Judge Grounds US Airways Pension Valuation

This is was meat ofJudge Stephen Mitchell’s decision in the US Bankruptcy Court for the Eastern District of Virginia in response to the PBGC’s claim with the bankruptcy court for its share of an unsecured creditors pot established in US Airways bankruptcy proceedings.

Earlier this year, US Airways terminated its pension plan and transferred the liability to the PBGC (See  PBGC Assumes US Airways Pension Plan ).   At the time of the transfer, which came as US Airways reached a joint plan of reorganization, US Airways set aside 10% of the company’s stock – approximately $560 million – for settlement with unsecured creditors.  

The PBGC contended it should be paid with the set aside stock due to the agency’s position as an unsecured creditor due to US Airways’ perceived error in the calculation of its unfunded liability.   When the PBGC took responsibility for the plan, it estimated the pension plan to be underfunded by $2.5 billion, since the plan only had $1.2 billion in assets to cover $3.7 billion in benefit liabilities. However, an assumed return on plan assets by the airline decreased the plan liability value to $890 million.

‘Prudent Investor’

US Airways and its army of actuaries argued that by using the PBGC’s valuation method, the agency’sclaim is approximately three times greater than the amount the PBGC actually needs to pay the pilots their promised benefits.   As an alternative, the airline says a bankruptcy court should “independently discount those benefits to present value using a hypothetical ‘prudent investor’ rate of return and an expected retirement age reflecting the financial disincentives for pilots to retire early,” Mitchell’s decision said.

“In a nutshell,” Mitchell said in the court’s opinion, US Airways was contending that a bankruptcy court is not legally bound to the pension underfunding valuation regulations of ERISA, and thus is free make “its own finding in order to prevent the PBGC from receiving a ‘windfall’ and to ensure equal treatment of creditor claims.”  

However, the court did not agree with the argument presented by the airline, instead saying that the PBGC’s claim for unfunded benefit liabilities should be determined using the PBGC valuation regulation, “since Congress has chosen to define the claim by reference to that regulation,” Mitchell penned.  

Even if the amount calculated using the PBGC’s method may “exceed the amount a hypothetical ‘prudent investor’ would have to set aside to pay the promised benefits as they became due,” Mitchell reasoned, it still does a better job of protecting the retirees.   Otherwise, companies would essentially be allowed to rob Peter to pay Paul using their own “prudent investor” rates that would shift “the risk of loss from adverse stock market performance – such as led to the termination of the US Airways pilots plan in the first instance – to the retirees,” Mitchell continued.

Thus even though the PBGC’s method may not be without flaws, the regulations “gives proper weight to Congress’s goal of protecting the health of the nation’s private pension system,” Mitchell said, and thus “is to be preferred over the use of discount rate premised on uncertain projections of future stock market returns.”

With these reasons, Mitchell said a separate order would be entered allowing the PBGC’s claim as filed.

Participant Reactions

Not surprisingly, given that the Bankruptcy Court ruled in favor of the PBGC, the agency’s Executive Director Steven Kandarian had positive comments about the decision.  

“This ruling is a victory for the financial integrity of the federal pension insurance system. It upholds the commonsense view that it should not be cheaper to terminate a pension plan with the PBGC than with a private insurance company,” Kandarian said in a news release.   “The proper measure of PBGC’s claim against the sponsor of an underfunded pension plan is the cost of buying annuities in the private marketplace. As Judge Mitchell’s opinion makes clear, companies cannot use non-market assumptions to artificially slash pension underfunding and escape the true cost of their obligations.”

Equally predictable was US Airways’ disagreeing with the Court’s decision.   “We respectfully disagree with the Court’s decision, as we believe we used a prudent calculation methodology for the unfunded liability of the pilot pension plan,” the airline said in a news statement.   ” Over the next week, we will be analyzing the decision and evaluating our appeal alternatives.”