CAPTAIN DUANE E. WOERTH, PRESIDENT
AIR LINE PILOTS ASSOCIATION, INTERNATIONAL
BEFORE THE DEPARTMENT OF LABOR
WORKING GROUP ON DEFINED BENEFIT PLAN FUNDING
AND DISCOUNT RATE ISSUES
JULY 24, 2003
I am Captain Duane Woerth, President of the Air Line Pilots Association, International, which represents 66,000 airline pilots who fly for 42 U. S. and Canadian airlines. ALPA appreciates the opportunity to present this statement on proposals to replace the 30-year Treasury bond interest rate and on related pension plan funding proposals.
Airline Industry Pension Funding Problems
Defined benefit plans, particularly in the airline industry, are facing an unprecedented funding crisis. The current low interest rates and abysmal market performance have combined to create this crisis. Interest rates are at levels not seen since the 1960's, and stocks are only recently appearing to show signs of recovery from the longest and deepest bear market since the Great Depression. On top of that, the airline industry is experiencing record losses. The industry's current losses far exceed the losses sustained during the 1992 recession, when losses exceeded all the profits earned over the entire airline industry's 60-year history. The war in Iraq and the outbreak of SARS have tempered any hopes of an economic recovery in the near term. Employers, and in particular airline carriers, are now required to contribute additional funding to pension plans when they can least afford to pay. Additionally, the extraordinary pension contributions required under the deficit reduction funding laws are exacerbated by the artificially low 30-year Treasury bond rate, which is used to measure plan liabilities.
This crisis has already resulted in US Airways terminating the pilots’ defined benefit plan, raising fears that plans at other airlines are soon to follow. The termination of the pilots’ defined benefit plan at US Airways in March resulted in pilots losing significant retirement benefits and significant liability being transferred to the Pension Benefit Guaranty Corporation (PBGC).
This crisis is not the result of employers failing to adequately fund their pension plans during the 1990's. Airline defined benefit plans were well funded, or fully funded, in the years 1999 and 2000. At the end of 1999, airline industry pension plans held $33.1 billion in assets to support $32.4 billion in projected benefit obligations. However, by 2002, three years of declining stock markets and record low interest rates caused the level of funded benefits to drop at all airlines. At the end of 2002, the plans of major airlines had assets of $26.2 billion to support projected benefit obligations of $48.7 billion. Record losses in the airline industry beginning in 2001 have caused airline liquidity to dwindle, reducing available cash to fund retirement plans in 2002 and 2003. The industry lost $10 billion in 2001 and $11 billion in 2002, and is estimated to lose between $8 billion and $13 billion in 2003. Sizeable shortfalls in pension funding and lack of liquidity have created the present pension funding crisis.
In 1999, the US Airways pilots’ plan had enough assets to cover 97% of all benefits. By 2000, the plan was more than fully funded, with assets covering 104% of the benefits. But the level of funding dropped to 74% in 2002, and to only 50% as of January 1, 2003. Because the plan's funding level was less than 80%, the deficit reduction funding laws kicked in, requiring the airline to make extraordinary additional pension contributions, which it could not afford. From 1997 through 2002, the funding rules did not require US Airways to make any contribution to the pilots’ plan, but due to poor market performance and low interest rates, it is estimated that the company's funding obligation would have been $365 million for 2003 and $389 million for 2004. The airline's inability to pay these bloated pension contributions was the main factor leading to termination of the pilots’ plan on March 31, 2003.
US Airways is not alone in facing astronomical increases in pension contributions this year. In 1999 and 2000, the defined benefit plans sponsored by most other airlines were also at or in excess of 100% funding. By the end of 2002, these plans saw their funding levels drop significantly. In one plan, for example, the funding level exceeded 140% in the year 2000, but is now estimated to be less than 80%.
It is important to point out that all of these plans, including the US Airways pilots’ plan, met the minimum funding requirements of ERISA and the Internal Revenue Code. In fact, many of these plans, including the US Airways pilots’ plan, had significant credit balances in their funding standard account at the beginning of 2002. This is an indication that they had been funded in excess of the minimum funding requirements in prior years.
Replacement of 30-Year Treasury Rate
As you are aware, ERISA sets specific funding requirements for defined benefit plans to ensure that plans have sufficient assets to meet the promised benefits. Several pension funding rules require the use of interest rates based on 30-year Treasury bonds. Congress originally chose the 30-year Treasury bond rate as the basis for funding because it believed it would approximate group annuity purchase rates. Group annuity purchase rates determine pension liability by the amount of money that would be needed to purchase benefits in the private annuity market if a plan were to terminate. Unfortunately, the Treasury Department stopped issuing 30-year Treasury bonds last year. The Treasury bond rate is now artificially low, due in part to the fact that they are not issued, and therefore no longer provides a good proxy for group annuity rates. The artificially low 30-year Treasury bond rate has resulted in employers being required to make larger contributions to their pension plans, during a period of a severe economic downturn. The airline industry, in particular, has been hit hard by astronomical pension funding requirements during this period of record industry losses.
