The New York Times - November 6, 2004

 

News Analysis:

For Pension Plans Like United's, a Healthy Glow That's Paper Thin

By MARY WILLIAMS WALSH 
 

If anyone still needed more evidence, United's move to
terminate its pension plans provides the most glaring proof
yet: a company can observe federal law scrupulously year
after year, and still end up with a hopelessly insolvent
pension fund.

Thirty years ago, President Gerald R. Ford signed the
Employee Retirement Income Security Act, which was supposed
to keep insolvencies from happening. The law, known as
Erisa, requires companies that offer pensions to set aside
money to secure the benefits. Companies are not supposed to
guess; they must follow a detailed set of rules in
calculating contributions.

United, up until the end, was setting aside money at the
rate the law required. Only in July did the airline finally
miss a scheduled quarterly pension contribution, of $72.4
million.

That might sound like a serious omission, until one
considers how vastly underfunded the pensions were by then.
At that point, United's pension funds were $8.3 billion
short of what they owed current and future retirees. The
missed payment would have covered less than 1 percent of
the shortfall.

Nor is United unique. Nearly every company that has
defaulted on its pensions made the contributions the law
required, even as the trust funds sickened and died.

Records at the Labor Department show similar events at
Bethlehem Steel, US Airways, Consolidated Freightways and
other companies that have defaulted on their pension
promises. Their funds appeared viable until they collapsed,
often to the amazement of the employees, who had not been
told anything was wrong. At that point, the government's
pension insurance program picked up the pieces and began
paying retirees their benefits.

So how did United fall so far behind if it was following
the rules?

Much of the answer lies in rules that allow companies to
calculate pension values in ways that diverge sharply from
economic reality. Investors received a hint of the problem
last month, when the Securities and Exchange Commission
disclosed that it was reviewing the way companies calculate
their pension and health insurance obligations for
quarterly and yearly results. Critics have complained for
years that the accounting rules allow companies to
understate the amounts they owe their workers, by billions
of dollars in some cases. The effect is to inflate
earnings.

When companies calculate their pensions for funding
purposes, the problem is basically the same, although the
rules - those set up by Erisa - are different. The rules
offer plenty of latitude to make the obligation look
smaller, or make a fund look strong when it is at death's
doorstep.

In this case, the result is not pumped-up earnings and
misled shareholders, but an opportunity for the company to
put less into the pension fund than the fund actually
needs.

Consider United's plan for its pilots, the employees with
the richest benefits and consequently the most to lose in a
pension default. In 2002, the last year for which the Erisa
numbers are available, United declared the pilots' plan to
be 102 percent funded. That is, for every dollar of
benefits the airline owed its pilots, it had $1.02 in their
fund.

Because the plan was deemed fully funded, United did not
have to take any of the steps the law requires when a
pension fund starts to weaken severely. When a pension
funding ratio falls below 90 percent, the company must
notify the employees and pay higher premiums into a
government program that insures pensions. If the fund's
ratio stays below 90 percent for several more years, the
company must make accelerated contributions to bring it up.
United, claiming a 102 percent ratio, did not have to do
any of those things for the pilots' pension fund.

It was much the same for United's other three pension
funds. The mechanics and ramp workers' fund was declared
104 percent funded; the flight attendants' fund was
considered 94 percent funded. The management and
administrative workers' plan was 96 percent funded in 2002.
None tripped any special funding requirements.

But United's financial statement for 2002 told a different
story. There, the four pension funds were declared, as a
group, to be only 50 percent funded - well on their way to
collapse. Even that ratio, reached by using generally
accepting accounting rules, is believed by many specialists
to understate pension debt.

There is no accounting scandal here; United was, in each
case, simply following the rules laid out by federal law.

One reason its pension funds looked vibrant when in fact
they were failing is the rule for tracking excess
contributions made in previous years. Companies that set
aside more than the required minimum in a certain year can
keep credits in a running tab. If, in one year, they do not
have much cash but do have plenty of credits, they can
"pay" that year's contribution from their credit balance.

That is what United did. In the 1990's, it made larger
pension contributions than it had to, building up $1.3
billion of credits by 2000. Then the technology bubble
burst, stock prices fell, and in the real world, much of
that $1.3 billion melted away. But the funding rules, which
date back to the mid-1970's, did not anticipate that
companies would be investing their pension funds in assets
that can take wild swings.

Consequently, United was not required to write down the
value of its funding credits. They stayed on the books at
$1.3 billion, helping to make the airline's four pension
funds look sound when they were not.

When quarterly or annual contributions came due, United did
not have to part with any cash, it had only to reach for
the funding credits. Thus in 2001, when the flight
attendants' pension fund slid to 88 percent funding for the
second time in three years, United was required to make
emergency contributions. So it took $68 million out of its
credit balance and, using those book entries, fulfilled its
legal requirement to revive the pension fund. In actual
dollars, United did not contribute a penny that year.

With no new cash coming in, the pension fund was even
sicker in 2002. But United's filing with the Labor
Department for that year states that it had recovered, with
its funded ratio back up to 94 percent. Back out of danger
- at least on paper - the fund no longer required emergency
treatments and the flight attendants did not have to be
notified that anything was amiss.

Now that United has announced its intention to terminate
the plans, it will use yet another set of rules to
calculate the values of its pensions. The insurance agency
has already made these calculations - that is where the
estimated $8.3 billion shortfall comes from. Of that, the
insurance program will cover $6.4 billion; United's work
force will absorb the remaining $1.9 billion in the form of
reduced benefits.

The Pension Benefit Guaranty Corporation has also
calculated that since 1974, when the insurance program was
created, United has paid $50 million in premiums to insure
its employees' pensions. Of the $6.4 billion the agency
will be paying United's retirees in the coming years, $6.35
billion - all but what United paid in premiums - will be
borne by the other companies that run pension plans and
participate in the federal insurance program. If those
companies ever tire of footing other companies' bills, they
can be expected to cancel their pension plans and drop out
of the system. At that point, the taxpayers will have to
step in.

In the meantime, United will get $8.3 billion in debt
relief from the system, a windfall from an increasingly
shaky program that finance specialists refer to as the
"pension put," because it works like an option, allowing a
defaulting company to put its debt to the government. That
is one value that does not show up in United's numbers.