Drastic Solutions

That fact has some companies contemplating even more drastic solutions. "Many corporations are thinking about whether they should file for bankruptcy in order to unload their retiree promises," says Mitchell.

If a company goes bankrupt, the plan would be taken over by the Pension Benefit Guaranty Corporation (PBGC), a federal agency that insures private-sector pensions. Created under the Employee Retirement Income Security Act of 1974, the PBCG guarantees payment of basic pension benefits for 44 million American workers and retirees in more than 29,000 private-sector defined benefit plans. The PBGC paid out $4.29 billion in benefits to more than 640,000 people in 2008, and collected $1.49 billion in insurance premiums from pension plan sponsors, which are its main source of funding.

But there is a limit to how much the PBGC will pay in benefits. The maximum guaranteed pension for participants in plans that terminated in 2008 was $51,750 per year at age 65, and lower for couples or early retirees. Workers who were promised more than that would be out of luck if their company declared bankruptcy. "It's important to understand what is actually guaranteed," Mitchell says.

In addition to taking over pensions from distressed companies, the PBGC also takes over fully funded plans that employers voluntarily terminate. (Companies cannot choose to terminate a plan unless it is fully funded.)

The problem, Mitchell points out, is that the PBGC itself is $11.15 billion in the hole. PBGC's annual report for 2008 notes: "The Corporation has sufficient liquidity to meet its obligations for a number of years; however, neither of its insurance programs at present has the resources to fully satisfy PBGC's long-term obligation to plan participants." Says Mitchell: "There is a big concern about that insurance guarantor. And if any one of the big auto companies goes bust, that could double or triple the PBGC's underfunded status."

PBGC spokesman Gary Pastorius says the PBGC has run a deficit for most of its history -- in fact, its deficit shrunk in 2008 -- and has a healthy enough cash flow to keep things going. "On a cash flow basis, we're pretty strong," Pastorius says. "The assets are on hand now. The liabilities, we pay out into the future. Not everybody's ready to retire yet."

At least the PBGC doesn't have to worry about funding pensions for public employees. "There is not a PBGC for state and local government pension plans," says Keith Brainard, research director at the National Association of State Retirement Administrators (NASRA), which represents 82 statewide public retirement systems for about 22 million working and retired employees of state and local governments. "By and large, the taxpayers are the backstop."

Like 401(k) accounts and private-sector pensions, public pension funds have watched assets fall during the financial crisis. According to the most recent figures from the Center for Retirement Research at Boston College, aggregate assets for state and local pensions have dropped $1.3 trillion since the peak of the market on October 9, 2007. NASRA estimates that its members are now about 85% funded, on average.

Cities and towns throughout the United States are juggling tightening budgets with pension shortfalls, straining to find a way to make ends meet without raising taxes and causing more economic strife. "So the question is, what happens if they go broke?" asks Mitchell. "And it's really unclear."

In response to a budget crisis, the City of Philadelphia recently announced it would suspend contributions to the city employees' pension fund and extend amortization of the shortfall from 20 to 40 years, Mitchell notes. "They can't fill the potholes and police the crime. So what it means is that we're consuming the services today, but we're going to make our grandchildren pay for them."

The other looming question, says Mitchell, is: What would happen if a state pension got into big trouble? Most states' employee pension plans are guaranteed by a combination of the state constitution and state law. That could make it difficult for states to scale back on pension contributions, because the only way to cut the pension would be to amend the constitution, Mitchell notes.

Brainard calls the doomsday scenarios for state and local pensions "a distant and unlikely event.... States and cities don't typically declare bankruptcy, they're not acquired and they don't go out of business. Most public pension plans have assets to continue meeting their liabilities indefinitely or for decades."

Besides, the true impact of the current financial crisis will not show up for most public pensions for at least another year, because there is a lag in reporting, Brainard adds. Since the fiscal year for most state and local governments ends in June rather than December, most of the worst market losses haven't even been recorded. Also, as public pensions do not fall under the PPA, most are able to smooth gains and losses over a much longer period than their private-sector counterparts -- from three to 15 years.

So if the economy rebounds soon, the astounding losses of 2008 could largely fade away. And if the economy continues to sputter, the worst shortfalls for public pensions may be yet to come. "It is really going to take a few years to understand and recognize what effect the market decline has had," Brainard says.