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Report to Congressional Committees:
September 2005:
Commercial Aviation:
Bankruptcy and Pension Problems Are Symptoms of Underlying Structural
Issues:
[Hyperlink, http://www.gao.gov/cgi-bin/getrpt?GAO-05-945]:
GAO Highlights:
Highlights of GAO-05-945, a report to congressional committees:
Why GAO Did This Study:
Since 2001 the U.S. airline industry has lost over $30 billion. Delta,
Northwest, United, and US Airways have filed for bankruptcy, the latter
two terminating and transferring their pension plans to the Pension
Benefit Guaranty Corporation (PBGC). The net claim on PBGC from these
terminations was $9.7 billion; plan participants lost $5.3 billion in
benefits (in constant 2005 dollars).
Considerable debate has ensued over airlines’ use of bankruptcy
protection as a means to continue operations. Many in the industry have
maintained that airlines’ use of this approach is harmful to the
industry. 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.
At the request of the Congress, we have continued to assess the
financial condition of the airline industry and focused on the problems
of bankruptcy and pension terminations. This report details: (1) the
role of bankruptcy in the airline industry, (2) whether bankruptcies
are harming the industry, and (3) the effect of airline pension
underfunding on employees, airlines, and the PBGC.
DOT and PBGC agreed with this report’s conclusions. GAO is making no
recommendations.
What GAO Found:
Bankruptcy is endemic to the airline industry, owing to long-standing
structural challenges and weak financial performance in the industry.
Structurally, the industry is characterized by high fixed costs,
cyclical demand for its services, and intense competition.
Consequently, since deregulation in 1978, there have been 162 airline
bankruptcy filings, 22 of them in the last five years. Airlines have
used bankruptcy in response to liquidity pressures and as a means to
restructure their costs. Our analysis of major airline bankruptcies
shows mixed results in being able to significantly reduce costs—most
but not all airlines were able to do so. However, bankruptcy is not a
panacea for airlines. Few have emerged from bankruptcy and are still
operating.
There is no clear evidence that airlines in bankruptcy keep capacity in
the system that otherwise would have been eliminated, or harm the
industry by lowering fares below what other airlines charge. While the
liquidation of an airline may reduce capacity in the near-term,
capacity returns relatively quickly. In individual markets where a
dominant carrier significantly reduces operations, other carriers
expand capacity to compensate. Several studies have found that airlines
in bankruptcy have not reduced fares and rival airlines were not harmed
financially.
The defined benefit pension plans of the remaining airlines with active
plans are underfunded by $13.7 billion, raising the potential of more
sizeable losses to PBGC and plan participants. These airlines face an
estimated $10.4 billion in minimum pension contribution requirements
over the next 4 years, significantly more than some of them may be able
to afford given their continued operating losses and other fixed
obligations (see figure). While spreading these contributions over more
years would relieve some of these airlines’ liquidity pressures, it
does not ensure that they will avoid bankruptcy because it does not
fully address other fundamental structural problems, such as other high
fixed costs.
Comparison of Legacy Airline Cash Balance with Future Fixed
Obligations:
[See PDF for image]
[End of figure]
www.gao.gov/cgi-bin/getrpt?GAO-05-945.
To view the full product, including the scope and methodology, click on
the link above. For more information, contact JayEtta Z. Hecker at
(202) 512-2834 or heckerj@gao.gov.
[End of section]
Contents:
Letter:
Results in Brief:
Background:
Bankruptcy Is a Response to the Airline Industry's Structural
Challenges:
No Evidence That Bankruptcy Protection Harms the Industry or Hurts
Competitors:
Airlines Have Shed Billions in Pension Obligations, but Structural Cost
Problems Remain:
Concluding Observations:
Agency Comments:
Appendixes:
Appendix I: Scope and Methodology:
Appendix II: Case Studies Describing Market Responses to Airline
Withdrawals:
Colorado Springs: Western Pacific Moved Its Operations to Denver:
Columbus: America West Eliminated Its Hub:
Greensboro: Continental Lite Service Was Dismantled:
Kansas City: Vanguard Ceased Operations:
Nashville: American Dismantled a Hub:
St. Louis: American Acquired TWA:
Appendix III: Comments from the Pension Benefit Guaranty Corporation:
Appendix IV: GAO Contact and Staff Acknowledgments:
Related GAO Products:
Tables:
Table 1: Airline Bankruptcy Filings Since 2000:
Table 2: Cost Reductions Achieved during Major Airline Bankruptcies:
Table 3: Recent Examples of Airline Financing:
Table 4: Case Examples of Markets' Response to Airline Withdrawals:
Table 5: Bankruptcy Filings, 1978-2004:
Table 6: Costs of Terminating Airline Pension Plans:
Table 7: Estimated Benefit Cuts for United Airlines Active Employees:
Table 8: Estimated Benefit Cuts for United Airlines Retirees:
Table 9: 2006 Estimated Deficit Reduction Contribution Payments under
Different Amortization Periods:
Figures:
Figure 1: Average Annual Spot Price for Gulf Coast Jet Fuel, 1998-2005:
Figure 2: Percentage Change in Passenger Yields Since 2000:
Figure 3: Difference in Unit Costs between Legacy and Low Cost
Airlines, 1998-2004:
Figure 4: Airline Operating Profits and Losses, 1998-2004:
Figure 5: Comparison of Airline and Overall Business Failure Rates,
1984-1997:
Figure 6: Average Duration of Bankruptcies, by Industry, 1980-2004:
Figure 7: Comparison of Airlines' and Other Industries' Bankruptcy
Outcomes, 1980-2004:
Figure 8: Growth of Airline Industry Capacity and Major Airline
Liquidations:
Figure 9: Return on Capital Invested, 1992-1996:
Figure 10: Operating Profits, 2000-2001:
Figure 11: Funded Status of Legacy Airline Defined Benefit Plans, 1998-
2004:
Figure 12: Pension Funding Status, 1998-2004:
Figure 13: Legacy Airlines' Projected Minimum Contribution
Requirements, 2005-2008:
Figure 14: Legacy Airlines' Pension Assets and Returns, 1998-2004:
Figure 15: Corporate and 30-Year Treasury Bond Yields, 1977-2005:
Figure 16: Legacy Airlines' Maximum Allowable Pension Contributions,
Actual Pension Contributions, and Operating Profits, 1997-2002:
Figure 17: Legacy Airline Pension Assets as a Percent of Liabilities,
1998-2003:
Figure 18: Comparison of Legacy Airlines' Year-end 2004 Cash Balances
with Fixed Obligations, 2005-2008:
Figure 19: Percentage Change in Colorado Springs Capacity and Total
Traffic:
Figure 20: Number of Destinations Served from Colorado Springs:
Figure 21: Percentage Change in Columbus Capacity and Total Traffic:
Figure 22: Number of Destinations Served from Columbus:
Figure 23: Percentage Change in Greensboro Capacity and Total Traffic:
Figure 24: Number of Destinations Served from Greensboro:
Figure 25: Percentage Change in Kansas City Capacity and Total Traffic:
Figure 26: Number of Destinations Served from Kansas City:
Figure 27: Percentage Change in Nashville Capacity and Total Traffic:
Figure 28: Number of Destinations Served from Nashville:
Figure 29: Percentage Change in St. Louis Capacity and Total Traffic:
Figure 30: Number of Destinations Served from St. Louis:
Abbreviations:
ASM: Available seat mile:
ATSB: Air Transportation Stabilization Board:
BTS: Bureau of Transportation Statistics::
CASM: Cost per available seat mile:
DOT: Department of Transportation:
DRC: Deficit Reduction Contributions:
FAA: Federal Aviation Administration:
PBGC: Pension Benefit Guaranty Corporation:
PFEA: Pension Funding Equity Act:
RLA: Railway Labor Act:
SEC: Securities and Exchange Commission:
Letter September 30, 2005:
Congressional Committees:
Since 2001, the U.S. airline industry has confronted financial losses
of unprecedented proportions. From 2001 through 2004, legacy airlines
(i.e., generally, those network airlines whose interstate operations
predated deregulation) incurred operating losses of $28 billion. Since
2000, four of the nation's largest legacy airlines--Delta Air Lines,
Northwest Airlines, United Airlines and US Airways--have gone into
bankruptcy.[Footnote 1] Together, these airlines provided over 40
percent of the available passenger seating capacity operated by all
U.S. airlines during the second quarter of 2005. Under bankruptcy
protection, United and US Airways terminated their pension plans and
passed the unfunded liability to the Pension Benefit Guaranty
Corporation (PBGC).[Footnote 2]
In recent years, considerable debate has ensued over legacy airlines'
use of chapter 11 bankruptcy protection as a means to continue
operations, often for years. Some in the industry and elsewhere have
maintained that legacy airlines' use of this approach is harmful to the
airline industry as a whole because it allows inefficient carriers to
stay in business, creating overcapacity and allowing these airlines to
potentially underprice their competitors. This debate has received even
sharper focus since US Airways and United defaulted on their pensions.
Without their pension obligations, critics argue, US Airways and United
enjoy a cost advantage that may encourage other airlines sponsoring
defined benefit plans to take the same approach.
Last year, we reported on the industry's poor financial condition, the
reasons for it, and the need for legacy airlines to reduce their costs
if they are to survive.[Footnote 3] At the request of Congress, we have
continued to assess the financial condition of the airline industry
and, in particular, the problems of bankruptcy and pension plan
terminations. Accordingly, this report details (1) the role of
bankruptcy in the airline industry, (2) whether bankruptcies are
harming the industry, and (3) the effect of airline pension
underfunding on employees, airlines, and PBGC.
To help answer these questions, we relied on a variety of data sources.
To assess the financial status of airlines, including bankrupt
airlines, we used airline financial and operating data reported to the
U.S. Department of Transportation (DOT). To assess the reliability of
these data, we reviewed the quality control procedures that the
Department and its contractors use in collecting and maintaining these
data. To analyze the impact of airline bankruptcies, we relied on two
different but complementary databases: Professor Lynn M. LoPucki's
Bankruptcy Research Database and New Generation Research's
bankruptcydata.com. We assessed the reliability of these data by
comparing key elements from the two data sources and also by comparing
key elements with corporate filings with the U.S. Securities and
Exchange Commission (SEC). To assess the effect of underfunding airline
pensions, we relied on PBGC data, supplemented by public financial
reports filed with SEC. We determined that the data we used were
sufficiently reliable for the purposes of this report. For our work, we
also reviewed academic studies, met with airline and trade association
representatives, government experts, and industry and legal analysts.
Additional information on our scope and methodology is available in
appendix I. We performed our work from August 2004 through September
2005 in accordance with generally accepted government auditing
standards.
Results in Brief:
Bankruptcy is endemic to the airline industry, owing to long-standing
structural challenges and weak financial performance in the industry.
Airlines have used bankruptcy in response to liquidity pressures and as
a means to restructure their costs. However, our analysis of major
airline bankruptcies shows mixed results in reducing costs while under
bankruptcy. For example, Continental Airlines was able to reduce costs
significantly during its first and second bankruptcies, while TWA was
far less successful and saw its unit costs rise faster than the rest of
the industry's during its first bankruptcy. Since deregulation in 1978,
there have been 162 airline bankruptcies, 22 of them in the last 5
years. While most of these bankruptcies affected small airlines that
eventually liquidated, four of the more recent bankruptcies (Delta,
Northwest, United, and US Airways) are among the largest corporate
bankruptcies ever, excluding financial services firms. The airline
industry is characterized by intense competition, high fixed costs,
cyclical demand, and vulnerability to external shocks. As a result,
airlines have performed worse financially and are more prone to failure
than most other industries. For airlines in bankruptcy, the process,
while well developed, can be contentious as the numerous stakeholders,
such as airline employees and creditors, fight for pieces of a
diminishing pie. We found some indication that airline bankruptcies
differ from those in many other industries: for example, they tend to
last longer and are more likely to terminate in liquidation.
There is no clear evidence that airlines in bankruptcy harm the
industry by contributing to overcapacity or underpricing their
competitors. We found that although an airline's liquidation may reduce
capacity in the near-term, capacity returns relatively quickly. Even
when a dominant carrier retreats from an individual market because it
has liquidated or changed its business strategy (by, for example,
dropping a hub city), other carriers quickly expand capacity to
compensate with little or no increase in fares. For example, in
Nashville, after American Airlines dismantled their hub there, other
airlines increased their capacity and total origin-and-destination
capacity actually increased. Several studies have also found that
airlines in bankruptcy have not reduced fares and rival airlines were
not harmed financially. Furthermore, bankruptcy is not a panacea for
airlines, and few have emerged from it.
While bankruptcy may not harm the financial health of the airline
industry, it has become a considerable concern for the federal
government and legacy airline employees and retirees because of the
recent terminations of pension plans by US Airways and United Airlines.
These terminations resulted in claims on PBGC's single-employer program
of $9.7 billion, and plan participants (employees, retirees, and
beneficiaries) are estimated to have lost more than $5.3 billion in
benefits that were not covered by PBGC. At termination in May 2005,
United's pension plans were underfunded by $9.8 billion; while the
plans promised $16.8 billion in benefits, they were backed by only $7
billion in assets. PBGC guaranteed $13.6 billion of the promised
benefits, resulting in a net claim on the agency of $6.6 billion and an
estimated loss of $3.2 billion in benefits to participants. The defined
benefit pension plans of the remaining legacy airlines with active
plans are underfunded by approximately $13.7 billion (according to data
from SEC), raising the potential for additional sizeable losses to PBGC
and plan participants. Since Delta and Northwest declared bankruptcy on
September 14, 2005, PBGC released estimates stating that their plans
are underfunded by a combined total of $16.3 billion on a termination
basis, of which PBGC estimates it would be liable for $11.2 billion.
Legacy airlines face an estimated minimum of $10.4 billion in pension
contributions over the next 4 years, significantly more than some of
them may be able to afford given continued losses and their other fixed
obligations. If the remaining legacy airlines with defined benefit
plans were to spread their contributions over more years, as some
airlines have proposed, they would relieve some of the liquidity
pressure but would not necessarily stay out of bankruptcy because this
approach does not fully address their fundamental cost structure
problems.
In its written comments on a draft of this report, PBGC generally
agreed with our findings and conclusions. PBGC noted that the report
makes a strong case for pension funding reform, demonstrating the
possible consequences of the weak funding rules now in place. DOT did
not provide any written comments. Both PBGC and DOT provided technical
comments and suggestions that we incorporated as appropriate.
Background:
In 1978, under the Airline Deregulation Act, the United States
deregulated its domestic airline industry. The main purpose of
deregulation was to remove government control and open the air
transport industry to market forces. Previously, the Civil Aeronautics
Board regulated all domestic air transport, controlling fares and
setting routes. In this regulated market, airlines competed more
through advertising and onboard services than through fares. When the
industry was deregulated, "legacy" airlines carried over the cost
structures that had been protected by price regulation. Similar to
other highly regulated industries, the airline industry was heavily
unionized, with a highly trained and stable workforce. By contrast,
carriers that started operations after deregulation sought to attract
passengers from legacy network carriers and to stimulate new passenger
traffic--and did so--by offering lower fares. These airlines generally
paid less for labor, on a unit cost basis, which helped them keep their
overall operating costs low.[Footnote 4]
In August 2004, we reported on the financial condition of the airline
industry. High-end demand for air travel had begun weakening in 2000
because of an economic turndown, and demand dropped significantly
following the September 11, 2001, terrorist attacks; the war in Iraq;
and the outbreak of SARS.[Footnote 5] We found that in response to
changing market conditions, legacy airlines had reduced costs, but
mostly by reducing capacity and not nearly enough to be competitive
with low cost airlines. Low cost airlines experienced significant
growth and a fall in their unit costs as measured by cost per available
seat-mile (CASM), whereas legacy airlines' unit costs did not improve.
In addition, we found that neither legacy nor low cost airlines
possessed much pricing power and suffered declining unit revenue. As a
result of their weak financial performance and mounting losses, legacy
airlines saw their financial liquidity and solvency seriously
deteriorate even as their debt and pension obligations mounted. Since
our 2004 report was issued, losses have continued to mount for airlines
even though traffic levels have returned to pre-9/11 levels. One of the
primary culprits has been record fuel prices, nearly doubling since
2003 (see fig. 1).
Figure 1: Average Annual Spot Price for Gulf Coast Jet Fuel, 1998-2005:
[See PDF for image]
Note: 2005 prices reflect average through August 16.
[End of figure]
Low fares have affected revenues for both legacy and low cost airlines.