ALPA encourages Congress to permanently replace the 30-year Treasury rate with another benchmark that approximates group annuity rates, thereby preserving Congress's original funding. Extending the stopgap funding measure currently in place for another two or three years is not sufficient relief. Cash-strapped airlines, some of which are in bankruptcy, are required by vendors, equipment leasers, lenders and bankruptcy courts to project pension contributions for seven or more years for business planning purposes. In making these projections, companies must assume that the stopgap relief will expire without any permanent interest rate fix. This causes the projected contributions to be very large for an extended period of time. In the case of US Airways, the bankruptcy judge said it would be folly for the company to assume that Congress would pass any relief until it actually does so.
ALPA believes that a composite rate based on three or more corporate bond indices would be an acceptable funding discount rate benchmark to replace the 30-year Treasury rate. This is primarily because corporate bond rates are related to and track group annuity purchase rates. Additionally, corporate bonds add a much needed hedge to the volatility of the pension plan funding process. Normally, when the economy weakens, Treasury bond yields decrease due to lack of general borrowing demand. Thus, pension funding requirements increase just when corporations can least afford to have them do so. Corporate bonds, on the other hand, trade in the market at a yield advantage, or spread, to Treasury bonds in order to compensate investors for the possibility that a corporate bond might default. During weak economic periods (when the possibility of default is greater) these spreads tend to widen. Conversely, during strong economic periods, corporate bond/Treasury bond spreads tend to narrow. The effect of this is that during weak economic periods, pension funding requirements will lessen, when employers need the greatest relief, and will tend to increase during times of a strong economy when corporations can better afford to make the pension contributions.
ALPA recommends adopting a composite rate, based on three or more corporate bond indices. These indices should be based on high quality, long-term corporate bonds. Such a composite rate could be incorporated into the existing statutory scheme, with only minor adjustments. The ceiling on the interest rate corridor in the minimum funding rules current liability calculation should be changed to a straight 100% of the four-year weighted average of the composite corporate bond rate. The use of a straight 100% of the four-year weighted average, instead of the corridor used today for the Treasury bond rate, would more accurately replicate group annuity purchase rates. Additionally, the mortality tables used to calculate current liability should be updated and based on the RP-2000 mortality tables.
The administration has proposed using a corporate bond yield curve to determine the rate corridor, based on the duration of plan liabilities. Adopting such a benchmark would add more complexity to the already complex funding rules. Actuarial funding for defined benefit plans is, by its nature, an inaccurate science given all of the assumptions that must be used. Trying to make this one interest rate assumption "more accurate" does little to improve the results and only serves to further confuse both plan sponsors and plan participants.
It should be noted that replacing the 30-year Treasury bond rate may have an impact on the amount of retirement benefits that is paid to individual plan participants. Some plans permit participants to elect lump sum payments upon retirement, and presently such lump sums must be calculated using the 30-year Treasury bond rate. If a permanent replacement for the 30-year Treasury bond rate is also applied to the calculation of lump sum payments, ALPA believes there must be a long transition period, similar to the transition period proposed in H.R. 1776, the pension legislation introduced by Representatives Portman (R-OH) and Cardin (D-MD). It would be unfair to pull the rug out from under those employees who have carefully planned their retirement finances. For pilots, this is particularly important since they must retire at age 60. It is not possible for pilots to fly longer to make up for amounts lost due to a change in the basis used to calculate lump sum payments.
Airline Pension Funding Relief
While ALPA strongly supports a permanent replacement of the 30-year Treasury bond rate with a composite corporate bond rate, we also feel that making this change alone is not enough relief to ensure the survival of airline pension plans. Over the last few months ALPA has been working with a coalition of airlines and all of the major AFL-CIO airline unions to develop temporary funding relief for certain defined benefit plans maintained by passenger airlines. Last week, Representative Dave Camp (R-MI) and a bi-partisan group of lawmakers introduced H.R. 2719, the Air Line Pension Act of 2003, which protects airline pension plans by creating a special funding rule for airline pension plans. Under this rule, there would be a five-year moratorium on the deficit reduction contribution, with the ability thereafter to amortize the unfunded liability over a 20-year period. This relief would be available to any passenger airline plan that has a funded percentage of less than 80% as of January 1, 2003.
Congress has historically recognized the unique circumstances of certain employers and has enacted special funding rules for certain employers and certain plans. This has been done most recently for Greyhound, due to the unique circumstances involved in that case. We feel that the passenger airlines are in a unique and deserving situation also. The airlines have been significantly impacted by (1) the events on September 11th, which reduced demand and increased security costs, (2) the global recession, (3) rising oil prices and the war in Iraq, and (4) the outbreak of the SARS virus.
