We'll use this timely AMR situation to compare private sector pension plans to public sector plans. The fundamental difference is that public pensions are riskless to the employee in that the promised pension benefit is fully backstopped by taxpayers.
Filing Puts Pension Benefits at Risk outlines the several complex issues now confronting AMR, its shareholders, creditors, employees and retirees, along with the Pension Benefit Guaranty Corporation (PBGC), the government agency who will end up paying most of the financial shortfall caused by AMR's bankruptcy proceeding.
By law PBGC is not funded by taxpayers but instead by private companies who are required to contribute to the fund. When pension plans are terminated, retirees look to the PBGC for pension payments to the extent that a shortfall exists in their company's pension fund.
One aspect of pension plan funding that's generally misunderstood is the idea of the "going concern." While individual employees may expect to work until normal retirement, if for some reason they don't, their pension benefits are much less than they would have been had they completed their working career as contemplated.
We'll use early retirement as an example. If a worker retires at age 55, for example, he will receive a much reduced and discounted pension benefit than if he continues to work until age 65 and then retires. The company in one case will fund and invest for ten fewer years in the case of early retirement. On the other hand, the company will fund, invest and then pay for ten more years when the employee works until his normal retirement date. Financially that makes a big difference to all concerned.
Thus, when the employee stops work prematurely, for whatever reason, there is frequently not enough money in the fund to pay full benefits.
Accordingly, the private sector pension plan sponsor funds the plan on the 'going concern' assumption that the plan will continue in operation and that employees will work until their normal retirement age. If that happens, the money for retirement pay benefits will be there, assuming investment returns match or exceed the returns assumed.
Even if the investment returns don't match expectations, the going concern intends to stay in business and make up any deficiencies from future successful operations. Unless, of course, that going concern ceases to operate as a successful going concern.
In the public sector, there may be no money set aside or insufficient money in the pension fund to pay retirement benefits in full. That's where the taxpayer backstop comes into play. The taxpayer guarantees the plan's retirement benefits regardless of whether any or enough money has been set aside to pay those retiree benefits.
With private company AMR now in bankruptcy proceedings, of course, there is no taxpayer backstop. In part the plight of AMR employees is described as follows:
"A spokesman for AMR said in a statement: "Our goal in this process is to be competitive, and for that to happen, our labor costs must become competitive."
"It is still too early to know precisely how that will be accomplished, but as with many Chapter 11 decisions, our creditors' interests will weigh heavily,," he added.
A person familiar with the situation said AMR hadn't yet decided how to handle pension obligations, and that any changes in retirement benefits could be packaged with other steps to reduce labor costs, including broader contract changes.
For AMR's active employees with pension plans, the age at which they retire could prove critical. A 65-year-old retiree guaranteed up to $4,653.41 in monthly payments from the PBGC in 2012 should the agency take over his or her plan. But a 55-year-old retiree is guaranteed just $2,094.03.
For someone expecting a $4,500 monthly payment, "that's a huge reduction," said David Kudla, chief executive of Mainstay Capital Management LLC, an investment adviser in Grand Blanc, Mich., that manages $1 billion. Mr. Kudla advised Delphi Corp. retirees on their benefits when the large auto supplier terminated pension obligations during bankruptcy proceedings.
AMR's pension plans are "significantly underfunded at this point and it's a cash-strapped company. If I'm an active employee, my PBGC risk has just gone up," he said.
Mr. Kudla said pension benefits can sometimes decrease by a third or even half depending on how a company restructures. When the PBGC took over US Airways's pensions a few years ago, one former pilot's $75,000 in benefits were reduced to about $25,000, Mr. Kudla said."
The head of the PBGC had this to say, "Following AMR's filing, "employees and retirees worry—and they should," Josh Gotbaum, the PBGC's director, said in a statement. "Based on our estimates, American Airlines employees could lose a billion dollars in pension benefits if American terminates their plans."
The basic point is that public sector employees enjoy benefits and guarantees that private sector employees don't have. Although fairness depends on where one sits, there is an obvious disconnect between retirement benefits afforded to employees of the private and the public sectors, respectively.
This private-public employee retirement pay disconnect is further exacerbated by the trend toward unguaranteed private sector 401k plan benefits in contrast to the taxpayer guaranteed public sector pension plan benefits.
The simple truth is that the numbers don't add up for many guaranteed pension benefit promises extended in earlier times and in a different era, whether those promises relate to private sector employee union compensation or government entitlements.
In that regard, AMR's bankruptcy filing is the merely latest omen.
The sooner this most serious problem is addressed in a comprehensive manner, the better it will be for America's future.
Thanks. Bob.
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