Yields, the amount of revenue airlines collect for every mile a
passenger travels, fell for both low cost and legacy airlines from 2000
through 2004 (see fig. 2). However, the decline has been greater for
legacy airlines than for low cost airlines. Only during the first half
of 2005 has stronger demand allowed airlines to increase fares
sufficiently to boost their yields.
Figure 2: Percentage Change in Passenger Yields Since 2000:
[See PDF for image]
[End of figure]
Legacy airlines, as a group, have been unsuccessful in reducing their
costs to become more competitive with low cost airlines. Unit-cost
competitiveness is essential to profitability for airlines after years
of declining yields. While legacy airlines have been able to reduce
their overall costs since 2001, they have done so largely by reducing
capacity and without improving their unit costs as compared to low cost
airlines. Meanwhile, low cost airlines have been able to maintain low
unit costs by continuing to grow and maintaining high productivity. As
a result, low cost airlines have been able to sustain a unit-cost
advantage over their legacy rivals (see fig. 3). In 2004, low cost
airlines maintained a 2.7 cent advantage per available seat mile over
legacy airlines. This advantage is attributable to lower overall costs
and greater labor and asset productivity. Thus far in 2005, airlines
have been able to trim most of their nonfuel-related costs, but high
fuel prices and debt interest charges have kept airlines' costs from
falling.
Figure 3: Difference in Unit Costs between Legacy and Low Cost
Airlines, 1998-2004:
[See PDF for image]
Note: "Other" costs include costs of aircraft, supplies, and
facilities.
[End of figure]
Weak revenues and the inability to realize greater unit-cost savings
have combined to produce unprecedented losses for legacy airlines. At
the same time, low cost airlines have been able to continue producing
modest profits (see fig. 4). Legacy airlines have incurred a cumulative
$28 billion in operating losses since 2001. Despite a modest recovery
for some airlines during the first half of 2005, analysts predict the
industry will lose another $5 billion to $9 billion in 2005.
Figure 4: Airline Operating Profits and Losses, 1998-2004:
[See PDF for image]
[End of figure]
Owing to continued losses, legacy airlines built cash balances not
through operations but by borrowing. Legacy airlines have lost cash
from operations and compensated for operating losses by taking on
additional debt, relying on creditors for more of their capital needs
than in the past. In doing so, several legacy airlines have used all,
or nearly all, of their assets as collateral, potentially limiting
their future access to capital markets.
Airlines (and other businesses) that are unable to operate profitably
over time may seek recourse under the U.S. Bankruptcy Code.[Footnote 6]
In general, two major provisions of the bankruptcy code govern actions
taken by airlines and other businesses:
* Chapter 7 of the code governs liquidation of the debtor's estate and
is often referred to as a "straight bankruptcy." A trustee is appointed
to sell off available assets to repay creditors.
* Chapter 11 of the code governs business reorganizations. This chapter
is designed to accommodate complicated reorganizations of publicly held
corporations. Among other things, it allows companies, with court
approval, to reject agreements made under collective bargaining and
renegotiate contracts with other creditors. With the approval of the
bankruptcy courts (which administer the bankruptcy laws), companies may
also modify retiree benefits.
Airline bankruptcies[Footnote 7] typically include a large number of
stakeholders. The primary stakeholder is the airline itself, known as
the debtor-in-possession. Federal stakeholders include the bankruptcy
judge, who presides over the administration of the case and decides
contested aspects, and the U.S. Trustee,[Footnote 8] whose duties
include ensuring the integrity of the process and approving the
retention of professionals (e.g., bankruptcy attorneys).[Footnote 9]
During this most recent round of airline bankruptcies, two additional
governmental entities have become major stakeholders in airline
bankruptcies: the Air Transportation Stabilization Board (ATSB), which
was formed after September 11 to administer a $10 billion loan
guarantee program for airlines, and PBGC, which insures defined benefit
pension plans. Both agencies have taken ownership stakes in bankrupt
and nonbankrupt airlines through ATSB's loan guarantees and PBGC's
taking over defined benefit pension plans terminated in
bankruptcy.[Footnote 10] The entities that provide the financing while
an airline is in bankruptcy (known as debtor-in-possession financing)
and upon its exit (exit financing) are also major stakeholders, as are
airline employees, many of whom are represented by labor
unions.[Footnote 11] Other secured and nonsecured creditors and
shareholders are also stakeholders in an airline bankruptcy. The
interests of unsecured creditors (including labor) and shareholders are
represented in the process by committees appointed by the U.S. Trustee.
Among the largest cost elements for both legacy airlines and low cost
airlines are those associated with employee compensation and benefits.
As part of the retirement benefits offered, legacy airlines have tended
to offer "defined benefit plans" and supplemental defined contribution
plans, whereas low cost airlines tend to provide only "defined
contribution plans."
* Defined benefit plans typically provide participants with an annuity
at retirement--a series of periodic payments over a specified period of
time or for the life of the participant. As designed, defined benefit
plan annuities are generally based on a participant's retirement age,
number of years of employment, and salary. As of December 31, 2004,
nine major airlines sponsored defined benefit plans for their
employees: Aloha, Alaska, American, Continental, Delta, Hawaii,
Northwest, US Airways, and United. These airlines generally offered
different pension plans for different groups of employees--pilots,
machinists, and flight attendants, for example--with varying levels of
promised benefits.
* Defined contribution plans base pension benefits on the contributions
to and investment returns on individual accounts. Contributions may
consist of pretax or after-tax employee contributions, employer
matching contributions that require employee contributions, and other
employer contributions that may be made independent of any participant
contributions. In a defined contribution plan, the employee bears the
investment risk and often controls how the individual account assets
are invested.
PBGC was established to encourage the continuation and maintenance of
voluntary private pension plans and to insure the benefits of workers
and retirees in defined benefit plans should plan sponsors fail to pay
benefits.[Footnote 12] However, if a pension plan's assets are
insufficient to pay accrued benefits, the plan can be terminated under
certain conditions, and PBGC then assumes responsibility for paying
retiree pensions. PBGC may pay only a portion of the benefits
originally promised to employees and retirees. For 2005, the maximum
statutory limit of annual benefits guaranteed by PBGC is $45,613.68 per
participant, for retirement at age 65. The amount paid decreases at
earlier retirement ages.
Bankruptcy Is a Response to the Airline Industry's Structural
Challenges:
Bankruptcy filings are prevalent in the U.S. airline industry because
of long-standing economic structural issues that have led to
historically weak financial performance for the industry. Structurally,
the airline industry is characterized by high fixed costs, cyclical
demand for its services, intense competition, and vulnerability to
external shocks. As a result, airlines have been more prone to failure
than many other businesses, and the sector's financial performance has
continually been very weak. Airlines frequently seek bankruptcy
protection because of severe liquidity pressures, but while bankruptcy
may provide some immediate protection from creditors, airlines in
bankruptcy have not always been able to reduce their costs or avoid
liquidation. Owing to the long history of airline bankruptcies, the
process is well developed, and the code includes provisions applicable
just to airline bankruptcies. Even so, the process can be lengthy and
contentious--for example, United is in its third year of bankruptcy,
and its process to date has included litigation over aircraft
repossessions as well as employee pensions.
Bankruptcies Are Endemic to the Airline Industry, and Airlines Fail at
a Higher Rate Than Most Other Industries:
Since the 1978 economic deregulation of the U.S. airline industry,
airline bankruptcy filings have become prevalent in the United States,
and airlines fail at a higher rate than companies in most other
industries. This has been particularly true for small, new entrant
carriers. Since 1978, there have been 162 airline bankruptcy filings in
the United States, 22 of them since 2000.[Footnote 13] Most of these
bankruptcies were chapter 11 filings by small, new-entrant airlines
that eventually liquidated. Only 24 of the filings were by airlines
with over $100 million in assets; however, 12 of these large
bankruptcies were filed after 2000 (see table 1).
Table 1: Airline Bankruptcy Filings Since 2000:
Filing date: 2/29/2000;
Airline: Tower Air; [A]
Chapter filed: 11;
Outcome: Ceased operations.
Filing date: 5/1/2000;
Airline: Kitty Hawk; [A]
Chapter filed: 11;
Outcome: Emerged from bankruptcy.
Filing date: 9/19/2000;
Airline: Pro Air;
Chapter filed: 11;
Outcome: Ceased operations.
Filing date: 9/27/2000;
Airline: Fine Air Services; [A]
Chapter filed: 11;
Outcome: Emerged from bankruptcy.
Filing date: 12/3/2000;
Airline: Legend Airlines;
Chapter filed: 11;
Outcome: Ceased operations.
Filing date: 12/6/2000;
Airline: National Airlines;
Chapter filed: 11;
Outcome: Ceased operations.
Filing date: 8/13/2001;
Airline: Midway Airlines; [A]
Chapter filed: 11;
Outcome: Ceased operations in 2002 before filing for chapter 7 in 2003.
Filing date: 11/10/2001;
Airline: Trans World Airlines; [A]
Chapter filed: 11;
Outcome: Acquired by American Airlines.
Filing date: 1/2/2002;
Airline: Sun Country Airlines;
Chapter filed: 7;
Outcome: Liquidated; new owners acquired assets and resumed operations.
Filing date: 7/30/2002;
Airline: Vanguard Airlines;
Chapter filed: 11;
Outcome: Ceased operations.
Filing date: 8/11/2002;
Airline: US Airways; [A]
Chapter filed: 11;
Outcome: Emerged but later refiled.
Filing date: 12/9/2002;
Airline: United Airlines; [A]
Chapter filed: 11;
Outcome: Still in bankruptcy.
Filing date: 3/21/2003;
Airline: Hawaiian Airlines; [A]
Chapter filed: 11;
Outcome: Emerged from bankruptcy.
Filing date: 10/30/2003;
Airline: Midway Airlines;
Chapter filed: 7;
Outcome: Ceased operations.
Filing date: 1/23/2004;
Airline: Great Plains Airlines;
Chapter filed: 11;
Outcome: Ceased operations.
Filing date: 1/30/2004;
Airline: Atlas Air/Polar Air Cargo;
Chapter filed: 11;
Outcome: Emerged from bankruptcy.
Filing date: 9/12/2004;
Airline: US Airways; [A]
Chapter filed: 11;
Outcome: Merged with America West.
Filing date: 10/26/2004;
Airline: ATA Airlines; [A]
Chapter filed: 11;
Outcome: Still in bankruptcy.
Filing date: 12/01/2004;
Airline: Southeast Airlines;
Chapter filed: 7;
Outcome: Ceased operations.
Filing date: 12/30/2004;
Airline: Aloha Airlines;
Chapter filed: 11;
Outcome: Still in bankruptcy.
Filing date: 9/14/2005;
Airline: Delta Air Lines; [A]
Chapter filed: 11;
Outcome: Still in bankruptcy.
Filing date: 9/14/2005;
Airline: Northwest Airlines; [A]
Chapter filed: 11;
Outcome: Still in bankruptcy.
Sources: Air Transport Association, Department of Transportation, Lynn
M. LoPucki's Bankruptcy Research Database, and media reports.
[A] Indicates airlines with over $100 million in assets.
[End of table]
Airline Bankruptcies Are the Result of Long-Standing Structural Issues
and Weak Financial Performance:
Because of certain structural characteristics, including its
susceptibility to external shocks and historically weak financial
performance, the airline industry is more prone to failure than many
other types of businesses. Airlines have high fixed costs and are
subject to highly cyclical demand and intense competition. Compounding
these other structural problems is the industry's vulnerability to
external shocks--such as terrorist attacks or war--that decrease demand
and increase costs. The result is that the airline industry has had the
worst financial performance of any major industry.
Structural Issues Hinder the Airline Industry:
Structural characteristics of the airline industry have resulted in
repeated cycles of boom and bust as its high fixed costs and particular
sensitivity to seasonal and business cycle changes strain declining
revenues. External shocks such as the Iraq War and the SARS epidemic
have exacerbated the situation. Operating an airline requires expensive
equipment and facilities as well as large numbers of people to operate
them. Aircraft are very expensive--for example, the 2005 list price for
a Boeing 777 ranges from $171 million to $253 million--and, therefore,
airlines use outside financing to acquire a fleet. In the United
States, airlines typically use operating leases, loans, or public
financing instruments to fund their aircraft. Servicing these leases or
debt instruments requires considerable and regular cash payments
regardless of how extensively the aircraft are used. Airlines also rely
on specialists like pilots and mechanics who cannot be easily replaced,
making labor force adjustments to changes in demand more difficult. In
addition, the workers of many carriers, particularly those of the
legacy carriers, are covered by multiyear collective bargaining
agreements. While such agreements may provide important protections to
employees, they may limit carriers' ability to respond quickly to
cyclical changes in demand, much less unanticipated shocks like the
September 11 attacks or SARS. Together, these characteristics result in
long-term high fixed costs for an industry whose fortunes fluctuate
with the business cycle.
The airline industry is very competitive and has become increasingly so
with the emergence of low cost airlines and the relative ease with
which new airlines gain access to capital and enter the industry. It is
difficult for airlines to reduce their capacity because of the high
fixed costs and low variable costs of providing service. Capacity
increases by individual airlines are frequently matched by competitors.
Low cost airlines grew over the last 5 years, from 10.8 percent of
domestic capacity in 1998 to 17.5 percent of domestic capacity in 2004.
Low cost airlines have been able to maintain their low costs by
continuing to grow. Finally, despite historic losses in the industry,
new airlines are still willing to enter the market. As of July 2005,
seven carriers were obtaining operating certificates, while at least
one other had obtained its operating certificate but was not yet
operating. It is uncertain if and when these carriers will actually
begin service. These carriers plan to provide domestic and
international scheduled and charter service.[Footnote 14] These new
airlines are indicative of the willingness of capital providers to
finance aircraft despite the industry's continued losses.
Demand for air travel is closely tied to the business cycle and is
subject to external shocks. So while airlines' most prominent costs--
for aircraft and labor--are locked into fixed payments and multiyear
contracts, airline revenues fluctuate because demand is cyclical.
External demand shocks can have a devastating impact on airline
finances. For example, beginning in 2000, an economic downturn
precipitated a decrease in high-end demand for air travel, while the
terrorist attacks of September 11, the Iraq War, and the outbreak of
SARS compounded that trend. These events contributed to the 22 airline
bankruptcy filings since 2000.
The Airline Industry's Financial Performance Has Historically Been
Poor:
The structural issues discussed in the previous section have
contributed to the airline industry's historically poor financial
performance and higher-than-average industry failure rate. This
performance is illustrated by the industry's weak revenues and lack of
profitability. In particular, legacy airlines in aggregate have
experienced operating losses in all quarters but one since September
11, 2001. A return to profitability that some financial analysts
expected for legacy airlines in 2004 and 2005 has not materialized, in
large part because of historically high oil prices.
One way to measure the inherent instability of the airline industry is
to compare its operating ratio with that of other industries. The
operating ratio is the ratio of a company's operating expenses to its
operating revenues. One study found that from 1983 through 2001, the
airline industry had the highest risk in relation to return of any
industry sector when measured using this ratio.[Footnote 15] This study
found that the airline industry had an operating ratio of 97 percent,
well above the average of 83.5 percent for all other industries.
Evidence of the volatility and weak financial performance of the
airline industry can also be found by comparing airline failure rates
with overall U.S. business failure rates. For 1997, the last year in
which Dun & Bradstreet produced these data, the overall U.S. business
failure rate was 0.9 percent, while the failure rate for the airline
industry was three times greater, at 2.9 percent. Although we do not
have overall business failure rates for more recent years, there is no
reason to believe that the disparity between the rates has changed
significantly since 1997 (see fig. 5).
Figure 5: Comparison of Airline and Overall Business Failure Rates,
1984-1997:
[See PDF for image]
Note: Dun & Bradstreet data were available only through 1997.
[End of figure]
Airlines Seek Bankruptcy as a Means to Restructure, but Are Not Always
Successful in Reducing Costs:
Bankruptcy has played a prominent role in the U.S. airline industry
since deregulation because many carriers have used the bankruptcy code
in an effort to restructure their operations and cut costs--by, for
example, terminating defined pension benefit plans and rejecting high-
cost aircraft leases. These carriers have met with varying degrees of
success. Prominent examples include US Airways, which has entered
chapter 11 twice since 2002 and has merged with America West Airlines,
which itself went through bankruptcy 11 years before; United Airlines,
which is hoping to emerge from bankruptcy in 2006 after more than 3
years in bankruptcy; and TWA, which entered bankruptcy three times
before its assets were eventually acquired by American Airlines in
2001.
