"Pension accounting is complicated and greatly misunderstood. Company earnings are influenced by nonoperating factors such as pension fund performance and often poorly disclosed actuarial assumptions. The balance sheet's description of pension funding can be wildly misleading; adjustments are critical. In our view, it is perilous to assume these issues are "in the stock."

Those words of warning come from a recent UBS Paine Webber study of how pension fund performance and accounting affects the earnings of the Standard and Poors' 500 Index and different industries and companies in that index.

Basically, the report tells us that in some industries and in some companies, the pension tail is wagging the company dog. Here, culled from the 66-page report, are some of the things investors should note.

•  Broadly Measured, Pensions Aren't A Gigantic Problem.   As recently as 1999 S&P 500 index company pension funds had a surplus over obligations of $252 billion. By the end of 2001 the surplus was down to $1.2 billion. At the end of August the report estimates a deficit of $126 billion or about 11 percent of pension benefit obligations. That's a large shift. The UBS Paine Webber analysts found, however, that adjusting reported earnings for pension effects didn't have a major impact on earnings or Price/Earnings multiples. That's the good news.

•  Measured by Industry, It's Another Story. Of the 500 companies in the S&P 500 Index, 145 don't have defined benefit pension plans so they are unaffected by the issues surrounding the performance of pension funds and accounting for pension funds. Of the 355 companies in the index with defined benefit pensions, however, they report 118 with "false assets"--- reported pension surpluses when the plan is actually in deficit. One way to gauge the potential impact of pension plans is to compare pension plan assets to the total market value of the company. Pension fund assets in the automobile industry, for instance, were 170 percent of total market capitalization while they were negligible to non-existent for younger industries. Since pension fund assets are a rough proxy for pension obligations and pension obligations must be funded from company earnings, the larger the pension assets the greater the influence the pension has on the value of the shares. (See table below)

The Ten Industries Most and Least Affected By Pension Fund Problems
Note the older, heavy industries dominate the most affected list while newer industries predominate in the least affected list.
Industry Pension Assets as % Market Cap.
… The Ten Most Affected
Automobiles 170.3%
Office Electronics    93.5
Auto Components    86.8
Aerospace & Defense    70.4
Airlines    65.0
Construction & Engineering    61.9
Metals & Mining    50.4
Leisure Equipment & Products    43.8
Paper & Forest Products    41.2
Containers & Packaging    36.6
… The Ten Least Affected
Wireless Telecommunication Services      0.0%
Internet Software & Services      0.0
Internet & Catalog Retail      0.0
Software      0.01
Biotechnology      0.02
Real Estate      0.21
Semiconductor Equipment & Products      0.30
Specialty Retail      0.40
Hotels Restaurants & Leisure      0.89
Healthcare Equipment & Supplies      2.06
Source: UBS Paine Webber

•  In Some Companies, The Workers May Be The Defacto Owners.   While most corporate obligations are reflected quite directly on corporate balance sheets, the calculation of pension obligations is based on a murky stew of assumptions.   As a consequence, worker claims on future corporate earnings may "crowd out" the shareholders interest. The pension assets of U.S. Steel Corp., for instance, are $8.6 billion. This is more than 5 times the total market value of the company shares. Whatever happens to the pension plan will have a very large effect on corporate earnings. The table below lists the ten most impacted S&P 500 Index companies.

The Top Ten Company Dogs Being Wagged By Long Pension Tails
Rank ordered list of S&P 500 index companies with major pension assets relative to their total market capitalization.
Company Pension Assets (mils) As % Mkt. Cap
United States Steel $       8,583 531%
Allegheny Technologies $       5,242 390
General Motors $   73,662 271
McDermott International $       1,822 241
Delta Air Lines $       8,304 230
Lucent Technologies $   35,359 182
Ford Motor $   48,754 171
TRW $       7,902 169
Navistar International $       2,872 161
AMR $       5,482 159
Source: UBS Paine Webber

Bottom line: Collapse of the fabled "new economy" notwithstanding, the "old economy" has problems of its own. That's why a stock market recovery is likely to lag an economic recovery.

Earlier Pension Related Columns:

April 4, 2002: Is A Pension Plan Time Bomb Ticking?

September 22, 2002: The Next Big Shoe: Pension Plans

September 24, 2002: How IBM Pulled a FAS One on Pensions