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Established Pilots

Airline Pension Financial Crisis

David Jones, Consulting Editor

Information about pilot pensions hasn't exactly dominated the news, but I suspect that this is a topic of major concern for just about all pilots with a defined benefit pension plan--and those who hope to one day work for an airline providing such a pension.

There are many reasons why pilots are interested in pension issues, not the least of which is the fact that pilots work hard for many years to earn the benefits paid out through pension plans.

The type of pension plan I will talk about today is the defined benefit pension plan, which is sometimes called an "A" plan in the industry. This type of pension typically pays out a monthly benefit to pilots, based on a formula that can be different at each airline. Final average earnings, length of service, and age all typically play major roles in determining a pilot's pension benefits. Some carriers offer a lump-sum option, which may be in-lieu of the monthly benefit or could supplement a smaller monthly benefit. Each plan is a little different, but suffice it to say that a pilot's defined benefit pension is a major part of his compensation; it's just that he won't see it until retirement.

Pilots today are at risk--of various degrees--of losing some of their pension benefits. This is a scary statement, but it is also a true one. Here is why:

Pension plan funding is extremely complex, and I won't even pretend to understand exactly how it works. What is happening, though, is that for several years the stock market has experienced a general decline. Simultaneously, interest rates are at 40-year lows, and interest rates play a major role in determining funding levels. Add to that the cash-flow crisis at most airlines, which makes it difficult for them to contribute the extra funds required to keep the pension adequately funded. This is what some have termed "the perfect storm" of pension underfunding, as all of these variables play a role in what is currently happening in the airline industry and others. I will also add that "underfunded" is a relative term. Some airlines will insist their pension plans are well-funded even when ratings agencies say otherwise.

The problem is not a new one. There are examples of airlines that have had their defined benefit pension plans terminated and then managed by the Pension Benefit Guaranty Corporation, or the PBGC. TWA is one recent example of this. The PBGC was created by the federal government to monitor pension plans and to make sure that retirees got some benefit in the event of a pension termination. The PBGC each year establishes a maximum benefit for retirees receiving pension payments from a terminated plan. While the maximum benefit itself (less than $44,000 per year, at age 65, for plans terminating in 2003; this amount fluctuates based on age, year of termination, etc.) is smaller than what many major airline pilots would earn from a fully funded pension, a closer look reveals additional concerns. Pilots are required to retire at age 60, yet the PBGC formula identifies normal retirement age as age 65. The maximum benefit at earlier ages is significantly reduced, while it is higher above the normal retirement age. The bottom line is that pilots, after working for 30 years at an airline, can retire and lose substantial benefits--tens of thousands of dollars per year--and never get these benefits back. And, while this is the worst-case scenario, the current economic environment in the airline industry requires pilots to take a serious look at their risk level. And while current pilots may have an increased risk over those who retire before their pension is terminated and handed over to the PBGC, retirees also have risk.

One airline, US Airways, sought legislative relief because it said it could not afford to fund its pilot pension obligation using current rules, which are set by law. Basically what US Airways asked for was more time to meet its funding obligation. The U.S. Senate, by a two-to-one margin, turned the airline down. The PBGC advised against allowing the carrier to terminate its pension and then attempt to recreate those benefits over a longer period of time. Steven A. Kandarian, PBGC's executive director, testified before a U.S. Senate appropriations subcommittee that such a move would put workers' retirement security "at risk".

The airline then filed for a distress termination of its pilot pension plan. The Air Line Pilots Association opposes the termination of the pension plan. US Airways has said, in addition to continuing attempts to get legislative relief, it will create a new, defined contribution pension plan for its pilots. That would, if the termination goes through, give currently employed pilots a payout from the terminated pension managed by the PBGC and a supplementary payment from the new plan. Pilots would not be guaranteed the payments they would have received under the old "A" plan if it had been adequately funded. Pilots, I believe, will fight hard to keep their defined benefit pension in some form, although it remains to be seen how successful they will be in this fight. Pension benefits are calculated on a pilot's final average earnings. And since pilots at several carriers--including US Airways--have taken pay cuts to assist their carriers in restructuring, these retirement-approaching pilots already face reduced benefits.

I would expect unions and others to push for some changes to the pension laws. Current law in some cases prohibits companies from making cash contributions when the plan is "overfunded." Things in the cyclical airline industry can and do change quickly. Some argue that not allowing companies to contribute to the plan when times are good--stock market, interest rates, and profitability--yet mandating large payments during a recession is asking for trouble. Additionally, companies with plans that are less than 90-percent funded are required to make additional contributions, and companies with underfunded pensions also pay higher premiums to the PBGC. Some argue that the system is broken and needs repaired--or at least tweaked--but Washington has yet to tackle the issue legislatively.

Airlines appear to be re-evaluating their plans to see what they can do about their pension obligations. One recent example of this is Delta's decision to change to a defined contribution plan for new employees, although this move does not apply to pilots. In a defined contribution plan, the company makes a set contribution now, based on the employee's salary, rather than providing a set benefit at retirement. It is less complicated, but employees must rely on the rate of return--rather than additional contributions by the company--to provide a specific amount of money at retirement. Also, employees manage their own assets in a defined contribution plan.

Another example is Northwest's decision to contribute stock of its wholly owned commuter airline, Pinnacle, to its employee pension plan. The move saves cash but may not be popular with some employees because stock is not cash. The carrier's pilots, however, must approve of a company plan to contribute Pinnacle stock to their pension plan because of rights granted in their collective bargaining agreement.

What can pilots do? In addition to hoping for a stock market turn-around and a return to profitability by the airlines, they can do a few things. They can stay informed with what is happening industry-wide, and respond to ensure their thoughts are known. As this issue gets more attention in Washington, they can involve themselves. But perhaps above all, they can make saving on their own for retirement a bigger priority. Many financial advisers recommend a philosophy of "paying yourself first," and this advice may help make your post-retirement dreams and plans a reality. Just like the funding challenges that lie ahead for Social Security have caused some Americans to take control of their financial future, perhaps the silver lining in this crisis is that pilots will save more in their 401(k)s, IRAs and other savings instruments. Hopefully, though, in time, this issue will get resolved and the overwhelming majority of pilots can be confident they will get the full retirement benefit they earned.

What does the future hold for pilot pensions? Will there be a push for better defined contribution plans, which give pilots control over their retirement assets but don't provide a set benefit? It may be too early to definitively answer these questions, but I have my opinion. One of the things that separates most of the major airlines from other types of employers--and one of the benefits that pilots look for during industry up cycles--is a defined benefit pension plan. It really is part of the pilot's compensation, although it is deferred until retirement. Airlines may look for ways to more accurately forecast their pension costs--hence Delta's move for non-pilot employees--but it is hard to envision most major airlines without this benefit.