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Airline crisis bedevils pension insurer
AMR bankruptcy would step up pressure on already limited funds
The shadow of a possible bankruptcy filing by AMR Corp. falls far beyond the employees and stockholders of the world's largest airline.
At the federally chartered agency that insures the pension benefits of 44 million retirees, officials are fretfully watching the airline industry and proposing rule changes aimed at stemming the tide of pension defaults.
Already dealing with a multibillion-dollar deficit, the Pension Benefit Guaranty Corp. fears a dominolike collapse of a large portion of the airline industry, as carriers seeking a level playing field follow each other into bankruptcy court and unload their burdensome pensions.
Experts outside the agency share those concerns. A similar rolling collapse across the steel industry contributed to an $11.4 billion loss for the agency last year.
That pool of red ink was five times larger than any in the 28-year history of the agency, which steps in to cover payment of pension benefits when a company goes bankrupt.
Even as the parent of American Airlines Inc. tries to slash costs and stay afloat, the prospect of the Fort Worth-based carrier heading to bankruptcy court looms larger as the industry downturn persists.
For both the airline industry and the pension agency, the question of airline pensions is huge.
Pension costs from bankrupt airlines could hammer the PBGC again, experts say. At the same time, the cost of supporting those pensions is a drag on the airlines as they try to stem their losses.
"The airlines have confirmed that pensions are their biggest problem – this will be the straw that breaks that camel's back," said analyst Christopher Struve of Fitch Ratings, which studies companies' financial health.
Two airlines are already under bankruptcy protection – US Airways Group Inc. and UAL Corp., parent of United Airlines.
A bankruptcy judge recently approved a plan for the PBGC to take over US Airways' pilots' pension, although the deal is not final.
UAL, meanwhile, has asked for another six months to come up with a bankruptcy reorganization plan that is expected to include the abandonment of its pension plan to the PBGC.
Last week, AMR started lining up loans and consultants that could help it through a bankruptcy. An AMR spokeswoman declined to comment on any speculation surrounding a bankruptcy filing.
According to Fitch Ratings, AMR's pension plan needs $3 billion more in assets to cover its obligations to present and future retirees – a shortfall known as underfunding. US Airways' pension is underfunded by $3 billion, and United's by $4.1 billion.
Overall, the airline industry's pensions have $28 billion in assets to cover $46 billion in obligations, placing the funding level at about 60 percent, Fitch says.
"Historically, having your plan fall below 60 percent funded means your fund is going to be assumed by the PBGC," Fitch's Mr. Struve said.
The airline industry's pension plans have gone from a $1 billion surplus in 1999 to $20 billion in underfunding in 2002, Fitch estimates. If the PBGC had to swallow that entire $20 billion in underfunding today, it would nearly eliminate the agency's $25 billion in assets.
In testimony to the Senate Finance Committee on Tuesday, the PBGC's executive director urged that steps be taken now to strengthen the agency's position. One solution he offered was toughening rules governing the funding levels that companies must maintain in their pensions.
"The current $3.6 billion deficit, even though it is the largest in history, does not create an immediate liquidity problem for PBGC – we will be able to continue paying benefits for a number of years," executive director Steven A. Kandarian said. "But with $29 billion in benefit liabilities and only $25 billion in assets, we should not wait to put the insurance program on a sound financial basis."
Shortfalls
Pension shortfalls have been a major problem for corporate America over the last year. Investment losses have hurt many companies' bottom lines and forced some to shore up their pensions with cash.
The PBGC estimates that the total underfunding in defined- benefit plans now exceeds $300 billion, the largest number ever recorded. Merrill Lynch estimates that earnings of companies in the Standard & Poor's 500-stock index will be reduced by 10 percent in 2003 because of pension losses.
For many airlines – facing a tough economy, heavy competition and threats of terrorism – pension troubles may be insurmountable.
"We believe it is highly probable that the PBGC also will assume United's pension," Mr. Struve said.
Mr. Struve worries that if United and US Airways succeed in having the PBGC assume their pension liabilities, all of the other major airlines may follow suit to survive.
"These guys are facing monstrous cash calls for the next few years at the worst possible time," Mr. Struve added. "It's pretty hard to envision a world where the other guys retain their pensions."
Delta Air Lines Inc.'s funding gap is the largest, at $4.4 billion, while Continental Airlines Inc. and Northwest Airlines Corp. are burdened with gaps of greater than $3 billion, according to Fitch.
Barring a bankruptcy filing, those gaps must be filled one of two ways – by the airlines injecting some of their scarce cash into the pension plans or by the stock market making a quick turnaround and boosting the plans' returns.
Dallas-based Southwest Airlines Co., the one profitable carrier in a troubled industry, doesn't have a pension plan.
Philip Baggaley, airline credit analyst with Standard & Poor's, said he sees a worst-case scenario in which all but one of the biggest airlines land in bankruptcy court. Under that scenario, the surviving airline would be operating at a serious cost disadvantage.
