Underfunded pension plans are a symptom of the  financial turmoil the airline industry currently faces. Several industry  trends, such as the emergence of well-capitalized low cost airlines and  reliance on the Internet to distribute tickets, are fundamentally reshaping  the structure of the airline industry. These and other factors have combined to create  a highly competitive environment, which has been particularly challenging  for the legacy airlines. As we reported in August, the financial performance and viability of legacy  airlines has deteriorated significantly compared with low-cost airlines  since 2000. Legacy airlines have collectively lost $24.3 billion over the last  3 years, while low-cost airlines made $1.3 billion in profits. Legacy airlines also  face considerable debt and pension funding obligations in the next few  years. As part of reducing their  labor costs, a number of legacy airlines have begun to consider  terminating their DB pension plans, under current bankruptcy and pension  laws. United Airlines recently announced that it would not make roughly  $500 million in contributions to its pension plans this year. The potential termination of these underfunded pension plans confronts  Congress with three key policy issues. The most visible is the financial  exposure of PBGC. The agency reports that airline pensions are currently  underfunded by $31 billion. Second, thousands of plan participants and beneficiaries will  lose pension benefits due to limits on PBGC guarantees and certain  provisions affecting PBGC’s insurance program. Finally, airlines that  terminate their plans may gain a competitive advantage because such  terminations effectively lower overall labor costs. Pension Problems Extend Broadly

We have highlighted several potential sources of problems in the pension  system that have contributed to the broad underfunding of DB pension  plans generally, including airline plans. Single-employer pension plans  have suffered from a so-called “perfect storm” of key economic conditions,  in which declines in stock prices lowered the value of pension assets used  to pay benefits, while at the same time a decline in interest rates inflated  the value of pension liabilities. The combined “bottom line” result is that  many plans have insufficient resources to pay all of their future promised  benefits. While these cyclical factors may improve and reverse some of the  pension underfunding, other trends suggest more serious structural  problems to the single-employer insurance program’s long-term viability. These include a declining number of DB plans, a decline in the percentage  of participants that are active (as opposed to retired) workers, and a rise  in alternative retirement savings vehicles, such as defined contribution  (DC) plans, which provide retirement benefits with more portability but  which transfer the investment risk from the employer to the employee. In  addition, as the PBGC takeover of severely underfunded plans suggests,  the existing pension funding rules have not ensured that sponsors  contribute enough to their plans to pay all the retirement benefits  promised to date. The current pension crisis facing the airline industry and PBGC illustrates  the need for comprehensive pension reform that tackles the full range of  challenges across all industries, not just airlines. Reforms must include meaningful incentives for sponsors to adequately  fund their plans. They must provide additional transparency for  participants, and ensure accountability for those firms that fail to match  the benefit promises they make with the resources necessary to fulfill  them. Pension Policy Issues Have Broad Implications

The rules of the current pension system, and any attempts to reform these  rules, carry wide-ranging implications for airlines and other industries, as  well as pension participants and beneficiaries, the PBGC, and potentially  the American taxpayer. The current problems plaguing many pensions in the airline industry  should be seen as symptomatic for the pension system overall and should  demonstrate that the way we currently fund and insure pension benefits  has to change.
Why GAO Did This Study

At the same time that "legacy" airlines face tremendous competitive pressures that are contributing to a fundamental restructuring of the airline industry, they face the daunting task of shoring up their underfunded pension plans, which currently are underfunded by an estimated $31 billion. Terminating these pension plans confronts Congress with three policy issues. The most visible is the financial exposure of the Pension Benefit Guaranty Corporation (PBGC), the federal agency that insures private pensions. The agency's single-employer pension program already faces a deficit of an estimated $9.7 billion, and the airline plans present a potential threat to the agency's viability. Second, plan participants and beneficiaries may lose pension benefits due to limits on PBGC guarantees. Finally, airlines that terminate their plans may gain a competitive advantage because such terminations effectively lower overall labor costs. This testimony addresses (1) the situation the airlines are facing today, (2) overall pension developments, and (3) the policy implications of addressing these issues.

What GAO Found

The problems posed by the airlines' underfunded plans, while extremely serious in the short term, are only the latest symptom of the decline in the health of our nation's defined benefit (DB) pension system. These problems illustrate weaknesses in the pension system overall and demonstrate that the way plans currently fund and insure pension benefits has to change. Underfunded pension plans are a symptom of the financial turmoil currently facing the airline industry. Industry trends, including the emergence of well-capitalized low cost airlines and other factors, have created a highly competitive environment that has been particularly challenging for the legacy airlines. Since 2000, the financial performance of legacy airlines has deteriorated significantly. Legacy airlines have collectively lost $24.3 billion over the last 3 years. Despite cost-cutting efforts, legacy airlines continue to face considerable debt and pension funding obligations. In this context, a number of legacy airlines have begun to consider terminating their DB pension plans. For example, United Airlines recently announced that it would not make roughly $500 million in contributions to its pension plans this year and US Airways announced that it does not plan to make roughly $100 million in contributions. The problems of underfunded DB pension plans extend far beyond the airline industry. We have highlighted several problems that have contributed to the broad underfunding of DB plans generally, including airline plans. These problems include cyclical factors like the so called "perfect storm" of key economic conditions, in which declines in stock prices lowered the value of pension assets used to pay benefits, while at the same time a decline in interest rates inflated the value of pension liabilities. The combined "bottom line" result is that many plans today have insufficient resources to pay all of their future promised benefits. Other long term trends suggest more serious structural problems to the system, including a declining number of DB plans, a decline in the percentage of participants that are active (as opposed to retired) workers, and other factors. Existing pension funding rules and the current structure for paying PBGC insurance premiums have not ensured that sponsors contribute enough to their plans to pay promised benefits. The current pension crisis facing the airline industry and PBGC, and how the Congress chooses to address that crisis, has wide-ranging implications for airlines and other industries, as well as for pension participants, PBGC, and potentially the American taxpayer. This crisis also illustrates the need for comprehensive pension reform that tackles the full range of challenges crossing all industries and not just airlines. Such a comprehensive reform would include meaningful incentives for sponsors to adequately fund their plans, provide additional transparency for participants, and ensure accountability for those firms that fail to match the benefit promises they make with the resources necessary to fulfill those promises.