Fitch: Pension Bills Could be Big Help for Airlines

According to a new Fitch Ratings research report, the bill that was approved last week by the Senate Finance Committee would “help ease airline liquidity pressures” by delaying so-called deficit reduction contributions starting in 2005. Fitch estimated that the largest US air carriers collectively face an unfunded pension liability of more than $20 billion. A pension reform bill in the House currently contains no such contribution deferral provision.

The Senate bill, the National Employee Savings and Trust Equity Guarantee Act sponsored by Finance Committee Chairman Charles Grassley (R-Iowa), would exempt companies from making deficit reduction contributions to pension plans for a period of three years beginning after December 31, 2003 (See    Finance Committee Gives Grassley Pension Bill the Go-Ahead  ). Only companies that were not required to make deficit contribution payments during pension plan years beginning in 2000 could use the funding exemption. Since most major airline plans were near fully funded status in 2000, they would be be in a position to take advantage of the exemption.

Deficit reduction contributions are made by companies when the market value of assets in their defined benefit plans drops below 80% of the current pension liability to current and future retirees. Accelerated ‘catch-up’ contributions then kick in to ensure that future obligations can ultimately be met.

Funding Woes

For the major US airlines, the combination of poor market returns and declining interest rates over the past three years has created a situation in which plan asset values are well below the 80% funding threshold. As of year-end 2002, the pension plans of the six largest US network airlines (American, United, Delta, Northwest, Continental and US Airways) were all funded at less than 65% of the projected benefit obligation (PBO) – a common accounting measure of the pension liability (See    Fitch: Airlines’ Pension Picture ‘Most Dire”  ). Since the beginning of the year, however, the industry-funding gap has narrowed as a result of strong plan asset returns and an increase in interest rates from their historically low levels.

In addition to the adverse trends in asset returns and interest rates, the funded status of many big-carrier plans has been further undermined by lucrative labor contracts (signed before the industry downturn) that drove accrued benefit levels higher.

The cash flow and liquidity implications of the airline industry’s current underfunded position are particularly severe in light of the continuing financial challenges confronting the largest hub-and-spoke carriers. While revenue trends have improved steadily since April as demand patterns have strengthened, airline balance sheets remain weak as a result of big increases in debt loads and the need to fund large operating losses incurred since early 2001. Even with steady improvement in airline operating profiles resulting from across-the-board cost cutting and better unit revenue trends, carriers face substantially higher claims on operating cash flow through 2006 as a result of large debt repayment needs and required pension plan funding.

A New Interest Rate Mechanism

The House and Senate are expected to act quickly in passing legislation aimed at establishing rules to be used in calculating the level of funding in private employer defined benefit plans. The rules would also determine the size of payments that must be made by employers if the value of pension plan assets drops substantially below the present value of benefits to be paid to retirees and current employees. Much of the debate now centers on the appropriate interest rate to be used in discounting expected future benefit amounts to today’s dollars. A discount rate tied to the yield on 30-year Treasury securities now applies, but authorization for that rate expires at the end of the year, forcing Congress to move quickly in passing pension reform legislation. While both the Senate and House bills would allow for a temporary move to peg the discount rate to high-quality corporate bond yields, the Senate bill goes much further in its approach to seriously underfunded plans.

The Grassley bill also ties pension plan discount rates to a blended corporate bond yield for three years before a five-year transition period during which a yield curve-based mix of discount rates would be applied in computing pension liabilities. The increase in the discount rate would lower the present value of pension obligations, thereby reducing the level of required cash contributions to plans for all companies.

In the House, Representative John Boehner (R-Ohio) has introduced legislation that would temporarily replace the 30-year Treasury bond yield as the benchmark for defined benefit pension plan discount rates. Instead, a corporate bond yield would be used as the benchmark for two years before a permanent solution to the interest rate issue can be developed (See    Pension Partisianship Set Aside in 30-Year Treasury Rate Compromise ). The Boehner bill is far more limited in its scope, however, and would not change deficit reduction funding requirements for employer plans that are significantly underfunded. The bill reportedly will be considered on the House floor by the end of the month, and appears to benefit from strong support from a bipartisan group of co-sponsors.

Airlines with substantially underfunded plans and major unions continue to lobby for an alternative piece of industry-specific relief legislation known as the Airline Pension Act of 2003 (HR 2719), introduced by Rep. Dave Camp (R-Michigan) (See    Lawmaker’s Bill Would Offer Airline Pension Relief ). The Camp bill, backed vigorously by the Airline Pilots Association (ALPA), would establish a five-year moratorium period during which airlines would be exempt from making deficit reduction payments to their plans. After that period, the unfunded liability would be amortized over 20 years, with interest-only payments required in the first five years after the moratorium.