Testimony 

Before the Committee on Transportation 

and Infrastructure, Subcommittee on 

Aviation

United States Government Accountability Office

GAO

For Release on Delivery 

Expected at 2:00 p.m. EDT 

Wednesday, June 22, 2005 COMMERCIAL AVIATION

Preliminary Observations 

on Legacy Airlines’ 

Financial Condition, 

Bankruptcy, and Pension 

Issues 

Statement of JayEtta Z. Hecker, Director 

Physical Infrastructure Issues 

and 

Barbara D. Bovjberg, Director 

Education, Workforce, and Income Security Issues 

GAO-05-835T 
What GAO Found

United States Government Accountability Office

Why GAO Did This Study

Highlights

Accountability Integrity Reliability

www.gao.gov/cgi-bin/getrpt?GAO-05-835T.

To view the full product, including the scope 

and methodology, click on the link above. 

For more information, contact JayEtta Hecker, 

(202) 512-2834 or heckerj@gao.gov. 

Highlights of GAO-05-835T, a testimony 

before the Committee on Transportation 

and Infrastructure, Subcommittee on 

Aviation, House of Representatives 

June 22, 2005

COMMERCIAL AVIATION 

Preliminary Observations on Legacy 

Airlines' Financial Condition, Bankruptcy, 

and Pension Issues 

U.S. legacy airlines have not been able to reduce their costs sufficiently to 

profitably compete with low cost airlines that continue to capture market 

share. Internal and external challenges to the industry have fundamentally 

changed the nature of the industry and forced legacy airlines to restructure 

themselves financially. The changing demand for air travel and the growth 

of low cost airlines has kept fares low, forcing these airlines to reduce their 

costs. They have struggled to do so, however, especially as the cost of jet 

fuel has jumped. So far, they have been unable to reduce costs to the level 

of their low-cost rivals. As a result, legacy airlines have continued to lose 

money--$28 billion since 2001. 

Although some industry observers have asserted that airlines undergoing 

bankruptcy reorganization contribute to the industry’s financial problems, 

GAO found no clear evidence that historically airlines in bankruptcy have 

financially harmed competing airlines. Bankruptcy is endemic to the 

industry; 160 airlines filed for bankruptcy since deregulation in 1978, 

including 20 since 2000. Most airlines that entered bankruptcy have not 

survived. 

While bankruptcy may not be detrimental to the health of the airline 

industry, it is detrimental for pension plan participants and the PBGC. The 

remaining legacy airlines with defined benefit pension plans face over 

$60 billion in fixed obligations over the next 4 years, including $10.4 

billion in pension contributions -- more than some of these airlines may 

be able to afford given continued losses (see figure). Various pension 

reform proposals may provide some immediate liquidity relief to those 

airlines, but at the cost shifting additional risk to PBGC. Moreover, 

legacy airlines still face considerable restructuring before they become 

competitive with low cost airlines. 

0

5

10

15

20

Other obligations

Operating leases

Capital leases

Long term debt

Pension obligations

Cash at end of 2004

2004 2005 2006 2007 2008 

In billions of dollars

Source: PBGC and SEC filings.

Note: Fixed obligations in 2008 and beyond will likely increase as payments due in 2006 and 2007 

may be pushed out and new obligations are assumed. 

Since 2001, the U.S. airline industry 

has confronted unprecedented 

financial losses. Two of the 

nation’s largest airlines—United 

Airlines and US Airways--went into 

bankruptcy, terminating their 

pension plans and passing the 

unfunded liability to the Pension 

Benefit Guaranty Corporation 

(PBGC). PBGC’s unfunded liability 

was $9.6 billion; plan participants 

lost $5.2 billion in benefits. 

Considerable debate has ensued 

over airlines’ use of bankruptcy 

protection as a means to continue 

operations, often for years. Many 

in the industry and elsewhere have 

maintained that airlines’ use of this 

approach is harmful to the 

industry, in that it allows inefficient 

carriers to reduce ticket prices 

below those of their competitors. 

This debate has received even 

sharper focus with pension 

defaults. Critics argue that by not 

having to meet their pension 

obligations, airlines in bankruptcy 

have an advantage that may 

encourage other companies to take 

the same approach. 

