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WASHINGTON—The Pension Benefit Guaranty Corp. could be hit with its biggest loss ever, while American Airlines employees and retirees could lose hundreds of millions of dollars in promised benefits, if the financially ailing company terminates its four massively underfunded pension plans.
Speculation about the future of American's pension plans loomed large after last week's Chapter 11 bankruptcy reorganization filing by American parent company AMR Corp. in Fort Worth, Texas.
According to preliminary PBGC estimates, the four plans, which cover nearly 130,000 participants, have about $8.3 billion in assets and about $18.5 billion in promised benefits. The PBGC said if the plans fold, the agency would be liable for about $17 billion in benefits, resulting in an $8.7 billion loss to the agency. American, in its 2010 10-K report, said the plans, at year-end, had about $7.8 billion in assets and a projected benefit obligation of about $13.5 billion.
Depending on the final value of plan assets and liabilities, if the plans are terminated the loss could be the PBGC's largest, eclipsing the $7.35 billion loss it sustained in its 2005 takeover of four United Airlines pension plans.
AMR officials have not said whether they will seek to terminate their plans. But Thomas Horton, AMR's president, chairman and CEO, said the airline needs to reduce its labor costs to achieve a competitive cost structure.
“We must address our cost structure, including labor costs, to enable us to capitalize on these foundational strengths and secure our future. Our very substantial cost disadvantage compared to our larger competitors, all of which restructured their costs and debt through Chapter 11, has become increasingly untenable,” Mr. Horton said in a statement after the bankruptcy filing.
On the pension side, none of American's key competitors offer ongoing defined benefit plans. Aside from United, the PBGC in 2003 and 2005 took over three US Airways Inc. pension plans, incurring a $2.75 billion loss. Then, in 2006, the PBGC took over a Delta Air Lines Inc. plan covering the airline's pilots at a cost of $1.72 billion. Those terminations occurred in the wake of bankruptcy filings by the two airlines.
In addition, Delta sponsors a frozen plan—participants do not accrue new benefits—for nonpilot employees and retirees, as well as three frozen plans covering Northwest Airlines Inc. employees and retirees, which Delta acquired in 2008.
Other major American competitors, including Southwest Airlines Co. and JetBlue Airways Corp., do not sponsor defined benefit pension plans.
Benefit experts attribute the bulk of the massive underfunding of American's pension plans, to the same factors—the slump in the equities markets from earlier peaks and low interest rates—that have walloped funding levels for employers nationwide.
“There have been tremendous asset losses, while interest rates have slumped,” said John Ehrhardt, a principal with Milliman Inc. in New York.
“Poor market returns and lower interest rates together have combined to produce greatly lower funded ratios,” said Arthur Noonan, a senior consultant in the Pittsburgh office of Mercer L.L.C.
For example, last year, defined benefit pension plans sponsored by 100 U.S. employers with the largest pension programs were on average 83.9% funded, according to an annual Milliman survey. That was a huge drop compared with 2007—just before the economy began to slump—when the plans on average were 105.4% funded.
American's pension funding woes, experts say, also were exacerbated by an exemption from tougher funding rules that Congress passed in 2006 as part of the Pension Protection Act. Under that law, employers have to amortize plan liabilities over a seven-year period, a greatly accelerated time frame compared with the 30-year requirement set under prior law.
A catalyst that helped convince lawmakers that funding rules needed to be tightened was the recognition that prior law was so weak that companies could comply with all funding rules—as United Airlines did—and still have massively underfunded pension plans, exposing the PBGC to huge losses.
But in passing the PPA, Congress carved out an exception—written in such a way as to apply to American—to exempt the airline from some of the PPA's tough funding rules.
Under that exemption, airlines that haven't frozen their pension plans can fund them over 10 years rather than over the PPA's seven-year standard. In addition, eligible airlines can use a higher interest rate assumption in valuing plan liabilities. That special treatment reduced what American otherwise would have had to contribute to the plans, observers say, though by exactly how much isn't known.
“This isn't the only time Congress has decided to exempt industries or companies from funding requirements...Congress made the judgment, with administration support, that was the right thing to do,” said PBGC Director Joshua Gotbaum.
“But no one should pretend that does not increase the risk” to the PBGC and to plan participants; if companies receiving such exemptions later fail, their pension plans will be even more underfunded, Mr. Gotbaum said.
Mr. Gotbaum said the massive underfunding of American's pension plans is not an appropriate example in evaluating whether the PPA has been a success or failure in improving plan funding, because the law in this case was not fully applied.
If the PBGC ends up taking over American's plans, it would be the agency's first multibillion-dollar loss since 2009, when the agency assumed control of hugely underfunded pension plans sponsored by failed auto parts manufacturer Delphi Corp., which the PBGC estimates will cost more than $6.3 billion.
In fiscal 2011, the PBGC reported a record $26 billion deficit in its insurance programs.