Generally, major airlines have been able to reduce their costs during
bankruptcy. Reductions in operating expenses were generally achieved
through reductions in wages and in capacity. In eight of the nine
largest airline bankruptcies over the last 25 years, operating expenses
and capacity were reduced (see table 2).[Footnote 16] The exception was
the first Continental Airlines bankruptcy, when the airline's capacity
doubled but expenses rose by only one-third. Typically, cost savings
were achieved disproportionately by cutting wages--in six of the nine
cases, reductions in wages were greater than the overall reduction in
operating expenses. Most critically, however, unit costs were reduced
in only five of the nine cases, and in two cases (TWA 1 and US Airways
1) unit costs went up and by more than the industry average, perhaps
explaining why those airlines filed for bankruptcy again within 2
years.
Table 2: Cost Reductions Achieved during Major Airline Bankruptcies:
Airline bankruptcy: Continental 1;
Date: Entered: 9/24/83;
Date: Emerged: 6/30/86;
Change in wages: Airline: 1%;
Change in wages: Industry: 18%;
Change in operating expense: Airline: 31%;
Change in operating expense: Industry: 16%;
Change in capacity (ASM)[A]: Airline: 103%;
Change in capacity (ASM)[A]: Industry: 30%;
Change in unit costs (CASM)[B]: Airline: -35%;
Change in unit costs (CASM)[B]: Industry: -11%.
Airline bankruptcy: Eastern;
Date: Entered: 3/9/89;
Date: Emerged: Failed[C];
Change in wages: Airline: -34%;
Change in wages: Industry: 19%;
Change in operating expense: Airline: -17%;
Change in operating expense: Industry: 34%;
Change in capacity (ASM)[A]: Airline: -9%;
Change in capacity (ASM)[A]: Industry: 13%;
Change in unit costs (CASM)[B]: Airline: -9%;
Change in unit costs (CASM)[B]: Industry: 19%.
Airline bankruptcy: Continental 2;
Date: Entered: 12/3/90;
Date: Emerged: 4/27/93;
Change in wages: Airline: -1%;
Change in wages: Industry: 2%;
Change in operating expense: Airline: - 20%;
Change in operating expense: Industry: -4%;
Change in capacity (ASM)[A]: Airline: -3%;
Change in capacity (ASM)[A]: Industry: 9%;
Change in unit costs (CASM)[B]: Airline: -18%;
Change in unit costs (CASM)[B]: Industry: -12%.
Airline bankruptcy: America West;
Date: Entered: 6/27/91;
Date: Emerged: 8/25/94;
Change in wages: Airline: -23%;
Change in wages: Industry: 9%;
Change in operating expense: Airline: - 20%;
Change in operating expense: Industry: 10%;
Change in capacity (ASM)[A]: Airline: -12%;
Change in capacity (ASM)[A]: Industry: 9%;
Change in unit costs (CASM)[B]: Airline: -9%;
Change in unit costs (CASM)[B]: Industry: 1%.
Airline bankruptcy: TWA 1;
Date: Entered: 1/31/92;
Date: Emerged: 11/3/93;
Change in wages: Airline: -23%;
Change in wages: Industry: 2%;
Change in operating expense: Airline: -18%;
Change in operating expense: Industry: 2%;
Change in capacity (ASM)[A]: Airline: -22%;
Change in capacity (ASM)[A]: Industry: 1%;
Change in unit costs (CASM)[B]: Airline: 5%;
Change in unit costs (CASM)[B]: Industry: 1%.
Airline bankruptcy: TWA 2;
Date: Entered: 6/30/95;
Date: Emerged: 8/23/95;
Change in wages: Airline: -22%;
Change in wages: Industry: 2%;
Change in operating expense: Airline: -11%;
Change in operating expense: Industry: 2%;
Change in capacity (ASM)[A]: Airline: -10%;
Change in capacity (ASM)[A]: Industry: -5%;
Change in unit costs (CASM)[B]: Airline: 0%;
Change in unit costs (CASM)[B]: Industry: 7%.
Airline bankruptcy: US Airways 1;
Date: Entered: 8/11/02;
Date: Emerged: 3/31/03;
Change in wages: Airline: -2%;
Change in wages: Industry: -13%;
Change in operating expense: Airline: - 3%;
Change in operating expense: Industry: -7%;
Change in capacity (ASM)[A]: Airline: -13%;
Change in capacity (ASM)[A]: Industry: -10%;
Change in unit costs (CASM)[B]: Airline: 12%;
Change in unit costs (CASM)[B]: Industry: 4%.
Airline bankruptcy: United Airlines;
Date: Entered: 12/9/02;
Date: Emerged: Current[D];
Change in wages: Airline: -45%;
Change in wages: Industry: -19%;
Change in operating expense: Airline: - 7%;
Change in operating expense: Industry: 14%;
Change in capacity (ASM)[A]: Airline: -7%;
Change in capacity (ASM)[A]: Industry: 4%;
Change in unit costs (CASM)[B]: Airline: 0%;
Change in unit costs (CASM)[B]: Industry: 10%.
Airline bankruptcy: US Airways 2;
Date: Entered: 9/12/04;
Date: Emerged: Current[D];
Change in wages: Airline: -23%;
Change in wages: Industry: -8%;
Change in operating expense: Airline: -7%;
Change in operating expense: Industry: 0%;
Change in capacity (ASM)[A]: Airline: -3%;
Change in capacity (ASM)[A]: Industry: -5%;
Change in unit costs (CASM)[B]: Airline: -5%;
Change in unit costs (CASM)[B]: Industry: 6%.
Source: GAO analysis of Department of Transportation data.
[A] ASM = available seat mile.
[B] CASM = cost per available seat mile.
[C] Change measured through fourth quarter of 1990, the last quarter
for which data were reported.
[D] Change measured through first quarter of 2005.
[End of table]
The Airline Bankruptcy Process Is Well Developed and Understood:
Most airlines file to reorganize their operations and finances under
chapter 11 of the bankruptcy code, some sections of which will change
under the new bankruptcy law that comes into effect in October 2005.
Given the number of airline bankruptcies that have occurred over the
last 20 years, the process is well developed and understood by those
involved, but it can still be quite contentious.
Airlines Typically File for Chapter 11 Reorganization:
Most U.S. airlines that are in financial distress and choose to file
for bankruptcy protection file under chapter 11 of the U.S. bankruptcy
code. Chapter 11 provides protection from creditors and allows a
company to reorganize itself and become profitable again. Management--
as the debtor-in-possession--continues to run the airline, but all
significant decisions must be approved by the bankruptcy court. In a
chapter 7 filing, the airline stops all operations and a trustee is
appointed to sell the assets to pay off the debt. According to SEC,
most publicly held companies will file under chapter 11 rather than
chapter 7 because they can still run their business and control the
bankruptcy process. For airlines, 148 of the 162 bankruptcy filings
since 1978 were chapter 11 filings.
Several sections of the bankruptcy code have played a prominent role in
airline bankruptcies. Section 362--the automatic stay provision--gives
an airline breathing room from its creditors by stopping all collection
efforts and foreclosure actions and permitting the debtor to attempt to
develop a repayment plan.[Footnote 17] Under section 1121, the
airline's management--or the private trustee if one has been appointed-
-currently has the exclusive right to file a reorganization plan for
120 days following the filing of the bankruptcy petition; this period
may be extended for cause. Other parties-in-interest may file a plan if
120 days have elapsed without the debtor's filing a plan or if 180 days
have elapsed and the debtor's plan has not been accepted by each class
of creditors. This period may also be extended for cause. Other
sections of the code govern actions an airline might take to
restructure its operations and lower its costs in order to emerge from
bankruptcy. For example, section 1113 governs the rejection of labor
contracts and requires that the airline complete certain steps before
requesting that the court abrogate contracts. Section 1110 gives an
airline 60 days to accept or reject aircraft leases, which allows the
airline to continue to operate without fear that its chief assets will
be repossessed. Additionally, several subsections of section 365
currently relate to airline leases of aircraft terminals and gates. For
example, an airline that leases more than one terminal or gate may not
assume or assign the leases unless it assumes or assigns all of them to
the same entity, which limits the ability of an airline to realize the
full value of its leases. To emerge from bankruptcy, the airline
devises and obtains approval of a reorganization plan from the
bankruptcy court and obtains exit financing, which is used to operate
the company once it is no longer within the jurisdiction of the
bankruptcy court.
Airline Bankruptcies Follow a Well-Practiced but at Times Disputed
Process:
The airline bankruptcy process has been honed over the past 27 years as
carriers, large and small, have built on prior experiences and
expertise. We interviewed numerous industry experts (attorneys,
consultants, analysts, and current and former airline officials), many
of whom have had experience in more than one airline bankruptcy.
Additionally, several of these experts confirmed that the case law and
documents produced by each bankruptcy case provide a body of expertise
available for subsequent filers. They indicated that this documentation
serves as precedent that is useful even though each bankruptcy case is
unique.
The process can also be contentious as the various stakeholders compete
for their share of a dwindling pie. In recent airline bankruptcies,
labor groups have disputed airlines' right to cancel collective
bargaining agreements and terminate defined benefit pension plans while
airlines have challenged creditors. For example, United Airlines has
been involved in litigation with its flight attendants over its
termination of their pension plan and with a group of aircraft lessors
over their aircraft repossessions during its current bankruptcy.
Changes under New Bankruptcy Law Might Affect Future Airline Filings:
On October 17, 2005, the first major overhaul of the nation's
bankruptcy laws in 9 years will become effective. Many provisions of
the Bankruptcy Abuse Prevention and Consumer Protection Act of
2005[Footnote 18] apply to consumer bankruptcies, but several important
provisions apply to corporate bankruptcies. Some of these provisions
may induce distressed airlines to seek bankruptcy before the new law
takes effect while other provisions may provide more advantages to
airlines in bankruptcy. The mid-September Delta and Northwest
bankruptcy filings may be an indication that these carriers were
seeking to avoid some portions of the new bankruptcy law.
First, the 2005 law limits the "exclusivity period" for the debtor to
file a reorganization plan to 18 months after the bankruptcy filing.
Currently, the debtor has the first 120 days to file a plan, and can
obtain numerous extensions. The new limit will not force liquidations
but will give other parties an opportunity to file a competing plan
somewhat sooner, thereby limiting the debtor's "exclusive period" of
control of the business. One bankruptcy expert we spoke with indicated
that this change would not affect the majority of business
bankruptcies, since most are concluded within 180 days. However,
because airline bankruptcies tend to take longer than those in many
other industries, this change may induce airlines considering
bankruptcy to file before October 17, 2005.
Second, the new law eliminated two subsections of the code--365(c)(4)
and 365(d)(5)-(9)--that limited bankrupt airlines' options when
assuming or assigning terminal and gate leases. This change in the law
will favor airlines that control gates and leases, because they will
have the potential to realize greater value from these assets when in
bankruptcy.
Third, the 2005 act increases the time limits on assuming or rejecting
unexpired commercial and real property leases but limits extensions.
Under the current code, the debtor has 60 days from the commencement of
the case to assume or reject commercial real property leases, and this
time is often extended by the bankruptcy court. The 2005 act increases
the initial decision period to 120 days but allows for only one
extension (of up to 90 days) after that. Therefore, debtors will have a
maximum of 210 days from the commencement of the bankruptcy case to
make a decision on these leases. The court may grant a subsequent
extension only upon prior written consent of the lessors in each
instance.
In addition, the new law expands the grounds on which a chapter 11 case
may be converted to chapter 7 and increases the circumstances under
which a chapter 11 trustee may be appointed. The act also encourages
fast-track chapter 11 cases by making it easier for debtors to
implement prearranged plans. Finally, the new law regulates the
circumstances for approval of key employee retention plans and related
severance payments by requiring that (1) the debtor establish that the
bonus is essential to retain the employee, (2) the employee have a bona
fide job offer, and (3) the debtor prove that the employee's services
are essential to the survival of the company. Additionally, these
bonuses and severance packages are linked to those that are paid to
nonmanagement employees. This provision also might induce pre-October
17, 2005, airline bankruptcy filings.
Airline Bankruptcies Can Differ Significantly from Bankruptcies in
Other Industries:
Airline bankruptcies can differ notably from bankruptcies in other
industries along a number of dimensions. However, it is hard to
determine whether the differences are directly attributable to the
unique sections of the bankruptcy code specific to airlines or are the
result of factors unique to the airline industry.
Airline bankruptcies can take a long time to resolve. According to our
analysis of the Bankruptcy Research Database,[Footnote 19] airline
bankruptcies ranked fifth in overall duration (averaging 714 days),
behind bankruptcies in such industries as water transportation and
petroleum refining, and lasted significantly longer than the average
for bankruptcies in all of the industries in the database, which was
518 days. (See fig. 6).
Figure 6: Average Duration of Bankruptcies, by Industry, 1980-2004:
[See PDF for image]
[End of figure]
Airlines in bankruptcy also appeared to retain assets better than other
industries, but at the cost of much greater debt; however, a limited
number of observations precludes firm conclusions. According to
available data for 19 of the top 50 bankruptcies since 1970,[Footnote
20] which involved 3 airlines and 16 other companies, the airlines'
assets were 0.8 percent lower on average after bankruptcy, while the
other companies' assets were 47.2 percent lower on average. At the same
time, the airlines' liabilities decreased 32.1 percent while the
liabilities of companies in the other industries decreased 56.9
percent.
Outcomes also differed for airline and other industry bankruptcies,
according to Bankruptcy Research Database. The airlines were more
likely than the other industries in our analysis to liquidate. (See
fig. 7.) However, airlines are also more likely than other industries
to start bankruptcy in chapter 11, which may account for their greater
tendency to liquidate once in chapter 11. For each group, a majority of
the companies had reorganization plans confirmed by the court (i.e.,
the companies had exited or emerged from bankruptcy), though for
airlines this majority was smaller because of the larger percentage of
liquidations.
Figure 7: Comparison of Airlines' and Other Industries' Bankruptcy
Outcomes, 1980-2004:
[See PDF for image]
Note: "Company liquidated" means that the company sold its assets
either in chapter 11 or chapter 7; "plan confirmed" means that the
company obtained approved of a reorganization plan from the bankruptcy
court; "case dismissed" means that the bankruptcy case was rejected by
the bankruptcy court; and "case pending" means that the case is still
in progress.
[End of figure]
Our analysis of the Bankruptcy Research Database also revealed no
discernable difference between airlines' and other industries'
likelihood of reentering bankruptcy within 5 years. The rates at which
airlines and other industries filed again for bankruptcy were just
under 15 percent. However, these rates should be accepted with some
caution and perhaps viewed as conservative because the database
captured only refilings that occurred within 5 years and excluded
companies with assets of less than $100 million.[Footnote 21] As a
result, filings by companies not meeting one or the other criterion
were not counted.
No Evidence That Bankruptcy Protection Harms the Industry or Hurts
Competitors:
There is no clear evidence that airlines in bankruptcy are harming the
industry or their rivals or that bankruptcy is a panacea for airlines
seeking an easy path to profitability. Some have asserted that
protecting airlines in bankruptcy, rather than forcing liquidation,
contributes to overcapacity in the industry. They further contend that
bankrupt airlines underprice their rivals, hurting the financial well-
being of healthier competitors. We found no evidence to support either
contention and some evidence to the contrary. For example, despite many
airline liquidations since deregulation in 1978, some of which were
quite large, industry capacity has continued to grow unabated thanks to
the growth of existing airlines and new entrants, often using the just-
liquidated airline's planes. We also found that capacity rebounded
quickly in individual markets that experienced the liquidation or
retreat of a significant airline, as other carriers quickly expanded
capacity to compensate with little or no increase in overall average
fares. Several studies have also found that airlines in bankruptcy have
not reduced fares and did not harm rival airlines financially.
Bankruptcies are not a panacea for airlines, as some might believe.
Bankruptcy entails significant costs, loss of management control, and
damaged relations with employees, investors, and suppliers. Of the 162
airlines that have filed for bankruptcy, 142 (88 percent) are no longer
in operation.
