Pensions: is United deal the tip of the iceberg?

Just how serious is the situation facing private pension plans? Is it headed the way of the savings and loan crisis, with a huge taxpayer-financed bailout in the offing? Or are the alarm bells likely to bring some kind of changes that will stave off such a calamity?

The executive director of the Pension Benefit Guaranty Corp., Bradley Belt, has raised the S & L analogy. To avert such a crisis, Belt has called for significant revisions to the pension guaranty system, including tighter funding requirements on plan sponsors, risk-based premiums and additional transparency. His comments came at a time when troubles buffeting a number of industries--particularly the major airlines and automakers--have raised the possibility that the current guaranty system that could be swamped by a wave of bankruptcies or court-sanctioned plan cancellations.

The immediate trigger for concern was the pension drama at United Airlines, which agreed in late April to give the government $1.5 billion in securities in exchange for taking over the airline's four under-funded pension plans. The deal with the PBGC would save United $4.4 billion in cash contributions over the next six years, including $1.3 billion this year, according to court documents.

"We need to take care of this issue now, because the last thing we want is for this to become another [savings and loan] crisis," Belt told a banking conference in Chicago this spring. Specifically, Belt pointed to the current level of under-funding in insured single-employer plans, which he estimated at $450 billion. Of that total, $100 billion is represented by companies whose bond ratings are currently "junk"--a huge increase from $10 billion two years ago.

Belt noted that the PBGC carried a $23 billion deficit at the end of 2004. Declining conditions in the domestic airline and auto/auto parts industries this year make it likely that the deficit will grow substantially this year. In fact, both Delta Air Lines and Northwest Airlines warned in early June that they will seek bankruptcy protection unless Congress passes a reform bill to ease restrictions on funding their plans.

The PBGC director, in fact, blamed much of the problem on "a flawed set of funding rules." While the Employee Retirement Income Security Act (ERISA) establishes clear funding requirements, those apparently have not guaranteed prudent funding levels by plan sponsors.

Moreover, Belt noted, a "moral hazard" condition remains for weak plan sponsors, who may choose to under-fund pension costs, knowing that the pension tab would be passed to the PBGC if their company fails. Belt added that even when UAL had been in compliance with ERISA, it had underfunded the plans by almost $10 billion.

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Dr. David Friend, managing director of financial advisory and restructuring firm Alvarez & Marsal, agrees that there may be a significant moral hazard if the rules remain as they are. He notes that in the macroeconomic picture, "very significant promises have been made to certain segments of society. There is a huge demographic wave of retirees coming, and there will be tremendous demand on the system. Are there enough resources? Clearly, the answer seems to be 'no.'"

But Friend doesn't believe that a wave of pension plan terminations is necessarily coming. While such terminations might create "a big competitive advantage for bad actors," he says, ailing companies that truly care about employees and about their reputations might elect not to cancel their plans.

He calls the pension plan situation a "gray area" that offers a lot of opportunity to convene the affected parties and brainstorm about how plans could be restructured. "We need people who understand finance and health care," Friend says. He also compliments the PBGC, saying "For my money, they've done a very good job of averting problems."