	Legacy Airlines Must Reduce Costs to Restore Profitability

Since 2000, legacy airlines have faced unprecedented internal and external  challenges. Legacy airlines, as a group, have been unsuccessful in reducing their costs  to become more competitive with low cost airlines. Meanwhile, low cost airlines  have been able to maintain low unit costs, primarily by continuing to grow. At the  same time, low cost airlines have been able to continue producing modest  profits as a result of lower unit costs (see figure 4). Legacy airlines have  lost a cumulative $28 billion since 2001 and are predicted to lose another  $5 billion in 2005, according to industry analysts. Bankruptcy is Common in the Airline Industry, but There is No Evidence that it is Harmful to the Industry or Competitors

Airlines seek bankruptcy protection for such reasons as severe liquidity  pressures, an inability to obtain relief from employees and creditors, and  an inability to obtain new financing, according to airline officials and  bankruptcy experts. As a result of the structural problems and external  shocks previously discussed, there have been 160 total airline bankruptcy  filings since deregulation in 1978, including 20 since 2000, according to the  Air Transport Association. With very few exceptions, airlines that enter bankruptcy do not emerge  from it. Contrary to some assertions that bankruptcy protection has led to  overcapacity and under pricing that have harmed healthy airlines, we  found no evidence that this has occurred either in individual markets or to  the industry overall. Both studies  found that airlines under bankruptcy protection did not lower their fares  or hurt competitor airlines, as some have contended. Legacy Airlines Face Significant Near-term Liquidity Pressures, including $10.4 Billion in Pensions Contributions over the Next 4 Years

Under current law, legacy airlines’ pension funding requirements are  estimated to be a minimum of $10.4 billion from 2005 through 2008. The growth of pension underfunding is attributable to 3 factors. Airline management has funded  their pension plans far less than they could have. For example, PBGC  examined 101 cases of airline pension contributions from 1997 through  2002; these cases covered 18 pension plans sponsored by 5 airlines.During this time, $28.2 billion dollars could have been contributed to these  pension plans on a tax-deductible basis; actual contributions amounted to  $2.4 billion, or about 8.5 percent of what they could have contributed,  despite earning profits in 1997-2000 (see figure 9) The maximum  deductible contribution was made in only 1 of the 101 pension  contribution cases examined by PBGC. The cost to PBGC and participants of defined benefit pension terminations  has grown in recent years as the level of pension underfunding has  deepened. The effect of various proposals to reform  pension requirements on airlines, PBGC, and plan participants will vary. Dramatic  changes in the level and nature of demand for air travel combined with an  equally dramatic evolution in how airlines meet that demand have forced a  drastic restructuring in the competitive structure of the industry. However, this should not  be confused with causing the industry’s instability. However, the  termination of pension obligations by United Airlines and US Airways has  had substantial and wide-spread effects on the PBGC and thousands of  airline employees, retirees, and other beneficiaries. If their plans are  frozen so that future liabilities do not continue to grow, allowing an  extended payback period may reduce the likelihood that these airlines will  file for bankruptcy and terminate their pensions in the coming year.
Why GAO Did This Study

Since 2001, the U.S. airline industry has confronted unprecedented financial losses. Two of the nation's largest airlines--United Airlines and US Airways--went into bankruptcy, terminating their pension plans and passing the unfunded liability to the Pension Benefit Guaranty Corporation (PBGC). PBGC's unfunded liability was $9.6 billion; plan participants lost $5.2 billion in benefits. Considerable debate has ensued over airlines' use of bankruptcy protection as a means to continue operations, often for years. Many in the industry and elsewhere have maintained that airlines' use of this approach is harmful to the industry, in that it allows inefficient carriers to reduce ticket prices below those of their competitors. This debate has received even sharper focus with pension defaults. Critics argue that by not having to meet their pension obligations, airlines in bankruptcy have an advantage that may encourage other companies to take the same approach. GAO's testimony presents preliminary observations in three areas: (1) the continued financial difficulties faced by legacy airlines, (2) the effect of bankruptcy on the industry and competitors, and (3) the effect of airline pension underfunding on employees, retirees, airlines, and the PBGC.

What GAO Found

U.S. legacy airlines have not been able to reduce their costs sufficiently to profitably compete with low cost airlines that continue to capture market share. Internal and external challenges to the industry have fundamentally changed the nature of the industry and forced legacy airlines to restructure themselves financially. The changing demand for air travel and the growth of low cost airlines has kept fares low, forcing these airlines to reduce their costs. They have struggled to do so, however, especially as the cost of jet fuel has jumped. So far, they have been unable to reduce costs to the level of their low-cost rivals. As a result, legacy airlines have continued to lose money--$28 billion since 2001. Although some industry observers have asserted that airlines undergoing bankruptcy reorganization contribute to the industry's financial problems, GAO found no clear evidence that historically airlines in bankruptcy have financially harmed competing airlines. Bankruptcy is endemic to the industry; 160 airlines filed for bankruptcy since deregulation in 1978, including 20 since 2000. Most airlines that entered bankruptcy have not survived. While bankruptcy may not be detrimental to the health of the airline industry, it is detrimental for pension plan participants and the PBGC. The remaining legacy airlines with defined benefit pension plans face over $60 billion in fixed obligations over the next 4 years, including $10.4 billion in pension contributions--more than some of these airlines may be able to afford given continued losses. Various pension reform proposals may provide some immediate liquidity relief to those airlines, but at the cost shifting additional risk to PBGC. Moreover, legacy airlines still face considerable restructuring before they become competitive with low cost airlines.