No Evidence That Bankruptcy Protection Contributes to Overcapacity or
Lower Fares:
Contrary to some assertions, we found no evidence that bankruptcy
protection has led to overcapacity and lower fares that have harmed
healthy airlines, either in individual markets or in the industry
overall. In 1993, a national commission to study airline industry
problems cited bankruptcy protection as a cause for the industry's
overcapacity and fare problems.[Footnote 22] Airline executives have
also cited bankruptcy protection as a reason for industry overcapacity
and low fares. However, we found no evidence to support these views and
some evidence to the contrary. Notably, both in individual markets and
industrywide, the liquidation of major airlines has had only a very
temporary or negligible effect on capacity, as other airlines have
quickly replenished capacity. In part, this short-term effect can be
attributed to the fungibility of aircraft and the notion that industry
capacity is determined by the entire aviation supply chain and not
solely by individual airlines. Finally, separate academic studies have
found that airlines in bankruptcy have not lowered their fares or
harmed the financial standing of their rivals.
Both a national commission and airline executives have asserted, but
without specific evidence, that bankruptcy protection allows airlines
to avoid liquidation, thus contributing to industry overcapacity and
underpricing that harms bankrupt carriers' rivals. According to a 1993
report by the National Commission to Ensure a Strong Competitive
Airline Industry, one of the causes of the industry's financial
problems was bankrupt airlines. Industry executives and some
publications have gone further, stating that bankrupt airlines damage
the entire industry.[Footnote 23] For example, a former Chairman of
American Airlines asserted that bankrupt airlines contribute to
industry overcapacity and are able to underprice rivals by virtue of
their bankruptcy protection. However, very little evidence has been
cited in any of these claims. In 1993, we testified that claims and
counterclaims concerning the underpricing of bankrupt airlines had not
been substantiated or considered in a larger context.[Footnote 24]
There is little evidence that bankruptcy protection has contributed to
industry overcapacity, at least in the long term. If it did, then some
evidence that liquidation permanently removes capacity from the market
should also exist. All indications are that this has not occurred. For
example, industry capacity, as measured by available seat miles (ASM),
grew two and one-half times from 1978 through 2004. Growth has slowed
or declined just before and during recessions, but not as a result of
large airline liquidations (see fig. 8).
Figure 8: Growth of Airline Industry Capacity and Major Airline
Liquidations:
[See PDF for image]
Note: Figure does not show liquidations of smaller airlines.
[End of figure]
Capacity has continued to grow despite liquidations for a variety of
reasons, including the fungibility of aircraft and the ease of entry,
but ultimately capacity in any industry can be traced to the flow of
capital into and out of the industry. For the airline industry, in
which the chief asset (aircraft) is easily resold (fungible) and
heavily leveraged, capital flows have supported the continued expansion
of capacity even during industry downturns. Except for government
subsidies to airlines or manufacturers, capital would flow to airlines
only if the providers of that capital received a return on their
investments. Evidence suggests that capital providers have profited and
helps explain why airlines in bankruptcy continue to receive
substantial capital support from other members of the value chain.
Experts have espoused the notion of the value chain in understanding
the role of companies in an industry.[Footnote 25] In the airline
industry, the value chain includes aircraft and engine manufacturers,
such as Boeing, General Electric, and Airbus; lessors, such as GE
Commercial Aviation Service and International Lease Finance
Corporation; global ticket distribution systems, like Sabre and
Worldspan; credit card companies; airports; suppliers; and others.
There is considerable evidence that these other members of the value
chain have earned a good return on capital while airlines have not (see
figs. 9 and 10). Those companies further up the value chain face less
competition and are able to impose higher costs on airlines.
Accordingly, these companies have a vested interest in ensuring that
airlines survive and that capacity not leave the industry.
Figure 9: Return on Capital Invested, 1992-1996:
[See PDF for image]
[End of figure]
Figure 10: Operating Profits, 2000-2001:
[See PDF for image]
[End of figure]
Data from sources of financing to airlines that are in bankruptcy or
financial trouble provide some evidence of the vested interests of
value chain members in keeping troubled airlines alive. Table 3 lists
some of the major injections of capital into airlines since 2004.
Table 3: Recent Examples of Airline Financing:
Dollars in millions.
US Airways;
Amount: $740;
Year: 2002;
Sources: Retirement Systems of Alabama.
Delta;
Amount: $1,100;
Year: 2004;
Sources: American Express, GE Commercial Aviation Services.
US Airways;
Amount: $140;
Year: 2004;
Sources: GE Commercial Aviation Services.
Independence Air;
Amount: $20;
Year: 2005;
Sources: GE Commercial Aviation Services;
Amount: $60;
Year: 2005;
Sources: Airbus.
US Airways/America West merger;
Amount: 1,500;
Year: 2005;
Sources: Regional airline, Airbus, hedge funds, credit card companies.
Hawaiian;
Amount: $60;
Year: 2005;
Sources: RC Aviation.
Source: Airline and media reports.
[End of table]
Our research indicates that the departure or liquidation of a carrier
from a market does not necessarily lead to a long-term decline in local
traffic (i.e., that which originates at or is destined for the
particular airport) for that market. We contracted with InterVISTAS-
ga2, an aviation consultant, to examine traffic to and from six cities
that experienced the departure or significant withdrawal of service of
an airline (see table 4). In most cases, while total capacity and
passenger traffic decreased, the reduction was largely attributable to
the loss of connecting passenger traffic from the departing carrier.
There was little diminution in local passenger traffic for most of
these markets because other carriers increased their capacity to
replace the departing carrier's capacity. This research provides
further evidence that demand drives capacity and that the departure of
a carrier due to bankruptcy or a change in market strategy does not
lead to a long-term decline in capacity. Appendix II contains
additional detailed information on each case study.
Table 4: Case Examples of Markets' Response to Airline Withdrawals:
Market: Greensboro, NC;
Year: 1995;
Airline: Continental Lite dismantled service;
Effect on passenger traffic: Other airlines' traffic increased. Origin
and destination traffic decreased.
Market: Nashville, TN;
Year: 1995;
Airline: American Airlines eliminated hub;
Effect on passenger traffic: Other airlines' traffic increased. Origin
and destination traffic increased.
Market: Colorado Springs, CO;
Year: 1997;
Airline: Western Pacific moved operations to Denver;
Effect on passenger traffic: Other airlines' traffic decreased. Origin
and destination traffic decreased.
Market: St. Louis, MO;
Year: 2001;
Airline: TWA acquired by American Airlines;
Effect on passenger traffic: Other airlines' traffic decreased. Little
change in origin and destination traffic.
Market: Kansas City, MO;
Year: 2002;
Airline: Vanguard Airlines suspended service;
Effect on passenger traffic: Little change in other airlines' traffic.
Little change in origin and destination traffic.
Market: Columbus, OH;
Year: 2003;
Airline: America West eliminated hub;
Effect on passenger traffic: Other airlines' traffic increased. Little
change in origin and destination traffic.
Source: InterVISTAS-ga2 and Department of Transportation.
Note: "Little change" means that origin and destination traffic
increased or decreased less than 10 percent. Changes in passenger
traffic are measured from 4 quarters before to 8 quarters after the
airline's departure.
[End of table]
A major study of airline bankruptcies' effects on air service also
found that bankruptcy generally does not harm individual airline
markets. This April 2003 study examined all major chapter 11
bankruptcies from 1984 through 2001 to determine if and how they
affected air service.[Footnote 26] The study found that the effect of
bankruptcies on large and small airports was insubstantial and not
separable from normal fluctuations in air traffic. However, for medium-
sized airports, the study found the bankruptcy of an airline with a
significant share of flights reduced service by amounts that were
statistically significant.
Two major academic studies have found that airlines under bankruptcy
protection do not lower their fares or hurt competitor airlines, as
some have contended. A 1995 study found that an airline typically
reduces its fares somewhat before entering bankruptcy.[Footnote 27]
However, the study found that other airlines do not lower their fares
in response and, more important, do not lose passenger traffic to their
bankrupt rival and therefore are not harmed by the bankrupt airline.
Another study came to a similar conclusion in 2000, this time examining
the operating performance of 51 bankrupt firms, including 5
airlines.[Footnote 28] Rather than examine fares as did the 1995 study,
this study examined the operating and financial performance of bankrupt
firms and their rivals. The study found that the performance of a
bankrupt firm deteriorates before the firm files for bankruptcy and its
rivals' profits also decline during this period. However, once the firm
is in bankruptcy, its rivals' profits recover.
Bankruptcies Are Not a Panacea and Few Airlines Have Emerged
Successfully:
With very few exceptions, airlines that entered bankruptcy did not
emerge from it. Many of the advantages of bankruptcy stem from the
legal protection afforded the debtor airline from its creditors, but
this protection comes at a high cost in loss of control over airline
operations and damaged relations with employees, investors, and
suppliers.
Bankruptcy Involves Costs:
Bankruptcy involves many costs for airlines that file. The financial
costs include the consultant and legal fees of managing a lengthy
bankruptcy. For example, United, which filed for bankruptcy in December
2002, had spent nearly $260 million in legal fees as of June 2005. A
study of bankruptcy fees found that large companies generally spend an
average of 2.2 percent of their assets on legal fees while in
bankruptcy.[Footnote 29] The fees for United are high for a company of
its size, and they are rising as the company continues to operate under
chapter 11. These fees, thus far, make United's bankruptcy the seventh
most costly bankruptcy of all time. Bankruptcy also wipes out
shareholders' equity, which may mean significant losses for the
original owners, and leaves them without a financial interest in the
company. Finally, airlines in bankruptcy do not immediately receive all
the cash from credit card ticket sales because credit card companies
protect themselves against liquidation by withholding a large
percentage of receipts until travel is actually taken. For the cash-
flow-intensive airline business, this wait is difficult.
In addition to financial costs, there are many negative factors to be
considered by firms filing for bankruptcy. Notably, airline officials
told us, loss of control over the airline's operations can be
significant, because the courts must approve important changes, such as
sales of assets or significant changes in fare structures or schedules.
Rival airlines are able to learn of strategic changes well before they
may occur. There may also be damage to public and customer perceptions
of the airline. Finally, bankruptcy damages, sometimes permanently,
relations with employees if they are made to bear a significant portion
of the bankruptcy costs. In other cases, an airline may suffer a "brain
drain" when its most talented employees seek employment elsewhere.
Very Few Airlines Have Emerged Successfully from Bankruptcy:
Very few airlines have emerged from bankruptcy and are still operating.
Many others have gone out of business through liquidation or merger. Of
the 162 airline bankruptcy filings by 142 different airlines since
1978, 148 were for chapter 11 reorganization and 14 were for chapter 7
liquidation (see table 5). Of the 148 chapter 11 reorganization
filings, in only 18 cases does the airline still hold an operating
certificate from the Federal Aviation Administration (FAA).
Table 5: Bankruptcy Filings, 1978-2004:
Filing for chapter 7 liquidation: 14.
Filing for chapter 11 reorganization: 148:
* Airline no longer certificated by FAA: 112.
* Airline refiled for bankruptcy and is no longer certificated by FAA:
18.
* Airline is still certificated and operating: 18.
Total filings: 162.
Source: Air Transport Association and Department of Transportation.
[End of table]
Airlines Have Shed Billions in Pension Obligations, but Structural Cost
Problems Remain:
Market factors, management-labor decisions, and pension law provisions
have played a role in airline pension underfunding of approximately
$13.7 billion, with an estimated $10.4 billion in minimum funding
requirements due from 2005 through 2008 as a result. These pension
obligations contribute to the liquidity problems faced by legacy
airlines that still operate pension plans, and may help cause
additional airlines to declare bankruptcy. Remaining airline pensions
expose PBGC to $23.7 billion in unfunded pension obligations and would
result in significant benefit reductions to participants if their
pension plans are terminated. PBGC has taken over a combined $24.9
billion in pension obligations from US Airways and United within the
last 3 years, at a cost of over $9.7 billion to the agency. While
eliminating or easing pension plan obligations may help ease legacy
airlines' immediate liquidity pressures, they do not eliminate the
structural cost imbalance between legacy and low cost airlines, or
guarantee that the legacy airlines will avoid bankruptcy. Pension
reform proposals--including extending payment time frames, changing
premium rules, and using a yield curve to calculate liabilities--would
have differential effects among airlines and implications for PBGC.
Pension Underfunding Will Require Airlines to Contribute a Minimum of
$10.4 Billion to Plans between 2005 and 2008:
Airline defined benefit pensions are underfunded by approximately $13.7
billion, according to airline financial reports filed with
SEC.[Footnote 30] This underfunding is down from $21 billion at the end
of 2004 as a result of the termination and transfer of US Airways'
remaining pension plans and all of United's pension plans to PBGC.
Under existing law, minimum pension contribution requirements for the
remaining legacy airlines that still operate plans are estimated to be
at least $10.4 billion from 2005 through 2008. These minimum
contribution requirements contribute to airline liquidity problems.
Estimates suggest the combined costs of the minimum pension
contribution requirements, long-term debt, capital leases, and
operating leases will exceed available cash.
Overfunded in 1999, Legacy Airlines' Pensions Were Underfunded by $21
Billion at the End of 2004:
The magnitude of legacy airlines' future pension funding requirements
is attributable to the size of the pension shortfall that has developed
since 2000. As recently as 1999, airline pensions were overfunded by
$700 million, according to SEC filings; by the end of 2004, legacy
airlines reported a deficit of $21 billion (see fig. 11), despite the
termination of the US Airways pilots' plan in 2003. Since these
filings, the total underfunding has declined to approximately $13.7
billion, in part because of the termination of the remaining US Airways
plans and all of the United plans.[Footnote 31]
Figure 11: Funded Status of Legacy Airline Defined Benefit Plans, 1998-
2004:
[See PDF for image]
Note: The termination of the United Airlines and remaining US Airways
defined benefit pension plans in 2005 reduced the total shortfall to
approximately $13.7 billion, according to 2004 year-end data. The SEC
liability data used in this report may include some pension plans not
guaranteed by PBGC.
[End of figure]
Extent of Pension Underfunding Varies Significantly by Airline:
The extent of pension underfunding varies significantly by airline. At
the end of 2004, before terminating its pension plans, United reported
underfunding of $6.4 billion, an amount equal to over 40 percent of its
total operating revenues in 2004. In contrast, Alaska reported pension
underfunding of $303 million at the end of 2004, equal to 13.5 percent
of its operating revenues. Since United terminated its pension plans,
Delta and Northwest have the most significant pension funding deficits-
-over $5 billion and nearly $4 billion, respectively--which represent
about 35 percent of each airline's 2004 operating revenues (see fig.
12). PBGC released estimated after Delta and Northwest declared
bankruptcy on September 14, 2005, stating that on a termination basis
Delta's defined benefit plans were underfunded by $10.6 billion, while
Northwest's underfunding totaled $5.7 billion.
Figure 12: Pension Funding Status, 1998-2004:
[See PDF for image]
Note: Funding status is based on projected benefit obligation data and
aggregates all plans sponsored by an airline into one measure.
[End of figure]
Over $10 Billion Needed to Meet Minimum Pension Contribution
Requirements over the Next 4 Years:
Under current law, companies whose pension plans fail certain funding
benchmarks and are underfunded by more than 10 percent on a current
liability basis must make deficit reduction contributions (DRC), in
addition to other contributions, to remedy the underfunding.[Footnote
32] Minimum contribution requirements, including DRCs, are estimated to
total a minimum of $10.4 billion from 2005 through 2008.[Footnote 33]
These estimates assume the expiration of the Pension Funding Equity Act
(PFEA) at the end of this year.[Footnote 34] PFEA permitted airlines to
defer the majority of their DRCs in 2004 and 2005. If this legislation
is allowed to expire at the end of 2005, payments due from legacy
airlines will significantly increase in 2006. According to PBGC data,
legacy airlines are estimated to owe a minimum of $1.5 billion this
year, nearly $2.9 billion in 2006, $3.5 billion in 2007, and $2.6
billion in 2008 (see fig. 13).
Figure 13: Legacy Airlines' Projected Minimum Contribution
Requirements, 2005-2008:
[See PDF for image]
[End of figure]
Market Factors, Management-Labor Decisions, and Pension Law Provisions
Have Played a Role in Airline Pension Underfunding:
Declines in pension plan assets from investment losses and low interest
rates have been significant factors in current pension underfunding.
Airline pension asset values dropped nearly 15 percent from 2001
through 2004 because of the decline in the stock market, while future
obligations have steadily increased because of (1) declines in the
yields on the fixed-income securities used to calculate the liabilities
of plans, and (2) new benefit accruals. Management and labor decisions
increased pension obligations in profitable years, but much less was
contributed to the pension funds than could have been. In addition to
these factors, pension funding rules have not prevented plans from
becoming significantly underfunded. Even though U.S. Airways and United
Airlines were in full compliance with the minimum funding rules for
pension plans prior to bankruptcy, their plans, in aggregate, were
underfunded by nearly $15 billion at termination.
