American Airline Pension Problems

American Airlines is definitely hitting financial turbulence. In November of last year, American Airlines filed for Chapter 11 bankruptcy. As I mentioned in my previous post about Hostess, bankruptcy does not mean a company and their assets instantly vanish. In Chapter 11, the company meets with its creditors and purposes a plan in order to meet its obligations. Creditors get to vote on the plan the company creates. American Airlines is now trying to restructure some of their costs and increase their revenue in order to save them from going under. American Airlines has lost money for three straight years. In 2010, the company lost $481 million, and in the first nine months of 2011 lost $982 million. In the past decade, the company has lost more than $11 billion. Clearly, this company is not creating value. It seems a little ironic that a company with the name American in it is losing so much money a year.

As part of restructuring their costs American Airlines is trying to terminate their pension plans (they have 4 due to different unions) in order to save money. The company needs $18.5 billion to cover all their pension promises made to current and former employees. However, the company only has $8.3 billion or can only meet 45% of their obligations. When pensions get in trouble the Pension Benefit Guaranty Corporation (PBGC) steps in to take over. The PBGC is a government sponsored entity (GSE) that doesn’t get its money from the government but rather through premiums that companies pay in order to protect them in case a company goes belly up. However, what is even more interesting is that the PBGC itself has a shortfall of $26 billion. So in essence the organization that is going to bail out a company needs more of a bailout than the company it’s bailing out. If American Airlines employees agreed to take a 55% decrease in their pension benefits the problem would be solved, however I think there would be so many union strikes you wouldn’t see an American Airlines plane over the ground for a while.

American Airlines is trying to get back on track by cutting their costs and increasing their revenue. The company recently announced they were going to lay off 13,000 employees or 15% of their workforce. The company is reducing their labor costs by 20% or $1.25 billion. The company is going to try to increase revenue by $1 billion by buying new planes that are more fuel efficient and increasing flights to certain cities. American Airlines seems to be a little too optimistic in terms of how much the new planes will save them.

Time will tell whether or not American Airlines can get its act together. The company will try to move its pension plan from a defined benefit to a defined contribution. What this simply means is that employees will actually have to contribute part of their salary to a 401k plan if they want money for retirement. Usually the company will match whatever they put in. The old way use to be a defined benefit plan where the company told the employee they would get x amount of dollars per month for the rest of their life depending on their years of service and salary. Defined contribution plans are better because a 401k plan can be managed by the employee and not the company like defined benefit plans are. I have a feeling though that the government will ultimately have to bail out American Airlines since I don’t know if the PBGC could handle it. I would prefer the PBGC to just disappear and have companies just set up defined contribution plans (which is what the current trend is). It seems a little ironic that a company with the name American in it is losing so much money a year. Warren Buffett was spot on when he said. “Indeed, if a farsighted capitalist had been present at Kitty Hawk, he would have done his successors a huge favor by shooting Orville down”.