The Retirement You Weren't Banking On

An uncertain future: After a federal bankruptcy judge approved a United Airlines proposal to jettison its pension plans, unionized employees protested outside the courthouse in Chicago.
An uncertain future: After a federal bankruptcy judge approved a United Airlines proposal to jettison its pension plans, unionized employees protested outside the courthouse in Chicago. (By Stephen J. Carrera -- Reuters)
By Katherine V.W. Stone
Sunday, May 15, 2005

Even if you don't work for an airline, last week's ruling by federal bankruptcy judge Eugene Wedoff -- permitting United Airlines to default on its pension plans, which cover more than 130,000 people -- should send shivers up your spine.

The immediate effect of the decision will be to cut by more than half the pensions of many members of United Airlines' four unions, who have now become wards of the federal government's pension guarantee program. While reducing the maximum United pension benefit from more than $100,000 a year to around $46,000 may not seem like a social disaster, the court's action may well mark the beginning of the end of the system of retirement planning as we know it. Indeed, this decision, more than the predicted shortfall of Social Security decades from now, will have a real impact on the retirement of real people who live in real time.

The United pension system was a creature of five decades' worth of collective bargaining agreements in which the airlines' unions had agreed to forgo present compensation in exchange for employer contributions to the airline's defined-benefit pension plans. The plans promised each employee a specific monthly benefit at retirement, based upon their length of service (beyond a minimum number of years) and their highest annual wage.

In the stock market boom years of the 1980s and 1990s, the funds became so flush that United, like many large corporations with surpluses in their pension plans, diverted some of the money earmarked for pension contributions to dividends, executive mega-salaries and general operations. Now, after five years of stock market decline, the pension fund has assets that fall short of its obligations by $9.8 billion. At the same time, rising fuel prices, declining consumer demand and fare wars have weakened the airline so severely that it has sought protection in bankruptcy court.

The combination of the gigantic shortfall in the pension plan and the financial crisis in the airline industry gave United the opportunity to shed its pension obligations once and for all. As part of its proposed plan for becoming profitable again, the airline asked the bankruptcy court for permission to hand over responsibility for its pension plans to the Pension Benefit Guarantee Corp. (PBGC), a quasi-public entity created by Congress in 1974. In sanctioning the pension termination, the court has left United's 134,000 active and retired employees with only a fraction of the retirement income they had expected.

Many analysts are predicting that the PBGC takeover of the United pension plans will have a ripple effect through the airlines, and possibly the automobile and other industries as well. What company wants to operate under the burden of expensive, under-funded pension obligations when it can simply declare a default and shift those liabilities to the PBGC? No doubt airlines that compete with United will want to shed their pension obligations too. Last week Delta Airlines hinted that it might try to shift its $5.8 billion under-funded pension liability to the pension agency. Northwest Airlines, with $3.8 billion in under-funded pension liability, and Continental, with $1.8 billion in under-funded liability, may not be far behind.

It's hard to imagine the sort of havoc this must be causing in the lives of thousands of retirees and future retirees. Many of us, heeding the advice of financial planners, have done some planning for our retirement. But such planning is worthless if a key source of income, such as a pension benefit, cannot be relied upon. Retirement should be about security, not risk. Yet uncertainty has become the essence of our discussions about retirement, including the debate over Social Security.

While the ruling on Tuesday was dramatic, it wasn't unprecedented. In the 1990s, several large manufacturing companies -- including LTV Steel, Bethlehem Steel and Kaiser Aluminum -- went into bankruptcy and succeeded in shifting their pension obligations to the PBGC in an effort to recover (in some cases, to make themselves more attractive for sale). Only a few months ago, U.S. Airways terminated pension plans covering 51,000 people and shifted $3 billion in under-funded pension obligations to the PBGC. The United takeover, however, is by far the largest in the agency's history.

How can the PBGC take on all these expensive obligations? The answer is that it can't -- because it wasn't set up to handle the escalating number of defaults now taking place. The PGBC's origins can be traced back to 1963 and the closing of the Studebaker auto plant in South Bend, Ind. Approximately 7,000 workers lost their pensions. The public outcry was so great that Congress set about to craft legislation to protect private pensioners. After 10 years, it enacted the Employee Retirement Income Security Act (ERISA). ERISA created the PBGC, an employer-financed but government-backed program of pension insurance that was loosely modeled on the Federal Deposit Insurance Corp., which provides insurance for bank accounts to give depositors some protection against bank failures.

According to Forbes, the PBGC currently faces a $23.3 billion gap between its assets and its liabilities. If other airlines and large corporations seek to shed their pension obligations, its deficit will mushroom. Eventually U.S. taxpayers are going to have to pay for the shortfall. In all likelihood, a PBGC bailout would be more expensive than the savings and loan rescue of the 1980s. If there is a bailout, the winners will be the corporations that created the crisis. They will be able to continue paying hefty executive compensation packages -- including handsome pension benefits -- while taxpayers and workers share the bill.

But there is still more at stake. Already, defined-benefit pension plans (those managed by employers and that provide a specific monthly payment) are an endangered species. If United's actions hasten the demise of all defined-benefit plans -- a reasonable assumption -- then many Americans' retirement income will become even more volatile and variable.

Many employers have terminated their defined-benefit plans or converted them to defined-contribution plans, such as 401(k)s, in which the employee (rather than the firm) bears all the risk of stock market fluctuations and investment choice. Furthermore, most defined-contribution plans require employees to decide whether and how much of their salary to set aside. Younger employees rarely foresee their retirement needs, and low-wage employees simply don't have the extra cash to divert into savings. Thus without the forced pension savings of a defined-benefit plan, many individuals are unlikely to set aside the money they will need in their elderly years.

As defined-benefit plans wither away, Social Security becomes more important than ever for many workers. Indeed, without reliable pension plans, Social Security will become the only dependable firewall between dignity and destitution in our old age. Even now, for one-third of all retirees, Social Security payments amount to 90 percent of their total income. Yet the current administration's proposals for whittling away Social Security and shifting to a program of private accounts would remove the certainty so many depend upon. The Republican proposals would take a portion of the last remaining "defined-benefit" component of the retirement system and convert it to a "defined-contribution" component. With respect to that portion, the risks of investment strategy and market fluctuation would be borne by the individual rather than the government.

The PBGC was designed to shore up the private pensions system so that pensions together with Social Security would ensure a secure retirement for working Americans. Clearly Congress needs to revisit the issue of retirement security in order to ensure all Americans a healthy and dignified old age. We all need retirement security that does not depend upon whether the firm we work for succeeds or fails, or whether we make crackerjack investment decisions at a young age. Maybe we could afford to "own" our Social Security if we had our pensions guaranteed. But after rulings like the one last week, the "ownership society" is one that most of us can't afford.

Katherine Stone is a professor of employment law at the UCLA School of Law and the author of "From Widgets to Digits: Employment Regulation for the Changing Workplace" (Cambridge University Press).

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