Asset Declines Have Contributed to Pension Underfunding:
Pension asset values for legacy airlines reached a high in 2000 of
$35.8 billion. Investment returns turned negative in 2001 and caused
the value of airline pension assets to decline. By 2002, the value of
legacy airline pension assets dropped to $26.2 billion--a loss of over
$9 billion (26.7 percent). By 2004, pension asset values recovered to
$30.4 billion, about 15 percent below the high in 2000 (see fig. 14).
If PBGC takes over an underfunded plan after it has been terminated,
the plan's liabilities and assets are transferred to PBGC. If the
plan's assets are insufficient to cover the plan's liabilities, PBGC,
and sometimes plan participants, must assume the loss. While the
Employment Retirement Income Security Act[Footnote 35] provides some
standards of conduct for the plan sponsor's investment practices, the
sponsor's chosen plan fiduciary has discretionary control over the
management of plan assets. We did not examine the investment practices
of airlines or other companies; however, one union has suggested that
airline investment practices may have contributed to plan failure and
has requested that PBGC conduct an audit to ensure the integrity of
asset investment practices. PBGC, however, does not have the authority
to conduct this type of audit; this responsibility falls under the
authority of the Department of Labor.
Figure 14: Legacy Airlines' Pension Assets and Returns, 1998-2004:
[See PDF for image]
[End of figure]
Falling Interest Rates Have Increased the Value of Pension Liabilities:
The decline in key interest rates compounded the loss in asset value by
increasing the value of pension liabilities. Interest rates are
critical factors in calculating the level of plan assets needed today
in order to fulfill promised benefits. When interest rates are lower,
projected returns on assets are lower, requiring more money to be
invested today to finance promised future benefits. At a 6-percent
interest rate, for example, a promise to pay $1 per year for the next
30 years has a present value of $14. If the interest rate is reduced to
1 percent, however, the present value of the promise to pay $1 per year
for the next 30 years increases to $26.
Bond yields underpinning the interest rates used to calculate pension
liabilities on a current liability basis have been trending lower since
the early 1980s, causing the value of future liabilities to grow. Until
2004, the interest rate used to calculate liabilities on a current
liability basis was based on the 30-year Treasury bond rate. PFEA
changed the basis of this interest rate from the 30-year Treasury bond
rate to a composite index of high-grade corporate bonds for years 2004
and 2005. As figure 15 shows, the two rates track each other fairly
closely, but the 30-year Treasury rate is lower.
Figure 15: Corporate and 30-Year Treasury Bond Yields, 1977-2005:
[See PDF for image]
[End of figure]
Management and Labor Decisions Contributed to the Size of Underfunding:
In addition to market forces, decisions made by management and labor
have increased pension liabilities. Although management and labor
unions have agreed to a number of changes to collective bargaining
agreements that have limited pension and other benefits in recent
years, labor agreements have also increased pension liabilities in a
number of instances since the late 1990s. In some instances, pension
benefits increased beyond what financially weak airlines could
reasonably afford. For example, in the spring of 2002, United's
management and mechanics reached a new labor agreement that increased
the mechanics' pension benefit by 45 percent, but the airline declared
bankruptcy the following December.[Footnote 36]
In addition, legacy airlines have funded their pension plans far less
than they could have, even during the airlines' profitable years. PBGC
examined 101 cases of airline pension contributions from 1997 through
2002 and found that while airlines made the maximum deductible
contribution in 10 cases, they made no contributions in 49 cases when
they could have contributed.[Footnote 37] When airlines did make tax
deductible contributions, the contributions were often far less than
permitted. For example, in 2000, the airlines PBGC examined could have
made a total of $4.2 billion in tax-deductible contributions, but they
contributed only about $136 million despite recording profits of $4.1
billion (see fig. 16).[Footnote 38]
Figure 16: Legacy Airlines' Maximum Allowable Pension Contributions,
Actual Pension Contributions, and Operating Profits, 1997-2002:
[See PDF for image]
[End of figure]
Pension Funding Rules Have Not Prevented Pension Underfunding:
PBGC has taken over a number of pension plans that have been
substantially underfunded even though their sponsors were in full
compliance with the minimum funding requirements. Existing laws
governing pension funding and premiums have not protected PBGC from
accumulating a significant long-term deficit and have not minimized the
impact of PBGC's exposure to the moral hazard[Footnote 39] arising from
insuring pension plans. The minimum funding rules depend on the plan
sponsor being in good financial health and continuing operations
indefinitely; the rules do not ensure that the plan sponsor will have
the means to meet the plan's benefit obligations if the plan sponsor
meets financial distress. Meanwhile, in the aggregate, premiums paid by
plan sponsors under the pension insurance system have not adequately
reflected the financial risk to which PBGC is exposed. Accordingly,
defined benefit plan sponsors, acting within the rules, have been able
to turn significantly underfunded plans over to PBGC, thereby creating
PBGC's current deficit. This section addresses three aspects of the
rules--the current liability measure, the use of credit balances in
meeting funding requirements, and PBGC's premium structure.[Footnote
40]
* The current liability measure, which measures the value of a plan's
accrued liabilities to date for funding purposes, may provide an overly
optimistic picture of a plan's financial status and the sponsor's
ability to fulfill its obligations. Such a picture is possible because
the current liability measure tacitly assumes, among other things, that
the plan and its sponsor are financially healthy, viable entities. For
a plan whose sponsor is in financial trouble, a more conservative
measure, the termination liability, is likely to present a more
realistic picture of the liabilities the plan has accrued to
date.[Footnote 41] From 1998 through 2002, airline pensions were
consistently funded above 90 percent on a current liability basis. By
that measure, the plan sponsors were not required to make contributions
because the "full funding limitation" exemption applied. In contrast,
the funding status of airline pensions on a termination basis during
this time was under 90 percent in each year except 2000, with a spread
of more than 25 percent between the two measures in 2003. Figure 17
illustrates the difference in aggregate funding status shown by each
measure.
Figure 17: Legacy Airline Pension Assets as a Percent of Liabilities,
1998-2003:
[See PDF for image]
[End of figure]
The result is that pensions often are significantly more underfunded
when plans are terminated than the current liability measure indicates.
US Airways' and United Airlines' recent pension plan terminations
illustrate this point. When these airlines terminated their pension
plans, the plans' combined benefit liability was $24.9 billion.
Combined assets in the funds totaled $10 billion--a 60 percent
shortfall.
* The ability of sponsors to use funding credits to fulfill minimum
contribution requirements has also contributed to pension plan
underfunding. Plan sponsors accumulate funding credits when they
contribute more than the minimum contribution requirement in a plan
year or when the plan's actual experience, including investment returns
on assets, exceed expectations; these credits can then be substituted
in later years for cash contributions. In this way, funding credits can
act as a buffer against potentially volatile funding requirements and
allow sponsors flexibility in managing their annual level of pension
contributions.
If the market value of a plan's assets declines, however, the value of
funding credits may be significantly overstated. This overstatement
occurs because credits are not measured at their market value and are
credited with interest each year. For example, a sponsor can accrue a
$1 million credit by making a $1 million contribution above the minimum
contribution requirement. Even if the $1 million in assets loses all
value in the following year, the $1 million credit balance remains and
may be used as a credit toward the plan's minimum contribution
requirement. In addition, the sponsor would have to report only a
portion of that lost $1 million in asset value as a plan charge the
following year because of smoothing rules that allow losses to be
amortized over multiple years.
Over the past 5 years, airlines have used funding credits to fulfill
minimum contribution requirements despite significant levels of pension
underfunding. For example, starting in 2000, United used funding
credits to avoid making cash contributions to its pilots' plan, even
though the true funded status of the plan had deteriorated. The plan
was only 50 percent funded at termination. Similarly, US Airways
avoided contributing cash to its pilots' plan by applying funding
credits to fulfill its minimum contribution requirements. At
termination, this plan was only 33 percent funded.
* Finally, the premium structure in PBGC's single-employer pension
insurance program does not reflect the agency's exposure to financial
risk. Although PBGC premiums may be partially based on plan funding
levels, they do not consider other relevant risk factors, such as the
economic strength of the sponsor or the plan's asset investment
strategies, benefit structure, or demographic profile. The current
premium structure relies heavily on flat-rate premiums, which are
unrelated to risk. PBGC also charges plan sponsors a variable-rate
premium based on the plan's level of underfunding; however, underfunded
plans are not required to pay this premium if they satisfy the full
funding limit or another exemption.
In addition, current pension funding and pension accounting rules--
especially those that permit assets to be smoothed rather than valued
at their market rate--may encourage sponsors to invest in riskier
assets and potentially benefit from higher expected long-term rates of
return. In determinations of funding requirements, a higher expected
rate of return on pension assets means that a plan needs to hold fewer
assets to meet its future benefit obligations. Under current accounting
rules, the greater the expected rate of return on plan assets, the
greater the plan sponsor's operating earnings and net income. However,
higher expected rates of return require riskier investments that lead
to greater investment volatility and risk of losses.
Airline Pension Underfunding Contributes to Airline Liquidity Problems,
Threatens Employee Retirement Benefits, and Is Costing PBGC Billions:
Estimated minimum pension contribution requirements of $10.4 billion
over the next 4 years, combined with other fixed obligations, threaten
the liquidity position of the remaining legacy airlines with pension
plans. As a result, some airlines have suggested they will be forced to
declare bankruptcy and terminate their pension plans if they are not
granted some form of pension relief. Pension plan terminations often
result in significant benefit cuts to participants and cost PBGC
billions. When United and US Airways terminated their pension plans and
transferred $19.6 billion in pension obligations to PBGC, participants
lost a total of $5.3 billion in benefits, and PBGC incurred costs of
$9.7 billion to cover the gap between guaranteed benefits and available
assets. Remaining airline pension plans expose PBGC to an additional
$23.7 billion in unfunded benefit obligations.[Footnote 42] Although
pension plan terminations provide airlines with significant liquidity
relief in the near term, these terminations alone will not make legacy
airlines cost competitive with low cost airlines, which offer 401(k)-
type defined contribution plans.
Pensions Obligations Contribute to Airlines' Liquidity Problems, but
Terminations Alone Do Not Solve Legacy Airlines' Structural Cost
Disadvantage:
The size of legacy airlines' future fixed obligations (including
pensions, long-term debt, and capital and operating leases) relative to
their financial position suggests these airlines will have trouble
meeting their various financial obligations, regardless of whether they
terminate their pension plans. Legacy airlines' fixed obligations in
each year from 2005 through 2008 significantly exceed the total year-
end 2004 cash balances of these same legacy airlines. Legacy airlines
carried a combined cash balance of just under $10 billion going into
2005 (see fig. 18) and have used cash to fund their operating losses.
These airlines' fixed obligations are estimated to be over $15 billion
in both 2005 and 2006, over $17 billion in 2007, and about $13 billion
in 2008. Fixed obligations exceed total year-end 2004 cash by an
average of $2.7 billion during this time even when pension obligations
are not included. While cash from operations can fund some of these
obligations, continued losses and the size of these obligations put
these airlines in a sizable liquidity bind. Fixed obligations in 2008
and beyond will likely increase as payments due in 2006 and 2007 may be
pushed out and as new obligations are assumed. If these airlines
continue to lose money this year, as analysts predict, their position
will become even more tenuous.
Figure 18: Comparison of Legacy Airlines' Year-end 2004 Cash Balances
with Fixed Obligations, 2005-2008:
[See PDF for image]
[End of figure]
Nor will easing required pension contribution requirements fix the
legacy airlines' underlying structural cost disadvantage. Pension
costs, while substantial, are only a small portion of legacy airlines'
overall unit costs. The cost of legacy airlines' defined benefit plans
accounted for approximately 0.4 cent per available seat mile, a 15
percent difference between legacy and low cost airline unit costs (see
fig. 3). The remaining 85 percent of the unit cost differential between
legacy and low cost airlines is attributable to factors other than
defined benefit pension plans. Furthermore, even if legacy airlines
terminated their defined benefit plans, this portion of the unit cost
differential would not be fully eliminated because, according to PBGC
staff and industry labor officials we interviewed, other plans would
replace the defined benefit plans.
Airline Pensions Have Cost PBGC Billions and Expose the Agency to $23.7
Billion in Benefit Liabilities:
The cost to PBGC and participants of defined benefit pension plan
terminations has grown in recent years as the level of pension
underfunding has deepened (see table 6). When Eastern Airlines
defaulted on its pension obligations of nearly $2.2 billion in 1991,
for example, the net claim against PBGC totaled $701 million.[Footnote
43] By comparison, US Airways' and United's pension plan terminations
cost PBGC $9.7 billion in combined claims against the agency.
Table 6: Costs of Terminating Airline Pension Plans:
In millions of constant 2005 dollars.
Eastern Airlines;
Date of termination: 1991;
Benefit liability[A]: $2,228;
PBGC liability[B]: $2,080;
Net claim on PBGC[C]: $701;
Cost to participants[D]: $148.
Pam Am;
Date of termination: 1991;
Benefit liability[A]: $1,674;
PBGC liability[B]: $1,602;
Net claim on PBGC[C]: $995;
Cost to participants[D]: $72.
TWA;
Date of termination: 2001;
Benefit liability[A]: $1,885;
PBGC liability[B]: $1,836;
Net claim on PBGC[C]: $728;
Cost to participants[D]: $49.
US Airways;
Date of termination: 2003, 2005;
Benefit liability[A]: $8,085;
PBGC liability[B]: $6,022;
Net claim on PBGC[C]: $3,062;
Cost to participants[D]: $2,062.
United Airlines;
Date of termination: 2005;
Benefit liability[A]: $16,800;
PBGC liability[B]: $13,600;
Net claim on PBGC[C]: $6,600;
Cost to participants[D]: $3,200.
Total;
Benefit liability[A]: $30,671;
PBGC liability[B]: $25,140;
Net claim on PBGC[C]: $12,086;
Cost to participants[D]: $5,531.
Source: PBGC.
Notes: Bureau of Economic Analysis GDP price indexes were used to
calculate constant dollars.
[A] The full value of the benefits promised to participants prior to
termination.
[B] The amount of the original benefit insured by PBGC after agency
limits are imposed.
[C] The difference between the PBGC liability and the assets
transferred at termination.
[D] The difference between the original benefit and the amount insured
by PBGC that the participants lose when PBGC takes over a plan.
[End of table]
The remaining legacy airlines' defined benefit plans expose PBGC to
billions more in potential losses. At the end of 2004, these legacy
airlines reported $23.7 billion in total termination liabilities for
their defined benefit plans, with assets to cover 48 percent of these
obligations.
Effect of Pension Plan Terminations on Airline Employees Varies:
When US Airways and United terminated their pension plans, active and
high-salaried employees generally lost more of their promised benefits
than did retirees and low-salaried employees because of statutory
limits. For example, PBGC generally does not guarantee benefits above a
certain amount, currently $45,614 annually per participant retiring at
age 65.[Footnote 44] For participants who retire before age 65, the
guaranteed benefit amounts are less; for instance, participants who
first receive benefits from PBGC at age 60 are guaranteed benefits of
$29,649. Commercial pilots often end up with substantial benefit cuts
when their plans are terminated because, according to PBGC, their
benefits generally exceed PBGC's maximum guaranteed amount. In
addition, if they elect to begin receiving benefits from PBGC at age
60--the age at which FAA requires pilots to retire from operating
commercial service flights--their benefits are cut further. While the
loss of a defined benefit plan can be substantial for pilots, they
typically have additional and sometimes sizable retirement plans, such
as 401(k) plans, that supplement their pension plans. Nonpilot retirees
are not as often affected by the maximum payout limits. For example, at
US Airways, fewer than 5 percent of the retired mechanics and flight
attendants faced benefit cuts when their pension plans were terminated.
Retirees generally fare better than active employees because they
receive higher priority when PBGC allocates existing assets at plan
termination. For example, PBGC estimates that the pension benefits of
all United's active ground employees will be cut, with 71 percent of
these employees facing estimated cuts of between 1 percent and 25
percent. Of United's retired ground employees, an estimated 39 percent
will face benefit cuts; of these retired employees, an estimated 93
percent will see reductions of between 1 to 25 percent. Tables 8 and 9
summarize the expected cuts in benefits for different groups of
United's active and retired employees.
Table 7: Estimated Benefit Cuts for United Airlines Active Employees:
Plan: Management, administrative, and public contact employees;
Active employees in plan: 20,784;
Active employees with benefit cuts: 19,231;
Extent of benefit cuts: 1% to <25%: 1,696;
Extent of benefit cuts: 25% to < 50%: 15,885;
Extent of benefit cuts: 50% or more: 1,650.
