
Memorial Day fireworks will be extra special for two airlines - American and Continental. In a pre-holiday move, Congress and the White House okayed the use of an 8.25% rate to determine the estimated DB liability, attempting to create parity for solvent airlines. (Higher discount rates lower the projected net unfunded liability for a defined benefit plan.) According to reporter John Crawley ("US Congress weighs new pension relief for airlines," May 24, 2007), this is "still below Northwest and Delta but more generous than the tougher formula required by lawmakers last year." Click here to read the article.
In response, the Allied Pilots Association (APA), "representing the 12,000 pilots of American Airlines (NYSE: AMR)" cautioned management not to use new rules as an an excuse to reduce funding. APA president , Captain Ralph Hunter, reiterated the unions' agreement to annual concessions of more than $600 million, motivated in part by the recognition of being "at risk in bankruptcy court." Click here to read the full text of the May 25, 2007 press release.
This is not the first, nor the last time, that discount rate discussions will take center stage. Questions about appropriate assumptions linger. (According to the H-15 Statistical Release, 20-year U.S. treasury bond yields as of May 21, 2007 were reported as approximately 5.02%.)
In a December 11, 2006 speech to CPAs, SEC Fellow Joseph B. Ucuzoglu cites an important element of the Pension Protection Act of 2006, taken together with the Financial Reporting Release No. 72. Registrants "should provide transparent disclosure in Management's Discussion & Analysis of the Act's anticipated impact on the company's liquidity and capital resources. Although in some circumstances it will be difficult to forecast precise funding requirements due to the annual recomputation required by the Act, it will often be possible to provide disclosure of the magnitude of cash commitments for future annual periods assuming present market conditions remain constant."
What are the implications?
1. New legislation allows additional airline carriers to use an estimated discount rate that is, by some accounts, "too high."
2. If the result is an artificially low estimated liability number, SEC filings could reflect an overly optimistic assessment of a company's liquidity situation and related ability to pay.
3. Plan participants may therefore want to take a tour "behind the numbers." After all, cash is required to pay benefits, irregardless of discount rate assumptions.
4. Don't stop with airlines. Compare reported discount rate assumptions with economic reality for a given plan. Does the number comport with current capital market conditions? Is it sustainable? If not, what is the likely TRUE impact on benefit plan payouts and the funding needs of the plan sponsor and isn't that important information to have?