Across America, corporate pension funds are in trouble. Here's why.

Some corporations use the pension money to buy the corporations own stock. Why? Because this raises the value of the shares. Senior managers have stock options. If a stock rises, they get to purchase shares at a fixed (pre-rise) price. So, if they can buy at $30 per share, and pension fund money raises shares to $60, managers can spend $30, buy a share, and then sell for $60. They pocket $30 per share. The most famous company that played this game and lost was Enron.

Other corporations let the stock market raise share prices. The increase is counted as having met the companies' required funding of their pension programs. So, if shares double in price, the company can use profits to do other things, such as give bonuses to senior managers.

The problem is, the stock market peaked in the year 2000. It has not yet reached the level it was then. This means that the companies' official prediction that the pension funds' managers would achieve 7% per year or 10% per year has not been met.

How will these pensions be paid off? No one knows.

Consider this news wire story.

DETROIT (AP) -- Standard & Poor's Ratings Services cut its corporate credit ratings to junk status for both General Motors Corp. and Ford Motor Co., a significant blow that will increase borrowing costs and limit fund-raising options for the nation's two biggest automakers.

Shares of both companies fell 5 percent or more after Thursday's downgrades, and the news sent the overall market lower. (May 5, 2005)

All of a sudden, without warning, the investment world is talking about the looming crisis at General Motors. Its pension fund obligations and health care obligations now appear to threaten the future of the company.

I have no objection to the experts' pessimism regarding the future of General Motors. I happen to share it, and have for years, precisely because of the pension issue. What astounds me is that investors and financial columnists have only just begun to regard the company's pension obligations as a significant factor in the future profitability of the firm. Why now? Why not in 2003 or ten years ago?

The United Auto Workers' officers and GM's senior managers decided decades ago to agree to high pension and health benefits in exchange for reduced increases in wages. Health care benefits are tax-free income for workers. Even retired workers are covered. It seemed like a low-risk deal for GM. Nobody thought about the price effects on health care of Medicare.

The health care market, like all markets, is a giant auction. If bidders get their hands on more money, they will bid up prices. All over America, workers are bidding health care prices. So are retirees.

A DISASTER CALLED OPEB

Alan Sloan, a financial columnist for "Newsweek," has painted a stark picture. He begins with a description of how GM got into this pickle.

Lower salaries meant that GM reported higher profits, which translated into higher stock prices -- and higher bonuses for executives. Commitments for pensions and "other post-employment benefits" -- known as OPEB in the accounting biz -- had little initial impact on GM's profit statement and didn't count as obligations on its balance sheet. So why not keep employees happy with generous benefits? It was a free lunch. Besides, GM's only major competitors at the time, Ford and Chrysler, were making similar deals.

This is the free lunch mentality: something for nothing. As with all free lunches, people eat more than they normally would. The price is right!

Now, as we all can see, pension and health care obligations are eating GM alive. The bill for the "free" lunch has come in -- and GM is having trouble paying the tab. In the past two years, GM has put almost $30 billion into its pension funds and a trust to cover its OPEB obligations. Yet these accounts are still a combined $54 billion underwater.

Note the phrase, "as we all can see." But nobody saw it until about February, 2004. Sloan says the problem by then had been building for over half a century.

GM began its slide down the slippery slope in 1950, when it began picking up costs for medical insurance, pensions and retiree benefits. There was huge risk to GM in taking on these obligations -- but that didn't show up as a cost or balance-sheet liability. By 1973, the UAW says, GM was paying the entire health insurance bill for its employees, survivors and retirees, and had agreed to "30 and out" early retirement that granted workers full pensions after 30 years on the job, regardless of age.

These problems began to surface about 15 years ago because regulators changed the accounting rules. In 1992, GM says, it took a $20 billion non-cash charge to recognize pension obligations. Evolving rules then put OPEB on the balance sheet. Now, these obligations -- call it a combined $170 billion for U.S. operations -- are fully visible. And out-of-pocket costs for health care are eating GM alive.

I report this because of the delay factor. This was all built in, Sloan says. He is correct. It is why I counselled small businessmen in the late 1970s not to set up health plans and pension plans for their employees. The legal liability was too great, I warned them. But I was almost alone in this view. Not now.

At the end of last year, GM says, its U.S. pension funds showed a $3 billion surplus. GM's pension accounting, which assumes that the funds will earn an average of 9 percent a year on their assets, is highly optimistic. But things are under control -- as long as GM stays solvent.

By contrast, OPEB is out of control. At year-end, OPEB was $57 billion in the hole, even though GM threw $9 billion into an OPEB trust in 2004.

Consider these numbers in relation to GM's market capitalization of about $17 billion. The company is deeply in debt: around $300 billion. This is a lot of money. It had to sell $17.6 billion in bonds in 2003 to meet its pension obligations. Yet in January, 2004, its share value peaked. Optimism still reigned supreme.

The problem has been building for a long time. The tax code has treated the funding of future benefits as deductible expenses to a company, but not taxable events for the employees. Labor union saw the advantage. They could claim victories in their negotiations with management. This is true across the board, in company after company.

Government-authorized accounting practices have added to the illusion of future wealth: assumptions regarding estimated future investment returns based on the post-1982 stock market boom-era. GM expects to earn 9% per annum in its pension fund. How?

The federal government has created business in its own image with respect to pension funds. The bills are now coming due.

Then there are GM's retirees: "Health care for retirees and their families -- there are 2.6 of them for every active worker - - is 69 percent of GM's health costs."

Up, up, up go medical costs. Down, down, down go GM's profits.

We think of GM as an auto company. But its auto division is small potatoes. About 80% of GM's profits come from GMAC, its in-house loan company: consumer credit and mortgages. It profited greatly during the mortgage boom. But this source of profits has begun to taper off.

Now what?

Why do you think GM is an exception? If your answer is, "Because I feel more comfortable by making this assumption," you are going to feel uncomfortable when you can least afford it: when you are retired and out of the job market.

I suggest that you stop making assumptions about your pension fund's solvency. Find out. Soon. You need to get these questions answered in writing:

What is the rate of return for the fund since 2000?
What rate of return has been assumed by management?
What is the total dollar value of the fund?
What are the obligations of the fund to 2040?
What percentage of the fund's assets is invested in the company's shares?

When you find out, you may find that things are not rosy. Then you may want to get more information on this site, especially in the fourms. Three departments apply: Retirement, Business Start-Up, and Your Career.

Meanwhile, don't forget to subscribe to my free Tip of the Week report, which is sent every Saturday morning. The sign-up box is on the Home page.