Plan: Ground employees;
Active employees in plan: 16,062;
Active employees with benefit cuts: 16,062;
Extent of benefit cuts: 1% to <25%: 11,448;
Extent of benefit cuts: 25% to < 50%: 3,441;
Extent of benefit cuts: 50% or more: 1,173.
Plan: Flight attendants;
Active employees in plan: 15,024;
Active employees with benefit cuts: 11,109;
Extent of benefit cuts: 1% to <25%: 1,305;
Extent of benefit cuts: 25% to < 50%: 7,067;
Extent of benefit cuts: 50% or more: 2,737.
Plan: Pilots;
Active employees in plan: 7,360;
Active employees with benefit cuts: 7,270;
Extent of benefit cuts: 1% to <25%: 3,927;
Extent of benefit cuts: 25% to < 50%: 2,039;
Extent of benefit cuts: 50% or more: 1,304.
Source: PBGC.
Note: Estimates calculated using January 1, 2005, PBGC data.
[End of table]
Table 8: Estimated Benefit Cuts for United Airlines Retirees:
Plan: Management, administrative, and public contact employees;
Retirees in plan: 11,360;
Retirees with benefit cuts: 2,996;
Extent of benefit cuts: 1% to <25%: 2,816;
Extent of benefit cuts: 25% to <50%: 104;
Extent of benefit cuts: 50% or more: 76.
Plan: Ground employees;
Retirees in plan: 12,676;
Retirees with benefit cuts: 4,961;
Extent of benefit cuts: 1% to <25%: 4,810;
Extent of benefit cuts: 25% to <50%: 121;
Extent of benefit cuts: 50% or more: 30.
Plan: Flight attendants;
Retirees in plan: 5,108;
Retirees with benefit cuts: 29;
Extent of benefit cuts: 1% to <25%: 27;
Extent of benefit cuts: 25% to <50%: 1;
Extent of benefit cuts: 50% or more: 1.
Plan: Pilots;
Retirees in plan: 6,087;
Retirees with benefit cuts: 3,041;
Extent of benefit cuts: 1% to <25%: 1,902;
Extent of benefit cuts: 25% to <50%: 975;
Extent of benefit cuts: 50% or more: 164.
Source: PBGC.
Note: Estimates calculated using January 1, 2005, PBGC data.
[End of table]
In addition to reducing pension plan benefits, airlines have made
significant cuts to active employees' health care benefits. For
example, American Airlines increased its active pilots' monthly
contributions for family health care coverage by 162 percent and began
to require contributions by disabled pilots for health care coverage.
Before 2003, United's ramp service employees did not have to make
monthly contributions for family health care coverage; however, these
employees now must contribute $173 a month for their coverage. While
active employees' health benefits have been cut, retirees' health care
plans have not changed significantly. Union officials said that
reductions in retirees' health care benefit would not produce the
savings sought by the airlines and were not considered foremost during
contract negotiations.
Congress Is Currently Considering Various Pension Reform Proposals:
The decline of PBGC's financial condition, the expiration of PFEA at
the end of the year, and pension plan terminations at US Airways and
United have prompted congressional consideration of various reform
proposals for defined benefit pensions. Currently, the three most
prominent proposals are the administration's plan; H.R. 2830, "The
Pension Protection Act of 2005;" and S. 219, "The National Employee
Savings and Trust Equity Guarantee Act of 2005."[Footnote 45] All three
are broad reform proposals that seek to strengthen the defined benefit
pension system in the long term and attempt to resolve fundamental
problems with the system, as highlighted in this report and other GAO
reports.[Footnote 46] For example, all three proposals contain, among
others, provisions that a) modify the measurement of pension assets and
liabilities, b) increase the premiums paid to PBGC, c) restrict lump-
sum distribution provisions, and d) adjust disclosure requirements.
From the airlines' perspective, an important difference among the bills
concerns the length of time over which they can amortize the large
minimum contribution requirements currently due over the next 4 years.
The administration's proposal and H.R. 2830 would use a 7-year payment
period. According to a document issued by the Joint Committee on
Taxation, S. 219 would extend the amortization payment period to 14
years, but only for airlines that "freeze" their defined benefit
plans.[Footnote 47] Table 9 suggests how this provision could
significantly reduce the airlines' minimum contribution requirements in
2006. Amortizing these obligations over 14 years would have an
immediate impact on the airlines' liquidity.
Table 9: 2006 Estimated Deficit Reduction Contribution Payments under
Different Amortization Periods:
Dollars in millions.
Amortization period: 4 years;
Alaska: 7;
American: 149;
Continental: 156;
Delta: 936;
Northwest: 562;
Total: 1,810.
Amortization period: 7 years;
Alaska: 4;
American: 85;
Continental: 89;
Delta: 535;
Northwest: 321;
Total: 1,034.
Amortization period: 15 years;
Alaska: 2;
American: 40;
Continental: 42;
Delta: 250;
Northwest: 150;
Total: 483.
Amortization period: 20 years;
Alaska: 1;
American: 30;
Continental: 31;
Delta: 187;
Northwest: 112;
Total: 362.
Amortization period: 25 years;
Alaska: 1;
American: 24;
Continental: 25;
Delta: 150;
Northwest: 90;
Total: 290.
Source: Bear Stearns.
Note: Bear Stearns' report did not include estimates for the 14-year
amortization period proposed for the airlines in S. 219.
[End of table]
The rationale for extending the amortization period is that unless
airlines receive funding relief, existing minimum contribution
requirements may have such an adverse effect on their liquidity that
they will be forced into bankruptcy. The airlines then could terminate
their pension plans and transfer billions in obligations to PBGC. To
prevent such terminations, according to the Joint Committee on
Taxation, S. 219 would decrease the required annual contribution by
allowing the airlines to extend their payments over a longer period.
Requiring the airlines to "freeze" their existing plans is designed to
limit PBGC's exposure in case the airlines cannot recover financially
and terminate the plans before fully funding them over the 14-year
period.
Although extending the amortization period would provide some liquidity
relief to the remaining legacy airlines with defined benefit plans, it
would not solve those airlines' overall financial problems, and the
extent to which it would limit PBGC's exposure to additional pension
liabilities is unclear. As shown in figure 18, pension obligations are
only part of a much larger set of fixed obligations through 2008. Given
these other fixed obligations and persistent high fuel prices, pension
relief alone will not solve those airlines' financial problems, nor can
it guarantee that airlines will not declare bankruptcy in the future.
Furthermore, there is no assurance that PBGC's financial exposure will
be limited. According to a summary by the Joint Committee on Taxation,
S. 219 requires pensions to be frozen for the extended amortization
period to apply; however, liabilities could still increase. For
example, liabilities may increase with salary increases for existing
participants because pension benefits are based on participants'
salaries. Even if liabilities are frozen, a plan's assets could
decrease, leaving PBGC with fewer assets to cover obligations. In the
short term, extending the amortization period might prevent airline
pension plan terminations, allow employees to collect more benefits
than they might otherwise collect, and allow PBGC to avoid taking over
plans that are significantly underfunded. In the long term, however,
special treatment of airlines could potentially expose PBGC to even
greater costs.
Concluding Observations:
After 27 years, deregulation continues to affect the structure of the
airline industry. 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 of the
industry. Airlines have experienced greatly diminished pricing power
since 2000. Profitability, therefore, depends on which airlines can
most effectively compete on cost. This development has created inroads
for low cost airlines and forced wrenching change on legacy airlines
that long competed using a high-cost business model.
The historically high number of airline bankruptcies and liquidations
is a reflection of the industry's inherent instability. However, these
events should not be misinterpreted as a cause of the industry's
instability. There is no clear evidence that bankruptcy has contributed
to the industry's economic ills, including overcapacity and
underpricing, and there is some evidence to the contrary. Equally
telling is how few of the airlines that have filed for bankruptcy
protection are still doing business. Clearly, bankruptcy has not
afforded these companies a special advantage.
Bankruptcy has become a well-traveled path by which some legacy
airlines are seeking to shed some of their costs and become more
competitive. However, the termination of pension plan obligations by US
Airways and United Airlines has had substantial and widespread effects
on PBGC and on thousands of airline employees, retirees, and other
beneficiaries. The recent filings by Delta Air Lines and Northwest
Airlines only exacerbate these concerns. Liquidity problems, including
$10.4 billion in near-term pension contributions, may force additional
legacy airlines to follow suit. Some airlines are seeking legislation
to allow more time to fund their pensions. If their plans are frozen so
that their 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 pension plans in the coming year.
However, unless these airlines can reform their overall cost structures
and become more competitive with low cost competition, this change will
be only a temporary reprieve.
We have previously reported that Congress should consider broad pension
reform that is comprehensive in scope and balanced in effect.[Footnote
48] Revising plan funding rules is an essential component of
comprehensive pension reform. For example, we recently testified that
Congress should consider the incentives that pension rules and reform
may have on other financial decisions within affected industries. Under
current conditions, the presence of PBGC insurance may create certain
"moral hazard" incentives--struggling plan sponsors may place other
financial priorities above "funding up" their pension plans because
they know PBGC will pay guaranteed benefits. Furthermore, because PBGC
generally takes over underfunded plans of bankrupt companies, PBGC
insurance may create an additional incentive for troubled firms to seek
bankruptcy protection, which in turn may affect the competitive balance
within the industry.
Agency Comments:
We provided a draft of this report to DOT and PBGC for their review and
comment. DOT and PBGC officials provided some technical and clarifying
comments that we incorporated as appropriate. DOT declined to provide
written comments, and PBGC's written comments appear in appendix III.
We also provided selected portions of a draft of this report to the Air
Transport Association to verify the presentation of factual material.
We incorporated their technical clarifications as appropriate.
We are providing copies of this report to the Secretary of
Transportation, the Executive Director of PBGC, and other interested
parties and will make copies available to others upon request. In
addition, this report will be available at no charge on the GAO Web
site at [Hyperlink, http://www.gao.gov]. If you have any questions
about this report, please contact me at 202-512-2834, or [Hyperlink,
heckerj@gao.gov]. Contact points for our Offices of Congressional
Relations and Public Affairs may be found on the last page of this
report. Other key contributors are listed in appendix IV.
Signed by:
JayEtta Z. Hecker:
Director, Physical Infrastructure Issues:
List of Congressional Committees:
The Honorable Ted Stevens:
Chairman:
The Honorable Daniel K. Inouye:
Co-Chairman:
Committee on Commerce, Science, and Transportation:
United States Senate:
The Honorable Conrad Burns:
Chairman:
The Honorable John D. Rockefeller:
Ranking Minority Member:
Subcommittee on Aviation:
Committee on Commerce, Science, and Transportation:
United States Senate:
The Honorable Don Young:
Chairman:
The Honorable James L. Oberstar:
Ranking Democratic Member:
Committee on Transportation and Infrastructure:
House of Representatives:
The Honorable John L. Mica:
Chairman:
The Honorable Jerry F. Costello:
Ranking Democratic Member:
Subcommittee on Aviation:
Committee on Transportation and Infrastructure:
House of Representatives:
[End of section]
Appendixes:
[End of section]
Appendix I: Scope and Methodology:
To examine the role of bankruptcy in the airline industry, we drew on
information from a variety of sources. We interviewed airline
officials, representatives of airline trade associations,
representatives of law firms with significant experience in
representing different parties involved in airline bankruptcies, credit
and equity analysts, academic experts, and private consultants. We
reviewed relevant research obtained from these and other sources. We
interviewed government experts from the Department of Transportation
(DOT) and its agencies--the Federal Aviation Administration (FAA) and
the Bureau of Transportation Statistics (BTS). To determine the
financial state of the airlines and the extent to which airlines were
able to reduce costs during bankruptcy, we analyzed DOT Form 41 data.
We obtained these data from BACK Aviation Solutions, a private
contractor that GAO has contracted with to provide DOT Form 41 and
other aviation data. To assess the reliability of these data, we
reviewed the quality control procedures applied to the data by DOT and
BACK Aviation Solutions and subsequently determined that the data were
sufficiently reliable for our purposes. To examine the prevalence and
length of airline bankruptcies and make comparisons with other
industries, we obtained data from two databases: New Generation
Research's bankruptcydata.com and Professor Lynn M. LoPucki's
Bankruptcy Research Database. To assess the reliability of these data,
we reviewed the quality control procedures applied to each data source
and subsequently determined that the data were sufficiently reliable
for our purposes.
To assess whether bankruptcies are harming the airline industry, we
reviewed relevant research, interviewed experts, and analyzed
historical data on bankruptcies. We interviewed airline officials,
representatives of airline trade associations and law firms with
significant experience in representing different parties involved in
airline bankruptcies, airline industry credit and equity analysts,
academic experts, and private consultants. We also reviewed relevant
research obtained from these and other sources. In addition, we
interviewed government experts from DOT, FAA, and BTS. We also
contracted with InterVISTAS-ga2, a private consulting firm, to analyze
changes in air service and fares at six hub cities where an airline
exited or significantly reduced its service. The cities were Colorado
Springs, Colorado; Columbus, Ohio; Greensboro, North Carolina; Kansas
City, Missouri; Nashville, Tennessee; and St. Louis, Missouri.
InterVISTAS-ga2's analysis included an examination of changes in
capacity (as measured by available seat miles, a common measure of the
available capacity in a market) and in passenger traffic (from 4
quarters before to 8 quarters after the airline left a given market or
significantly reduced its operations there). InterVISTAS-ga2 used DOT
airline data for this analysis; we reviewed the quality control
procedures InterVISTAS-ga2 and DOT applied to these data to assess
their reliability and determined that they were sufficiently reliable
for our purposes.
To assess the effect of airline pension underfunding on employees,
airlines, and the Pension Benefit Guaranty Corporation (PBGC), we
relied on a variety of sources. We drew on an extensive body of work
that we have completed on private pension issues. We also interviewed
airline officials, representatives of airline trade associations and
airline labor unions, airline industry credit and equity analysts,
academic experts, and officials from PBGC, DOT, FAA, and BTS. We
reviewed relevant research obtained from these and other sources. To
examine the current and historical financial status of airline pensions
plans, we reviewed data from PBGC (from Forms 5500 and 4010) and
Securities and Exchange Commission (SEC) filings, including funding
contributions, funding status, and estimated future funding
contribution requirements. To examine the effect of pension funding
requirements on the financial status and cost competitiveness of
airlines, we analyzed DOT Form 41 data obtained from BACK Aviation
Solutions. To assess the reliability of these data, we reviewed the
quality control procedures applied to the data by DOT and BACK Aviation
Solutions and subsequently determined that the data were sufficiently
reliable for our purposes.
We performed our work from September 2004 through September 2005 in
accordance with generally accepted government auditing standards.
[End of section]
Appendix II: Case Studies Describing Market Responses to Airline
Withdrawals:
For more in-depth information on what has occurred at hubs when
carriers have significantly reduced their presence, we contracted with
InterVISTAS-ga2,[Footnote 49] an aviation consulting firm, to collect
and analyze data on changes in capacity, as measured in available seat
miles (ASM),[Footnote 50] and traffic, including both local (origin and
destination) and total traffic.[Footnote 51] During preliminary
analysis and consultations, we screened out cases older than 10 years
and eliminated others for which sufficient data were not available
(thereby excluding, for example, the actions taken by US Airways at
Pittsburgh in the latter half of 2004, because not enough time had
passed to review these actions' possible effects on the market).
Consequently, we selected the following six cases for examination:
* Colorado Springs, Colorado--Western Pacific moved its operations to
Denver (1997).
* Columbus, Ohio--America West eliminated its hub (2003).
* Greensboro, North Carolina--Continental Lite service was dismantled
(1995).
* Kansas City, Missouri--Vanguard Airlines ceased service (2002).
* Nashville, Tennessee--American Airlines eliminated its hub (1995).
* St. Louis, Missouri--TWA was acquired by American Airlines (2001).
To eliminate the effects of seasonality, changes were measured from 4
quarters before to 8 quarters after an event for a total of 12 quarters
of data. We asked InterVISTAS-ga2 to provide us with benchmark industry
data for the same periods.
To determine changes in capacity and traffic, InterVISTAS -ga2 used
data reported by airlines to DOT. InterVISTAS-ga2 calculated 4-quarter
averages for each data element and determined percentage changes in
these averages 1 and 2 years after the event. Because dehubbing, or
withdrawing from a market, might occur over a period of time, however,
there was no single "bright line" when the withdrawal occurred for most
of these cases, so InterVISTAS -ga2 determined that the effective
quarter of the withdrawal was generally the quarter with the greatest
downturn in traffic.