"If there is an airline which is strong enough to avoid bankruptcy, they would certainly try to negotiate changes to lower their pension costs," Mr. Baggaley said. "But those changes could not be as extensive as the reductions from terminating plans in bankruptcy."
Mr. Baggaley retains some hope that a quick end to a war and even quicker resolution with its unions could save AMR from having to file. But he concedes that there are a lot of ifs in that scenario.
Company-funded firm
Formed in 1974 alongside the Employee Retirement Income Security Act, or ERISA, the PBGC is funded by pension insurance premiums paid by corporations to the tune of $800 million a year. In return, the agency insures the firms' $1.5 trillion in pension benefits.
Those premiums, coupled with the returns of the PBGC's own investments throughout the bull market, helped the agency operate with a surplus beginning in 1996. It was not until 2002, which saw five of history's 10 biggest bankruptcies, that it lost its surplus cushion.
In 2002, the PBGC took over 144 pension plans, a 40 percent increase over 2001, covering 187,000 people. The agency paid $1.5 billion in benefits last year. It expects to pay $2.5 billion to nearly 1 million retirees in 2003.
In his Senate testimony, Mr. Kandarian noted that the pension obligations the agency took over in 2002 were greater than the total for all previous years combined. In addition to the steelmakers, retailers including Grand Union and Bradlees and manufacturers such as Polaroid and Singer also landed on the PBGC's doorstep last year.
The biggest case in 2002 – and in the agency's history – was Bethlehem Steel. The agency booked as a "probable" loss the $3.9 billion it will swallow when it takes in the company's pension fund this year.
Bethlehem's proposed $1.5 billion acquisition by International Steel Group wouldn't have gone through if International Steel had had to assume Bethlehem's $11 billion in debt, much of which was associated with its pension liabilities. Bethlehem had $3.5 billion in assets remaining in its pension to cover a $7.8 billion obligation.
Bethlehem was one of three major steel companies to fold last year, largely due to massive legacy liabilities owed to retirees, who greatly outnumber current employees.
Murky outlook
Mr. Kandarian worries about a continued collapse of the steel and airline industries. He told senators that over the long term, the agency's deficit "may increase dramatically."
"In our most recent annual report, PBGC reported exposure to additional claims totaling $35 billion, which we classify as 'reasonably possible,' " Mr. Kandarian said. "Of this $35 billion, about half represents underfunding in airline and steel plans."
Experts agree that the PBGC's troubles would abate if the "perfect storm" that created the current deficit would reverse course: the stock market demise that has stripped assets from pensions, falling interest rates that have sent pension obligations skyrocketing and an economy that has crippled businesses.
The rash of U.S. corporate bankruptcies is expected to continue this year, although at a slower rate than in 2002, according to a recent PricewaterhouseCoopers report. It stated that about 180 publicly traded companies will file for Chapter 11 in 2003, compared with 189 filings in 2002 and 257 in 2001.
One solution Mr. Kandarian proposed would require companies' pensions keep a higher level of assets relative to obligations.
He also called for requiring companies to report more frequently on the health of their plans.
Another option would be to increase the insurance premiums that companies must pay, but Mr. Kandarian said that might discourage companies from offering pension plans to employees.
"Raising premiums enough to cover losses of the size the PBGC endured in 2002 could prove counterproductive, driving the financially healthy companies out of the defined-benefit system," Mr. Kandarian testified.
Disturbing similarities
Several experts have drawn parallels between the PBGC's situation and the savings and loan crisis of the 1980s, in which taxpayers had to cover depositors' losses when the industry collapsed.
Like the Federal Savings and Loan Insurance Corp., the PBGC is a quasi-government agency that guarantees a private liability – the FSLIC insures deposits and the PBGC insures pension benefits.
In 1996, Dr. Zvi Bodie of Boston University, an authority on pensions, wrote a paper in which he predicted heavy deficits at the PBGC if the economy, the stock market and interest rates all suffered protracted declines at the same time. Such a confluence of events, he said, could land taxpayers in a predicament in which a bailout might be the only option.
"History never repeats itself in the same way," Dr. Bodie said. "I never predicted the stock market and interest rates would fall at the same time. I merely said it was possible, and sure enough, it happened."
In October, he presented the PBGC with some solutions. They included requiring firms to pay higher premiums to the PBGC, depending on how aggressively they invest their pension plans' assets.
In his paper, he recalled a statement in the PBGC's 1992 annual report by former Secretary of Labor Lynn Martin: "One would have to be an ostrich with its head buried in the sand to ignore the warnings and not learn from the analogy of the savings and loan crisis."
Even before any sort of parallel crisis unfolds, lawmakers appear to be directing their attention to the PBGC's situation.
Although a spokeswoman for the Senate Finance Committee said no more hearings are planned for now, the House Education and the Workforce Committee has said it may schedule hearings on the agency's health in the spring.
"They still have reserves to more than pay out their benefits for quite a few years," said Kevin Smith, spokesman for the committee. "That doesn't constitute any sort of crisis. Now, if this continues to happen for several years, that might change."
