal of Accounting Research, 4,

71 - 111.

            Clark, G. L. & Urwin, R. (March 2009). Innovative Models of Pension Fund Governance in the

Context of the Global Financial Crisis. Center for Employment, Work and Finance, Oxford University

Center for the Environment, Version 16. pp. 1 - 29.

            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.

        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

(FARS) Paper

        Franzoni, F., & Marin, J. M. (2004). Pension Plan Funding and Stock Market Efficiency. Journal of


        Kapinos, K. A. (September 2008). On the Determinants of Defined Benefit Pension Plan

Conversion. Institute for Social Research, University of Michigan. pp. 1 - 29.

        Munnell, A. H. (July 2003). The Outlook for Pension Contributions and Profits in the U.S. Working

Paper, Center for Retirement Research at Boston College.

        Munnell, A. H., & Soto, M. (December 2007). Why Are Companies Freezing Their Pensions?

Working Paper, Center for Retirement Research at Boston College.

        United States Department of Labor (2009).

        Watson Wyatt (2009). Global Pension Asset Study. London

Altman, E. I. (1968). Financial Ratios, Discriminant Analysis and the Prediction of Corporate Bankruptcy.
       The Journal of Finance, 23(4), 589 - 609.

Beaver, W. H. (1966). Financial ratios as Predictors of Failure. Journal of Accounting Research, 4, 71 -

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