To determine whether a destination received service from a hub, we
obtained and reviewed the number of departures reported to DOT for the
first 4 quarters and the last 4 quarters of the period under review for
each hub city and for each carrier. If a destination received at least
80 departures in a quarter from any one carrier (roughly the equivalent
of daily service, allowing for less service on weekends), we counted it
as having received service. To determine whether small community
destinations suffered losses of service when these hub cities were
deemphasized, we assigned hub sizes to community airports on the basis
of the Federal Aviation Administration's (FAA) hub designation list for
the corresponding calendar year. We defined small community airports as
small and nonhub airports that are not located in major metropolitan
areas.[Footnote 52]
Colorado Springs: Western Pacific Moved Its Operations to Denver:
Colorado Springs served as the hub for Western Pacific Airlines, a low
fare airline that flew medium-haul routes from April 1995 to June 1997.
By June 1995, the airline was flying an average of 14 departures daily.
Western Pacific chose Colorado Springs because it believed the airport
could be an effective alternative to Denver International. In June
1997, Western Pacific, which was then operating 32 departures daily
from Colorado Springs, left Colorado Springs to establish a hub at
Denver. However, the airline filed for chapter 11 bankruptcy protection
on October 5, 1997, and shut down in February 1998.
Western Pacific's departure from Colorado Springs in June 1997 resulted
in significantly lower capacity and traffic. When Western Pacific left,
a significant amount of capacity was taken from the market, resulting
in decreased total traffic. (See fig. 19.) Local traffic also decreased
significantly, by 43.6 percent. No small communities had received
nonstop service out of Colorado Springs during this period, so none
were directly affected by Western Pacific's move to Denver. (See fig.
20.)
Figure 19: Percentage Change in Colorado Springs Capacity and Total
Traffic:
[See PDF for image]
Note: Percentage changes are calculated for the year beginning the
third quarter of 1996 compared with the 2-year period beginning the
third quarter of 1997.
[End of figure]
Figure 20: Number of Destinations Served from Colorado Springs:
[See PDF for image]
Note: We defined the period "before" Western Pacific's withdrawal as
the third quarter of 1996 through the second quarter of 1997. The
period "after" includes the third quarter of 1998 through the second
quarter of 1999.
[End of figure]
Columbus: America West Eliminated Its Hub:
America West began service at Columbus, Ohio, in December 1991--6
months after its June 1991 chapter 11 bankruptcy filing[Footnote 53]--
with 5 daily departures. During February 2003, America West announced
its plans to eliminate the Columbus hub operations. At that time,
America West mainline was operating 9 daily departures out of
Columbus.[Footnote 54] The airline reported the hub had lost $25
million annually and indicated that the elimination of the hub was part
of America West's response to difficult economic conditions. By
February 2004, America West mainline was operating 4 daily departures
from Columbus.
The elimination of America West's hub operations at Columbus, Ohio, had
little effect, since the carrier's mainline had captured less than 15
percent of total traffic before it withdrew. Therefore, decreases in
capacity and increases in total traffic were negligible. Total traffic
increased slightly overall because Southwest was increasing its
capacity. (See fig. 21.) However, this increase did not offset the 4.2
percent decline in local traffic. No small communities were served
nonstop out of Columbus by America West mainline. (See fig. 22).
Figure 21: Percentage Change in Columbus Capacity and Total Traffic:
[See PDF for image]
Note: Percentage changes are calculated for the year beginning the
first quarter of 2002 compared with the 2-year period beginning the
first quarter of 2003.
[End of figure]
Figure 22: Number of Destinations Served from Columbus:
[See PDF for image]
Note: We defined the period "before" America West's hub elimination as
the first quarter of 2002 through the fourth quarter of 2002. The
period "after" includes the first quarter of 2004 through the fourth
quarter of 2004.
[End of figure]
Greensboro: Continental Lite Service Was Dismantled:
Greensboro was one of the focus cities for Continental's point-to-
point, short-haul, no-frills, low-fare "Continental Lite" (CALite)
service initiated in the eastern United States in October 1993.
Continental quickly ramped up service from 3 departures per day to a
high of 74 per day by September 1994. However, after operational
problems and financial losses, Continental decided to dismantle the
CALite service in 1995. In June 1995, the airline was offering 52 daily
departures from Greensboro. By June 1998, Continental had reduced that
number to 6.
Dismantling the CALite service resulted in less overall capacity and
traffic at Greensboro.[Footnote 55] Greensboro's overall capacity
decreased despite capacity increases by other airlines. Total traffic
decreased nearly 30 percent with the reduction of the CALite service.
(See fig. 23.) Local traffic decreased 10.7 percent.
Figure 23: Percentage Change in Greensboro Capacity and Total Traffic:
[See PDF for image]
Note: Percentage changes are calculated for the year beginning the
third quarter of 1995 compared with the 2-year period beginning the
third quarter of 1996.
[End of figure]
Continental served 21 markets nonstop before it dismantled the
Greensboro hub; four of these were small community markets.[Footnote
56] After the airline decreased its capacity at Greensboro, it
continued nonstop service to its three hubs but cancelled nonstop
service to the small communities. (See fig. 24.)
Figure 24: Number of Destinations Served from Greensboro:
[See PDF for image]
Note: We defined the period "before" Continental's dismantling of
CALite service in Greensboro as the third quarter of 1995 through the
second quarter of 1996. The period "after" includes the third quarter
of 1997 through the second quarter of 1998.
[End of figure]
Kansas City: Vanguard Ceased Operations:
Vanguard Airlines began operating in 1994 as a low fare carrier and
eventually operated a hub in Kansas City, Missouri, with 2 departures
daily. Vanguard eventually served 13 percent of the passengers in
Kansas City. On July 30, 2002, the airline ceased operations and filed
for chapter 11 bankruptcy protection after being denied a federal loan
guarantee by the Air Transportation Stabilization Board. When the
company stopped operating, it had been flying 33 departures daily out
of Kansas City.
When Vanguard abruptly exited the Kansas City market, overall capacity
and thus traffic declined somewhat. Vanguard had a 13 percent market
share to Southwest's 36 percent share, and Southwest had cut its
capacity out of Kansas City during the same period while overall other
carriers had increased their capacity slightly. (See fig. 25). Local
traffic decreased 6.8 percent. Vanguard served only one small community
at the time it exited Kansas City, and during the period of our review
no other carriers served that community from Kansas City, so one small
community lost air service to Kansas City as a result of Vanguard's
demise. (See fig. 26).
Figure 25: Percentage Change in Kansas City Capacity and Total Traffic:
[See PDF for image]
Note: Percentage changes are calculated for the year beginning the
third quarter of 2001 compared with the 2-year period beginning the
third quarter of 2002.
[End of figure]
Figure 26: Number of Destinations Served from Kansas City:
[See PDF for image]
Note: We defined the period "before" Vanguard's demise as the third
quarter of 2001 through the second quarter of 2002. The period "after"
includes the third quarter of 2003 through the second quarter of 2004.
[End of figure]
Nashville: American Dismantled a Hub:
Nashville was one of six American Airlines hubs. The airline opened the
hub in April 1986, and at its peak in January 1992, it operated 135
daily departures out of Nashville.[Footnote 57] In December 1994, just
before it started dismantling the Nashville hub, it reduced daily
departures to 80. By December 1996, American had further reduced its
service at Nashville to 22 daily departures.
When American dismantled its Nashville hub, overall capacity and total
traffic declined. Other airlines increased their capacity and their
traffic substantially when American decreased its service. However,
because American had been so dominant at Nashville, a small decline in
overall traffic occurred. (See fig. 27.) Local traffic, however,
increased 28 percent. Southwest increased its share of Nashville's
traffic from 13 percent the year before American pulled out to 33
percent 2 years later.
Figure 27: Percentage Change in Nashville Capacity and Total Traffic:
[See PDF for image]
Note: Percentage changes are calculated for the year beginning the
first quarter of 1994 compared with the 2-year period beginning the
first quarter of 1995.
[End of figure]
When American Airlines dehubbed at Nashville, few small communities
were among those receiving service. As a result of the carrier's
actions, fewer total destinations--and just one small community--
received nonstop air service from that city. American and American
Eagle had served 32 of the 44 total nonstop destinations out of
Nashville, and 2 years later, American served 7 of 34 total
destinations. In the year before American's dehubbing at Nashville,
eight small hubs were served out of Nashville, five of which were
served by American and American Eagle. Two years later, American and
American Eagle had eliminated their small community service from
Nashville; another carrier maintained service to one small community.
(See fig. 28).
Figure 28: Number of Destinations Served from Nashville:
[See PDF for image]
Note: We defined the period "before" Continental eliminated its hub as
the first quarter of 1994 through the fourth quarter of 1994. The
period "after" includes the first quarter of 1996 through the fourth
quarter of 1996.
[End of figure]
St. Louis: American Acquired TWA:
When Trans World Airlines (TWA) filed for bankruptcy protection for the
third time on January 10, 2001, the airline had been operating a
domestic hub out of St. Louis and offering 324 departures daily. By the
end of that year, TWA--which had reduced its daily departures to 281--
had been acquired by American Airlines. American departures out of St.
Louis in 2001 decreased from 17 daily in January to 4 daily in
December. In January 2002, American departures increased to 286 daily
with the acquisition of TWA.[Footnote 58]
With American's takeover of TWA, capacity rose slightly in St. Louis
while total traffic decreased. The decrease in total traffic occurred
in spite of American's dramatic increase in traffic as it took over
TWA. (See fig. 29.) Local traffic, meanwhile, declined 6.1 percent
overall.
Figure 29: Percentage Change in St. Louis Capacity and Total Traffic:
[See PDF for image]
Note: Percent changes are calculated for the year beginning the third
quarter of 2001 compared with the 2-year period beginning the third
quarter of 2002.
[End of figure]
While TWA served a total of 27 small communities before the
acquisition, 11 of these were also served by American Airlines. Of the
16 markets that TWA served alone, American maintained service to 13
after the acquisition. Overall, however, more small communities
received nonstop service from St. Louis after American acquired TWA.
(See fig. 30).
Figure 30: Number of Destinations Served from St. Louis:
[See PDF for image]
Note: We defined the period "before" American's acquisition of TWA as
the third quarter of 2001 through the second quarter of 2002. The
period "after" includes the third quarter of 2003 through the second
quarter of 2004. The number of nonhubs served by all carriers after the
acquisition includes 8 nonprimary airports. Nonprimary airports are
commercial service airports enplaning 2,500 to 10,000 passengers
annually. Primary airports (nonhubs, small hubs, medium hubs, and large
hubs) have more than 10,000 enplanements annually and receive federal
Airport Improvement Program funds.
[End of figure]
[End of section]
Appendix III: Comments from the Pension Benefit Guaranty Corporation:
Pension Benefit Guaranty Corporation:
1200 K Street, N.W.,
Washington, D.C. 20005-4026:
Office of the Executive Director:
SEP 16 2005:
JayEtta Z. Hecker:
Director, Physical Infrastructure Issues:
United States Government Accountability Office:
441 G Street, NW:
Washington, DC 20548:
Dear Ms. Hecker:
Thank you for providing the PBGC the opportunity to review and comment
on GAO's draft report, Commercial Aviation: Bankruptcy and Pension
Problems Are Symptoms of Underlying Structural Issues. We commend you
and your team for examining the many issues affecting the funded status
of defined benefit pension plans and the special problems that face
defined benefit plans sponsored by companies in the airline industry.
The report is especially timely given the recent bankruptcy filings by
Delta Air Lines and Northwest Airlines. This report complements other
recent GAO reports that highlight problems with the current pension
funding rules. [NOTE]
The report makes two important points regarding airlines' pension
problems. First, the report highlights the fact that pension
contribution requirements, large as they appear to be, represent a
relatively small proportion of the airlines' future fixed costs (and an
even smaller part of their total costs). Second, the report explains
that the very high levels of pension underfunding in the airline
industry are the result of flawed minimum funding requirements and
decisions made by corporate management. Companies did not contribute as
much cash as they could when times were good, and in certain cases
contributed no cash at all when it was needed most. Too often, the
airlines satisfied their pension funding requirements with so-called
credit balances rather than cash payments that actually would have
improved the plans' funding levels. While the existing levels of
underfunding may result in financial and cash flow burdens on the
sponsors, they have the responsibility for ensuring that these pension
promises are honored by adequately funding their plans.
The report clearly shows that pension underfunding can lead to harsh
consequences for workers and retirees, as well as companies that have
acted responsibly in honoring their pension promises. When the United
Airlines and US Airways plans were terminated, participants lost $5.3
billion of the $24.9 billion in benefits they had earned and were
expecting to receive in retirement. The plans of Delta and Northwest
Airlines are underfunded by a combined $16.3 billion. If these plans
terminate, participants will lose over $5 billion in earned benefits.
Such losses can be devastating, especially for those in or near
retirement. In addition, Plan sponsors face increased PBGC premiums as
a result of the large losses the pension insurance program has incurred
during the past four years. As a result, all plan sponsors will have to
pay more to cover the claims from the plans of those sponsors who
failed to properly fund their plans.
One aspect of the report we found confusing was the mixed use of
underfunding data from two sources--the companies' 10-K filings with
the SEC (which show $13.7 billion in pension underfunding) and the
reports some of these companies file with PBGC as required under
section 4010 of ERISA (which show underfunding of about $23.7 billion).
From our perspective, the 4010 data are the more appropriate because
the SEC data are aggregated across all defined benefit plans sponsored
by the company (whether or not insured by PBGC) and because the SEC
data are not based on the termination value of plan liabilities. We
recognize that the Congress has restricted the ability of PBGC and GAO
to disclose the 4010 data on a plan-by-plan basis. To provide better
transparency on the funded status of defined benefit plans, the
Administration's pension reform proposal includes a provision that
would eliminate this restriction and make the 4010 data publicly
available.
Again, I would like to thank GAO for preparing this timely report which
strongly makes the case that pension funding reform is needed. Your
report ably demonstrates the unfortunate consequences that can occur
given the weak funding rules currently in place. We are looking forward
to working with GAO and the Congress on measures to strengthen the
defined benefit pension system and America's pension insurance program.
Sincerely,
Signed by:
Bradley D. Belt:
[NOTE] See: Pension Benefit Guaranty Corporation: Single-Employer
Pension Insurance Program Faces Significant Long-Term Risks, GAO-04-90
(Washington, D.C.: Oct. 29, 2003); Private Pensions: Recent Experiences
of Large Defined Benefit Plans Illustrate Weaknesses in Funding Rules,
GAO-05-294 (Washington, D.C.: May 31, 2005); Private Pensions: Revision
of Defined Benefit Pension Plan Funding Rules Is an Essential Component
of Comprehensive Pension Reform, GAO-05-794T (Washington, D.C.: June
7,2005); and Private Pensions: The Pension Benefit Guaranty Corporation
and Long-Term Budgetary Challenges, GAO-05-772T (Washington, D.C.: June
9, 2005).
[End of section]
Appendix IV: GAO Contact and Staff Acknowledgments:
GAO Contact:
JayEtta Z. Hecker (202) 512-2834:
Acknowledgments:
In addition to those named above, Joseph Applebaum, Paul Aussendorf,
Barbara Bovbjerg, Anne Dilger, David Eisenstadt, Charles J. Ford, David
Hooper, Charles A. Jeszeck, Ron La Due Lake, Steven Martin, Scott
McNulty, George Scott, Richard Swayze, Roger J. Thomas, and Pamela
Vines made key contributions to this report.
[End of section]
Related GAO Products:
[End of section]
Private Pensions: The Pension Benefit Guaranty Corporation and Long-
Term Budgetary Challenges. GAO-05-772T. Washington, D.C.: June 9, 2005.
Private Pensions: Government Actions Could Improve the Timeliness and
Content of Form 5500 Pension Information.
[Hyperlink, http://www.gao.gov/cgi-bin/getrpt?GAO-05-294].
Washington, D.C.: June 3, 2005.
Highlights of a GAO Forum: The Future of the Defined Benefit System and
the Pension Benefit Guaranty Corporation.
[Hyperlink, http://www.gao.gov/cgi-bin/getrpt?GAO-05-578SP]
Washington, D.C.: June 1, 2005.
Private Pensions: Recent Experiences of Large Defined Benefit Plans
Illustrate Weaknesses in Funding Rules.
