VideoUnited Air Lines is trying to lighten its load. Last November, the bankrupt carrier proposed terminating up to four of its pension plans that were collectively underfunded by $8.3 billion. But doing so would transfer a payload of up to $6.4 billion to another struggling organization: the Pension Benefit Guaranty Corp. (PBGC).
The PBGC, the government agency that insures defined-benefit pension plans, already assumed responsibility last December for United's pilots' plan. And in early February, the agency announced it would take over US Airway's three pension programs, which added another $2.3 billion to its burden. These are merely the latest in a string of worrisome plan terminations. In fiscal 2004, which ended September 30, the agency's net loss of $12.1 billion included a $14.7 billion loss from completed and probable pension terminations. Its year-end deficit rose to $23.3 billion, up from $11.2 billion in 2003.
Discouraging numbers, to be sure. The question now is what precedent these bailouts will set for other distressed airlines. At the end of calendar year 2003, the PBGC had a potential $31 billion exposure to 11 airlines, whose plans covered 440,000 participants.
"Certainly, if we were to absorb all the defined-benefit plans in the airline industry, that would have an adverse financial impact on the pension insurance fund," says Bradley D. Belt, the agency's executive director.
In a worst-case scenario, companies in other beleaguered industries could follow suit and dump their defined-benefit plans, causing the private pension system to wobble. "I think it's horrible what many companies with underfunded defined benefit plans are doing in terms of dumping them to the federal government," says Mark White, CFO of SAP America, a subsidiary of software giant SAP AG. "They're pushing their problems to the taxpayers as a way of lowering costs." And companies like SAP, with well-funded pension plans, will also suffer by paying higher premiums to the PBGC.
For the near term, at least, the PBGC says it has adequate resources. "With $39 billion in assets, we can continue to meet our obligations for a number of years," said Belt last November. "But with more than $62 billion in liabilities, it is imperative that Congress act expeditiously so that the problem does not spiral out of control."
In January, Secretary of Labor and PBGC chair Elaine L. Chao announced that her department would soon introduce reforms designed to shore up the health of the pension system. Ultimately, of course, any such reforms will have to be approved by Congress (see "Underfunding Fixes," at the end of this story).
Double Whammy
The worsening financial shape of the PBGC mirrors the declining health of the overall pension system. In 2004, 326 companies in the S&P 500 had underfunded defined-benefit plans, according to a recent study by Credit Suisse First Boston analysts David Zion and Bill Carcache, up from 320 in 2003. Zion estimates the aggregate shortfall for these plans now stands at $185 billion, compared with $172 billion in 2003. Among single-employer plans overall, the PBGC estimates that total underfunding for fiscal 2004 surpassed $450 billion, $100 billion greater than the total for 2003.
Much of the underfunding stems from the double whammy of declining stock prices, which depleted plan assets, and plummeting interest rates, which pumped up funding requirements. But another issue is that sponsors might have assumed unrealistic rates of return. The Securities and Exchange Commission is investigating half a dozen large companies that may have used overly optimistic assumptions to reduce pension contributions (see "Death to Smoothing?"). "Using a 9 or 10 percent assumption is not credible, and using that as a way to say you're fully funded is not credible," says White. SAP America assumes an 8 percent rate of return on the investment of its cash-balance pension plan's assets, he adds.
The widespread underfunding has come as an unpleasant surprise for many workers. For example, two years before it was shut down in 2003, the US Airways pilot pension plan reported that 94 percent of its liability was funded. After the plan was terminated, however, the PBGC found it was 33 percent funded on a termination basis, for a total shortfall of $2.5 billion. "It is no wonder US Airways pilots were shocked," fumes Steven Kandarian, Belt's predecessor at the PBGC.
Today, Belt seems especially annoyed about United's approach to funding its pensions. From 2000 to 2002, "notwithstanding the fact that asset values were falling precipitously, notwithstanding the fact that interest rates were coming down so the value of liabilities was going up, they contributed zero dollars to the pension plan," he notes. "And they also negotiated $800 million of new benefit increases" for the years 1997 through 2002. Those pension promises, offered largely in lieu of larger wage increases, were never fully funded. That United was able to contribute so little to its pension plans without breaking the law means there is a problem with the law, says Belt, who argues that legal funding targets are too low. (United officials declined to be interviewed for this story.)
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