The Air Line Pension Act of 2003 is a unified approach by the passenger airline carriers and its unions to solve an airline industry problem. It requires no financial commitment from the government, helps preserve the economic viability of the airline industry, and provides for a more secure and stable retirement for airline employees across the industry.
There are four components of the Air Line Pension Act of 2003. First, the pension plans of eligible passenger airlines would not be subject to the deficit reduction contribution funding rules for five years. The five-year moratorium would relieve the extraordinary funding pressures created by the historically low interest rates, three consecutive years of stock market losses, and unprecedented losses in the airline industry. Although a plan would be exempt from the deficit reduction contribution rules during the five-year moratorium period, it would not be exempt from ERISA's regular funding rules.
Second, the legislation contains a provision designed to mitigate the effect the additional funding charge would have when a plan emerges from the five-year moratorium. At the end of the moratorium period, the plan's unfunded current liability could be amortized over a period of 20 years, with interest-only payments for the first five years and level principal and interest payments for the last 15 years.
Third, the legislation contains a special rule that applies only to the US Airways pilots’ plan. Under this rule, the pilots’ plan would be taken away from the PBGC and restored to US Airways, as contemplated by ALPA and US Airways in their most recent collective bargaining agreement and consistent with the US Airways’ Plan of Reorganization.
Fourth, the legislation would require the unamortized portion of a pension contribution that has been waived by the IRS to be treated as a plan asset for purposes of calculating the deficit reduction contribution. Under current law, the unamortized portion of the waived amount cannot be treated as a plan asset. As a result, the unfunded current liability is overstated, causing the additional funding charge under the deficit reduction contribution to be overstated as well. Recognizing the waived amount as a plan asset in the deficit reduction calculation will result in a more appropriate deficit reduction contribution.
It should be noted that under the proposed legislation, neither the government nor the PBGC are at additional risk if an airline pension plan terminates during the proposed relief period. Under the legislation, a plan is treated as if it had been frozen for purposes of the PBGC guarantee under ERISA. This means that if a plan terminates during the five-year moratorium or during the five-year interest-only amortization period, a plan will be treated as if it had been amended to provide that participants would receive no additional benefit accruals under the plan after the first day of the plan year after enactment of the legislation. This mitigates the concern of transferring pension liability to the PBGC on plan termination.
Strengthening Pension Funding
In addition to the special funding rule for certain airline plans and the replacement of the 30-year Treasury bond rate, ALPA believes that the funding rules for defined benefit plans should be strengthened by permitting employers to make larger contributions to plans when they are able to afford them. One way to achieve this result is to allow employers to take into account expected cost-of-living increases in the limitations under Code Sections 415 and 401(a)(17) when calculating the plan's funding obligation. The current funding rules do not permit the plan actuary to anticipate such increases.
Additionally, the current full funding limitation should be replaced with one that permits employers to contribute more to defined benefit plans. Under current law, contributions cannot be made to a plan if the assets exceed the plan's accrued liability (including normal cost). Employers should be permitted to make deductible contributions to a plan until the plan's assets equal the greater of the present value of all future benefits or 130% of the current liability.
There has been much discussion lately about whether traditional defined benefit plans are the best retirement vehicles for many of America's workers. In a country where most workers change jobs on a regular basis, airline employees are somewhat unique. They tend to work for the same employer their entire careers, making traditional defined benefit plans the ideal mechanism for providing a major portion of their retirement benefits. While other workers need portability, most airline employees need a pension promise they can count on from their one and only employer.
Some government officials have made statements that Congress should not provide pension funding relief to the airline industry because when pension relief was provided to the steel industry, the government was still left with significant pension liabilities when the steel plans eventually terminated. The airline industry is starkly different than the steel industry. The airline industry is a cyclical, not a declining, industry. The steel industry has suffered a long-term decline over the last 25 years, with thousands of workers' jobs being lost to lower cost producers overseas and pension plans being underfunded for decades. The airline industry has not been in a protracted decline. Just three years ago the industry was profitable and pension plans were well funded. Foreign carriers cannot run domestic routes, so there will always be a domestic airline business. In short, the airline industry is going through a severe, but short-term problem caused by the extraordinary coincidence of events, as discussed earlier.
It is critical that airlines be able to continue to maintain and fund defined benefit retirement plans for their employees. The airline funding rule contained in the Air Line Pension Act of 2003 and the permanent replacement of the 30-year Treasury bond rate with a corporate bond rate would go far in achieving this goal. Adopting these rules would also protect the retirement benefits of pilots, who stand to lose hundreds of millions of dollars in pension benefits that are not guaranteed by the PBGC when a plan is terminated. It also protects the solvency of the PBGC by providing realistic limitations to the PBGC's exposure to pension liabilities on plan termination.
In conclusion, I want to thank you for holding this hearing on this critical issue and for inviting me to present the views of ALPA. We will be pleased to answer any questions that you or other members of the Working Group might have.