Pensions On A Precipice

Here's what could happen if UAL offloads its retirement plan on the feds

The threat by UAL Corp. (UALAQ ), parent of struggling United Airlines Inc., to walk away from its four pension plans has set off shock waves throughout the airline industry. Thousands of pilots, flight attendants, and mechanics are sweating possible drastic reductions in their retirement benefits. And if UAL were to make such a move, other ailing old-line carriers such as Delta Air Lines (DAL ), Northwest Airlines (NWAC ), and US Airways Group (UAIR ) might also slash pension costs to remain competitive. Yet UAL's crisis could spread well beyond airlines. Already it has renewed worries about the shaky financial health of the quasi-governmental agency that insures old-fashioned "defined benefit" pensions for 44 million Americans, the Pension Benefit Guaranty Corp. With the PBGC already $10 billion short of what it needs long-term to pay promised benefits, some experts fear the situation eventually may require a multibillion-dollar taxpayer bailout.

Here's a primer on what could happen if United or other airlines dump their underfunded pension plans on the PBGC.

Can UAL simply stop making payments to its pension plans?

That's a matter of contention. UAL, which is seeking new financing to emerge from bankruptcy protection, missed a July payment of $72 million owed to three of its plans and says it will skip more than $500 million in payments due in September and October. A bankruptcy court judge so far has not ruled on the PBGC's request that UAL make the payments, which are required under federal pension law. But UAL is under intense pressure to pony up. Treasury Secretary John W. Snow, who sits on PBGC's board, told BusinessWeek on Aug. 23 that he agrees that UAL must pay. Says Snow: "Those are binding obligations, and they have to be taken seriously."

How would a pension dump work?

To offload its pensions onto PBGC, United would have to prove it is under severe financial distress. That shouldn't be hard, since the carrier has been in Chapter 11 since 2002, and its financial condition remains weak. The PBGC would assume the assets and liabilities of the plans, which the insurer estimates are underfunded to the tune of $8.3 billion. That would be the largest corporate pension default ever, far surpassing the $3.6 billion that Bethlehem Steel Corp. saddled the agency with in 2002. PBGC could petition for more of UAL's assets, but it would fall in line behind many other creditors.

What would United's workers and retirees get?

Collectively, $1.9 billion less than they expect now, since the PBGC would cover only $6.4 billion of the underfunding. That's because the PBGC's payments to retirees are capped by law at $44,386. And that maximum annual payout is far less than most pilots and some attendants and mechanics have been promised. Pilots face a double hit: Not only are they big earners, but by law they must retire at 60. Yet the PBGC reduces its payouts for those who retire before age 65. That means a 60-year-old senior pilot at United, who could expect a yearly pension of $100,000, would receive just $28,500. Little wonder that some pilots at United and other older carriers who can take lump-sum pension payouts if they retire now, are calling it quits.

Would other carriers follow United's lead?

Very likely. If United can offload its pensions, it would add hundreds of millions in annual cash flow. That would enable it to boost spending on facilities and planes, and lower fares to compete with upstart carriers that don't offer traditional pension plans. Such a move would give UAL a huge edge, thus compelling Delta and US Airways to do the same, says Roger E. King, senior analyst at CreditSights Ltd., an independent debt research firm.

But handing pension plans over to the PBGC would essentially require airlines to file for Chapter 11, an unappealing step. That's why Standard & Poor's credit analyst Philip A. Baggaley thinks it's more likely that UAL's old-line rivals would use United's pension termination as a cattle prod to win big concessions from pilots and other employees. From their perspective, "even if concessions are bad, bankruptcy is far worse," says Baggaley.

So would ditching pension plans help the airline industry restructure?

Knocking out costly pensions alone won't offset the traditional carriers' triple whammy of the post-September 11 travel drop-off, high fuel prices, and the proliferation of low-cost carriers. And terminating plans can be a two-edged sword. "There is always the danger that the unionized workers who lose their pensions will want some sort of quid pro quo -- reduced productivity or more flexible work hours," says Stuart Klaskin of aviation consulting firm Klaskin, Kushner & Co. in Miami.

Consider the fate of US Airways. The carrier looked like it might pull out of its tailspin 17 months ago, when it filed for Chapter 11 and dumped its pilots' pension plan, underfunded to the tune of $2.5 billion, on the PBGC. But today it is again fighting off bankruptcy. At best, shedding pension plans would let the legacy carriers muddle along -- without sharply reducing bloated costs or eliminating the problem of too many carriers chasing too few passengers.

Can the PBGC withstand a raft of pension offloads from the airline industry?

In the short term, yes. The agency has $40 billion in assets and would inherit billions more up front from the carriers' plans to cover liabilities that would be paid out over decades.

Still, a funding crisis looms. Already, the PBGC is paying out $3 billion in benefits annually and taking in barely $1 billion in premiums. Investment income doesn't cover the gap. A string of corporate bankruptcies, many in the steel industry, have already hammered the agency. And the PBGC's premium base is shrinking as more employers switch from their insured traditional pensions to uninsured 401(k) plans, where employees bear the risk of making sure they save enough for retirement. Since the mid-1980s, in fact, the number of traditional defined-benefit plans has plunged by more than 72%.

Can the PBGC's finances be propped up?

Not easily. It takes an act of Congress to raise the PBGC's premiums. A spate of airline pension terminations would juice the agency's campaign on Capitol Hill to switch to risk-based fees keyed to a company's credit rating and the funding level of its plan. Currently, the agency gets most of its premium revenue from a $19 annual charge for every worker whose pension is insured. The PBGC "is unable to control its own destiny" because it doesn't set its own premiums or control who it insures, says Steven A. Kandarian, PBGC's former executive director.

But lawmakers and businesses are likely to balk. "Risk-based premiums put the higher burden on those who can afford it least," says Baruch A. Fellner, a partner at Gibson, Dunn & Crutcher and former PBGC associate general counsel. And raising premiums for all would penalize companies that have continued to fund plans. General Motors Corp. (GM ) floated a $14.5 billion debt offering last year to shore up its $19 billion pension shortfall. Higher premiums on top of that would be unfair, says GM Chairman G. Richard Wagoner Jr.: "It falls into the 'no good deed goes unpunished' category."

The danger is that companies that have played by the rules get fed up and switch to 401(k) plans. Workers would get the retirement benefits they've accrued -- but no new ones.

So what's the likely outcome?

Closing loopholes that let weak companies avoid making pension contributions would help to deter companies from overpromising benefits. So would raising the cap on tax-deductible contributions so companies could stash more in their plans in good times. But such reforms, which require congressional approval, may not come soon enough. Many experts think taxpayers will end up footing the bill for a PBGC bailout. "Unless PBGC gets lucky, this will be the next savings and loan scandal," says Kent Smetters, associate professor of insurance and risk management at the University of Pennsylvania's Wharton School. Except in this case, no one can say they didn't see it coming.

By Amy Borrus, with Lorraine Woellert, in Washington; with Nanette Byrnes in New York and Joseph Weber and Brian Grow in Chicago

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