[Hyperlink, http://www.gao.gov/cgi-bin/getrpt?GAO-05-294].
Washington, D.C.: May 31, 2005.
Commercial Aviation: Legacy Airlines Must Further Reduce Costs to
Restore Profitability.
[Hyperlink, http://www.gao.gov/cgi-bin/getrpt?GAO-04-836].
Washington, D.C.: August 11, 2004.
Private Pensions: Publicly Available Reports Provide Useful but Limited
Information on Plans' Financial Condition.
[Hyperlink, http://www.gao.gov/cgi-bin/getrpt?GAO-04-395].
Washington, D.C.: March 31, 2004.
Private Pensions: Multiemployer Plans Face Short-and Long-Term
Challenges.
[Hyperlink, http://www.gao.gov/cgi-bin/getrpt?GAO-04-423].
Washington, D.C.: March 26, 2004.
Private Pensions: Timely and Accurate Information Is Needed to Identify
and Track Frozen Defined Benefit Plans.
[Hyperlink, http://www.gao.gov/cgi-bin/getrpt?GAO-04-200R].
Washington, D.C.: December 17, 2003,
Pension Benefit Guaranty Corporation: Single-Employer Pension Insurance
Program Faces Significant Long-Term Risks.
[Hyperlink, http://www.gao.gov/cgi-bin/getrpt?GAO-04-90].
Washington, D.C.: October 29, 2003.
(544096):
FOOTNOTES
[1] Two other smaller carriers--ATA Airlines and Aloha--are also in
bankruptcy protection. Hawaiian Airlines emerged from bankruptcy
protection in June of this year.
[2] Through its single-employer insurance program, PBGC insures certain
benefits of the more than 34 million worker, retiree, and separated
vested participants of over 29,000 private-sector defined benefit
pension plans. Defined benefit pension plans promise a benefit that is
generally based on an employee's salary and years of service, with the
employer being responsible to fund the benefit, invest and manage plan
assets, and bear the investment risk. A single-employer plan is one
that is established and maintained by only one employer. It may be
established unilaterally by the sponsor or through a collective
bargaining agreement.
[3] GAO, Commercial Aviation: Legacy Airlines Must Further Reduce Costs
to Restore Profitability, GAO-04-836 (Washington, D.C.: Aug. 11, 2004).
[4] Despite variation in the size and financial condition of the
airlines in each of these categories, there are more similarities than
differences for airlines in each group. Each of the legacy airlines
adopted a hub-and-spoke network model that can be more expensive to
operate than a simple point-to-point service model. Low cost airlines
have generally entered the market since 1978, are smaller, and
generally employ the less costly point-to-point service model. The
seven low cost airlines (AirTran, America West, ATA, Frontier, JetBlue,
Southwest, and Spirit) have had consistently lower unit costs than the
seven legacy airlines (Alaska, American, Continental, Delta, Northwest,
United, and US Airways).
[5] Severe acute respiratory syndrome.
[6] 11 U.S.C. § 101 et seq.
[7] Henceforth, unless otherwise specified, references to airline
"bankruptcies" will mean bankruptcies filed under chapter 11 of the
bankruptcy code.
[8] Currently, bankruptcy cases in Alabama and North Carolina are not
within the jurisdiction of the U.S. Trustee Program.
[9] U.S. Trustees, upon order of the bankruptcy court, may also appoint
a private trustee to run the airline if it is determined that the
airline's current management has operated fraudulently or
incompetently, or if such action is deemed to be in the interests of
the creditors. A private trustee was appointed in the March 2003
Hawaiian Airlines bankruptcy case.
[10] ATSB ultimately provided $1.608 billion in loan guarantees to 6
airlines (Aloha, World, Frontier, US Airways, ATA, and America West).
[11] Since 1936, airline employees have fallen under the jurisdiction
of the Railway Labor Act (RLA), 45 U.S.C. section 151, et seq. Under
RLA, collective bargaining agreements do not expire; they instead
become amendable. The act provides for a lengthy process before
employees are allowed to strike and even at the point of a strike, a
presidential intervention could preclude a strike. In recent airline
bankruptcy cases, airlines gained permission from the courts to
abrogate collective bargaining agreements and unions have threatened
strikes in response. There is uncertainty as to whether a strike by
airline employees whose contract has been abrogated in bankruptcy would
violate RLA.
[12] The Employee Retirement Income Security Act of 1974 (ERISA) and
the Internal Revenue Code of 1986 set forth standards and requirements
that apply to defined benefit plans.
[13] This number includes repeat filings (e.g., US Airways in 2002 and
2004) as well as filings by different incarnations of airlines (e.g.,
Pan Am in 1991 and 1998).
[14] Additional applicants are requesting certification to provide
cargo, charter, and helicopter services.
[15] Richard D. Gritta et al., "The Instability of the Profitability of
the Major U.S. Domestic Airlines: Risk and Return Over the Period 1983-
2001--A Comparison to Other Industrial Groups," Credit and Financial
Management Review, Vol. 11, No. 1 (Spring Quarter 2005).
[16] Excluding Delta and Northwest Airlines, both of which filed for
chapter 11 just before this report was issued.
[17] 11 U.S.C. Sec. 362(a). Under certain circumstances, however,
secured creditors, governmental bodies, and other interests can obtain
relief from the automatic stay.
[18] P.L. 109-8.
[19] For this comparison, we relied on two different but complementary
databases: Professor Lynn M. LoPucki's Bankruptcy Research Database and
New Generation Research's bankruptcydata.com. The Bankruptcy Research
Database contains data--for such factors as duration, number of
employees, and assets--on the chapter 11 filings of public companies
with assets over $100 million that are required to file a form 10-K
(annual report) with SEC. Bankruptcydata.com provides information on
public companies with more than $50 million in assets that file for
bankruptcy.
[20] PricewaterhouseCoopers' 2004 Phoenix Forecast: Bankruptcy
Barometer. Comparable data for assets and liabilities before and after
bankruptcy were not available for 31 of the 50 companies (2 airlines
and 29 other companies).
[21] As measured in 1980 dollars.
[22] The National Commission to Ensure a Strong Competitive Airline
Industry, "Change, Challenge and Competition: A Report to the President
and Congress," August 1993.
[23] "[B]ankrupt carriers severely damage the economic health of the
entire airline industry. They transmit their financial condition to
other, solvent carriers much like a virus is transmitted from the sick
to the healthy" Aviation Week & Space Technology, 3, May 1993, p. 66.
[24] GAO, Airline Competition: Industry Competitive and Financial
Issues. GAO-T-RCED-93-49 June 9,1993.
[25] The value chain is based on the process view of organizations, the
idea of seeing a manufacturing or service organization as a system made
up of subsystems, each with inputs, transformation processes, and
outputs. The inputs, transformation processes, and outputs involve the
acquisition and consumption of resources - e.g., money, labor,
materials, equipment, and management --and how the value chain
activities are carried out determines costs and revenues. Airlines, to
adopt Porter's terminology, can be seen as being at the end of a chain
of vertical linkages that supply the ultimate air transport service.
Michael E. Porter, "Competitive Advantage: Creating and Sustaining
Superior Performance" and Kenneth Button, "Wings Across Europe: Towards
An Efficient European Air Transport System."
[26] Severin Borenstein and Nancy L. Rose, Do Airline Bankruptcies
Reduce Air Service?, National Bureau of Economic Research Working Paper
9636, April 2003.
[27] Severin Borenstein and Nancy L. Rose, Do Airlines in Chapter 11
Harm Their Rivals?: Bankruptcy and Pricing Behavior in U.S. Airline
Markets, National Bureau of Economic Research Working Paper 5047,
February 1995.
[28] Robert E. Kennedy, "The Effect of Bankruptcy Filings on Rivals'
Operating Performance: Evidence From 51 Large Bankruptcies,"
International Journal of the Economics of Business; February 2000; pp.
5-25.
[29] Lynn M. LoPucki and Joseph W. Doherty, "The Determinants of
Professional Fees in Large Bankruptcy Reorganization Cases," UCLA
School of Law, Law & Econ Research Paper No. 3-14, Journal of Empirical
Legal Studies, Vol. 1, January 2004.
[30] Exact pension underfunding varies daily because pension assets
change with market factors, and liabilities change with, among other
things, market factors and changes to labor agreements. This
underfunding estimate is based on year-end 2004 SEC filings, and does
not include pension data from United and US Airways because their plans
have been or are being terminated.
[31] SEC data and PBGC data on the funded status of plans can differ
because they serve different purposes, provide different information,
and are calculated differently. Corporate financial statements show the
aggregate effect of all of a company's defined benefit pension plans on
its overall financial position and performance. These data show airline
defined benefit plans were underfunded by $21 billion at the end of
2004; excluding the US Airways and United plans lowers this figure to
$13.7 billion. The PBGC data focus, in part, on the funding needs of
each pension plan. The two sources may also differ in the rates assumed
for investment returns on pension assets, how these rates are used, and
the rates used to calculate the values of pension liabilities. As a
result, the information available from the two sources often may appear
to be inconsistent. According to data filed on Form 4010 with PBGC
("4010" data), airline pension plans were underfunded by $33.2 billion
at the end of 2004; excluding the data for US Airways and United plans
lowers this figure to $23.7 billion. For more information on which
agency's data we used in different sections of this report, see app. I.
See also GAO, Private Pensions: Publicly Available Reports Provide
Useful but Limited Information on Plans' Financial Condition, GAO-04-
395 (Washington, D.C.: Mar. 31, 2004) and GAO, Pension Benefit Guaranty
Corporation: Single-Employer Pension Insurance Program Faces
Significant Long-Term Risks, GAO-04-90 (Washington, D.C.: Oct. 29,
2003).
[32] If a single-employer plan is at least 90 percent funded on a
current liability basis, the sponsor is not required to make any
contributions because of a "full funding limit" exemption. If the value
of plan assets is less than 90 percent of the sponsor's current
liability, a plan may be subject to a deficit reduction contribution.
However, a plan is not subject to this requirement if the value of plan
assets (1) is at least 80 percent of current liability and (2) was at
least 90 percent of current liability for each of the 2 immediately
preceding years or for each of the second and third immediately
preceding years. To determine whether the additional funding rule
applies to a plan, the Internal Revenue Code requires sponsors to
calculate current liability using the highest interest rate allowable
for the plan year. See 26 U.S.C. 412(l)(9)(C). See GAO, Private
Pensions, Recent Experiences of Large Defined Benefit Plans Illustrate
Weaknesses in Funding Rules, GAO-05-294 (Washington, D.C.: May 31,
2005).
[33] These estimates are based on 4010 filings and include data only
for legacy airlines that currently sponsor defined benefit pension
plans and reported their estimated pension obligations to PBGC. Pension
law provisions prohibit publicly identifying the airlines and other
plan sponsors that have reported 4010 information.
[34] Pension Funding Equity Act of 2004 (P.L. 108-218, Apr. 10, 2004).
A provision of this act changed the interest rate used to calculate
future liability from the 30-year Treasury bond rate to a corporate
bond rate, which effectively reduced the measured value of future
liabilities.
[35] 29 U.S.C. Sec. 1104.
[36] The increase in benefits was not fully guaranteed by PBGC because
PBGC phases in benefit increases made through plan amendments over 5
years. PBGC guarantees the greater of 20 percent of the benefit
increase or $20 per month of the increase on the anniversary of the
date the increase was effective. For example, if the plan was
terminated more than 3 years but less than 4 years after the benefit
increase, then PBGC would guarantee the greater of 60 percent of the
increase or $60 per month in increased benefits. The exact date of the
termination may not be important for the phase-in except to the extent
that it affects the guaranteed benefit amount.
[37] These 101 cases covered 18 pension plans sponsored by five
airlines.
[38] Pension funding rules permit sponsors to choose the interest rate
used to measure the plan's current liability from a specified range of
interest rates. The interest rate, in conjunction with other factors,
determines the maximum deductible pension contribution. Currently, the
interest rate must be chosen from an interest rate "corridor" that is
based on an index of investment-grade corporate bonds. In calculating
the maximum deductible contribution, a higher interest rate produces a
lower liability value and a lower deductible contribution limit. The
maximum deductible contributions referred to in this paragraph and in
figure 16 are calculated using the lowest interest rate permissible
from the interest rate corridor.
[39] Moral hazard emerges when the insured parties--in this case, plan
sponsors and participants--engage in behavior that they would not
otherwise have engaged in had they not been insured against certain
losses. In the case of the pension insurance system, such behavior
might include the willingness of parties to enter into agreements that
increase pension liabilities, rather than taking wage increases.
[40] An ongoing body of GAO work addresses these and other related
issues more comprehensively. See, for example, GAO, Private Pensions,
Recent Experiences of Large Defined Benefit Plans Illustrate Weaknesses
in Funding Rules, GAO-05-294, (Washington, D.C.: May 31, 2005).
[41] The termination liability measures the value of accrued benefits
using assumptions appropriate for terminating a plan.
[42] These estimates include only legacy airlines that currently
sponsor defined benefit pension plans and reported their estimated
pension obligations to PBGC. Pension law provisions prohibit publicly
identifying the airlines that have reported 4010 information.
[43] This dollar figure and other data in this section have been
converted to constant 2005 dollars.
[44] This guarantee level applies to plans that are terminated in 2005.
The amount guaranteed is adjusted actuarially (1) for the participant's
age when PBGC first begins paying benefits and (2) if benefits are not
paid as a single-life annuity. Because of the way the Employee
Retirement and Income Security Act of 1974 (ERISA), as amended,
allocates plan assets to participants, certain participants can receive
more than the PBGC-guaranteed amount.
[45] According to a Senate Finance Committee press release (9/27/05),
agreement has been reached on a compromise bill, the "Pension Security
and Transparency Act", which would include elements of S. 219,
including a special provision for airlines that would extend the
amortization period for paying unfunded pension liabilities to 14
years.
[46] See list of GAO reports in appendix V.
[47] See Joint Committee on Taxation, Modifications To The Senate
Finance Committee Chairman's Mark Of The "National Employee Savings And
Trust Equity Guarantee Act Of 2005" (JCX-57-05), July 26, 2005.
[48] See GAO-04-90; GAO-05-108T; GAO, Pension Benefit Guaranty
Corporation: Single-Employer Pension Insurance Program Faces
Significant Long-Term Risks, GAO-03-873T (Washington, D.C.: Sept. 4,
2003); Pension Benefit Guaranty Corporation: Long-Term Financing Risks
to Single-Employer Insurance Program Highlight Need for Comprehensive
Reform, GAO-04-150T (Washington, D.C.: Oct. 14, 2003); Private
Pensions: Changing Funding Rules and Enhancing Incentives Can Improve
Plan Funding, GAO-04-176T (Washington, D.C.: Oct. 29, 2003).
[49] InterVISTAS-ga2 is an aviation consulting firm specializing in
policy, regulatory, and economic analysis and planning.
[50] Available seat miles are the number of seats offered by an airline
multiplied by the number of scheduled miles flown. This is a typical
measure of capacity in the airline industry.
[51] Origin and destination traffic is local traffic that originates at
or is destined for a particular hub but does not connect through the
hub. Total traffic is the combination of a carrier's enplanements and
deplanements and thus includes passenger traffic that connects to
another flight at the airport.
[52] The categories of airports--large hub, medium hub, small hub, and
nonhub--are defined by statute. Small hubs and nonhubs are defined in
49 U.S.C. 41731. The categories are based on the number of passengers
boarding an aircraft (enplanements) for all operations of U.S. carriers
in the United States. A small hub enplanes 0.05 to 0.249 percent of all
passengers, and a nonhub less than 0.05 percent. In 2003, the latest
year for which FAA had data, there were 68 small hubs and 236 nonhubs.
[53] America West emerged from bankruptcy on August 25, 1994.
[54] Although America West Express also provided service out of
Columbus during this time, we did not include Express capacity,
traffic, and departure data in this analysis.
[55] Continental Express capacity and traffic changes out of Greensboro
are not included in this analysis.
[56] Continental Express, then Continental's wholly owned regional
affiliate, also provided service out of Greensboro, and its
destinations are included in the tallies for Continental.
[57] American Eagle, the regional subsidiary owned by American's parent
company, AMR Corp., also provided service out of Nashville, and its
traffic, capacity, and destinations are included in the tallies for
American.
[58] TWA capacity, traffic, and destinations served before its
acquisition and American destinations served after it acquired TWA,
includes service by TWA's and, later, American's regional partner,
Trans States Airlines."
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