The bankruptcy proceedings from American Airlines’ parent company AMR Corp. (PINK:AAMRQ) have officially gone from disheartening to surprising, not to mention from predictable to weird. Worse than either of those deteriorations, though, the restructuring of the company has moved from something that at least looked feasible, to something that doesn’t actually solve the problem at all.
Simply put, American Airlines isn’t going to turn its under-funded pension plan over to the government agency that makes up for the shortfall. Rather, it’s going to retain control of the pension fund and try to negotiate — with the plan’s participants — its way to a solution that works.
Not axing the pension plan is admirable. In this case, though, the pension plan is the problem.
Looks Good on Paper, Not So Good in Real Life
AMR, via American Airlines, is in serious financial trouble. Fading demand paired with excessive fuel costs have taken such a toll that it’s been forced into a Chapter 11 filing. Truth be told, though, it’s the burden of the four pension plans (pilots, groundworkers, mechanics and flight attendants each have their own) that gradually has made the airline so fiscally unsound.
Pension plans usually are reorganized during bankruptcy proceedings, too, and that was the plan following AMR’s late-November filing — to simply turn the keys to the four separate plans’ funds over to the Pension Benefit Guaranty Corporation and let it figure out how to bridge the gap between the $8.3 billion the plan has and the $18.5 billion the plan needs to meet its obligations. As of Tuesday evening, however, AMR has decided to figure out the pension problem itself, but proceed with all the other aspects of the bankruptcy.
Specifically, the company intends to “freeze” three of the four plans, meaning none of its participants add any new money to it, nor would the company. Benefits would not be cut, but clearly the plan’s value would weaken as time passed and the pool of money was exhausted. The fourth plan (the pilots’ plan) also likely would be frozen, but AMR was first hoping to cancel the lump-sum payout option that pilots have.
In all four cases, though, the ultimate goal is to transition away from a defined benefit plan and move toward a 401(k)/defined contribution plan.
Philosophically it’s a great idea. In reality, it’s too little, too late.
To give credit where it’s due, Jon Waite — the Director of Investment Management Advice for the SEI Institutional Group — noted very adeptly that the bankruptcy highlights the problems of providing a “legacy” benefit when industry competitors aren’t saddled with the same fiscal burden.
He’s right. Unfortunately, AMR’s about $10 billion late in figuring it out. No amount of freezing is going to get them from here to there.
There’s a Reason Every Other Airline Did It
Automobiles and airlines might be America’s last “legacy” businesses where the way they operate and compensate today hasn’t changed much in the last several decades. Up until recently, both industries predominantly paid their retirees a predetermined monthly benefit for as long as that worker lived, and both industries took care of their retirees’ basic health care costs as long as they lived.
Up until the 1980s, such a scheme was feasible because (and sorry to be blunt) people didn’t live that long after they retired until then, and health care costs didn’t start to get idiotically high until then. Now some workers are getting more out of these plans than they ever even came close to putting in them.
Clearly that’s some non-viability writing on the wall that the other airlines saw a few years back. That’s why United Airlines — now United Continental (NYSE:UAL) — filed for bankruptcy in 2002. US Airways (NYSE:LCC) did it in early 2003, killing the pension plan for its 6,000 pilots and setting the tone for Delta Air Lines (NYSE:DAL) and Northwest to both file Chapter 11 in 2005 — to rework their compensation structure and wipe away debilitating pension obligations.
Coincidence? No, there’s a reason every other major airline shed its legacy defined-benefit plan — they couldn’t afford them any longer. The weak demand following the 9/11 attacks was simply the final straw.
Wishful Thinking?
As was noted, the aim to keep the pension plans intact rather than hand them over to Pension Benefit Guaranty Corporation was admirable, since the PBGC almost assuredly would reduce benefit payouts (with some payouts being only half of what they would have been were the airline able to meet the original obligation). In the grand scheme of things, though, freezing the plans as they stand now still doesn’t solve the airline’s problem.
AMR has noted it still needs to reduce its costs by $2 billion and increase revenue by $1 billion to even have a shot at maintaining its pension plans as well as maintaining operations, even with the pension freeze.
Laying off 13,000 workers and cutting some benefits will take care of about $1.25 billion of the $3 billion gap. But for a company that seems to have hit an annual revenue ceiling of $24 billion and habitually loses around $2 billion per year — yet is shrinking the size of the operation as part of the Chapter 11 process — the remaining $1.75 billion need might be surprisingly difficult to meet.
Sadly, we might be seeing another Chapter 11 filing from AMR Corp. in the foreseeable future, with the second one finally doing the sad deed that has to be done to save the airline: axing the pension plan altogether.
As of this writing, James Brumley did not hold a position in any of the aforementioned securities.