GAO’s testimony presents 

preliminary observations in three 

areas: (1) the continued financial 

difficulties faced by legacy airlines, 

(2) the effect of bankruptcy on the 

industry and competitors, and (3) 

the effect of airline pension 

underfunding on employees, 

retirees, airlines, and the PBGC. 
Page 1 GAO-05-835T 

Mr. Chairman and Members of the Subcommittee: 

We appreciate the opportunity to participate in today’s hearing to discuss 

the financial condition of the U.S. airline industry—and particularly, the 

financial problems of legacy airlines.1

 Since 2001, the U. S. airline industry 

has confronted financial losses of unprecedented proportions. From 2001 

through 2004, legacy airlines reported losses of $28 billion, and two of the 

nation’s largest legacy airlines—United Airlines and US Airways—went 

into bankruptcy,2

 eventually terminating their pension plans and passing 

the unfunded liability to the Pension Benefit Guaranty Corporation 

(PBGC).3

 Two other large legacy airlines have announced that they are 

precariously close to following suit. 

In recent years, considerable debate has ensued over legacy airlines’ use of 

Chapter 11 bankruptcy protection as a means to continue operations, 

often for years. Some in the industry and elsewhere have maintained that 

legacy airlines’ use of this approach is harmful to the airline industry as a 

whole, in that it allows inefficient carriers to stay in business, exacerbating 

overcapacity and allowing these airlines to potentially under price their 

competitors. This debate has received even sharper focus with US 

Airways’ and United’s defaults on their pensions. By eliminating their 

pension obligations, critics argue, US Airways and United enjoy a cost 

advantage that may encourage other airlines sponsoring defined benefits 

plans to take the same approach. 

 1

While there is variation among airlines in regards to the size and financial condition, we 

adhere to a construct adopted by industry analysts to group large passenger airlines into 

one of two groups—legacy and low cost. Legacy airlines (Alaska, American, Continental, 

Delta, Northwest, United, and US Airways) predate airline deregulation of 1978 and have 

adopted a hub and spoke network model that can be more expensive to operate than a 

simple point-to-point service model. Low cost airlines (AirTran, America West, ATA, 

Frontier, JetBlue, Southwest, and Spirit) have generally entered the market since 1978, are 

smaller, and generally employ a less costly point-to-point service model. The 7 low cost 

airlines have consistently maintained lower unit costs than the 7 legacy airlines. 

2

Two other smaller carriers—ATA Airlines and Aloha—are also in bankruptcy protection. 

Hawaiian Airlines just emerged from bankruptcy protection earlier this month. 

3

The Pension Benefit Guaranty Corporation’s (PBGC) single-employer insurance program 

is a federal program that insures certain benefits of the more than 34 million worker, 

retiree, and separated vested participants of over 29,000 private sector defined benefit 

pension plans. Defined benefit pension plans promise a benefit that is generally based on 

an employee’s salary and years of service, with the employer being responsible to fund the 

benefit, invest and manage plan assets, and bear the investment risk. A single-employer 

plan is one that is established and maintained by only one employer. It may be established 

unilaterally by the sponsor or through a collective bargaining agreement. 
Page 2 GAO-05-835T 

Last year, we reported on the industry’s poor financial condition, the 

reasons for it, and the necessity of legacy airlines to reduce their costs if 

they are to survive.4

 At the request of the Congress, we have continued to 

assess the financial condition of the airline industry and, in particular, the 

problems of bankruptcy and pension terminations. Our work in this area is 

still under way.5

 Nonetheless, we can offer some preliminary observations 

about what we are finding. Our statement today describes our preliminary 

observations in three areas: (1) the continued financial difficulty faced by 

legacy airlines, (2) the effect of bankruptcy on the industry and 

competitors, and (3) the effect of airline pension underfunding on 

employees, retirees, airlines, and the PBGC. Our final report, which we 

expect to issue in September, will offer additional evidence and insights 

on these questions. 

In summary: 

• U.S. legacy airlines have not been able to reduce their costs sufficiently to 

profitably compete with low cost airlines that continue to capture industry 

market share. Challenges that are internal and external to the industry 

have fundamentally changed the nature of the industry and forced legacy 

airlines to restructure themselves financially. The changing demand for air 

travel and growth of low cost airlines has kept fares low, forcing legacy 

airlines to reduce their costs. However, legacy airlines have struggled to 

do so, and have been unable to achieve unit cost comparability with their 

low-cost rivals. As a result, legacy airlines have continued to lose money—

$28 billion since 2001—and are expected to lose another $5 billion in 2005. 

Additionally, airlines’ costs have been hurt by rising fuel prices – 

especially legacy airlines that did not have fuel hedging in place. 

• Bankruptcies are endemic to the airline industry, the result of longstanding structural issues within the industry, but there is no clear 

evidence that bankruptcy itself has harmed the industry or its competitors. 

Since deregulation in 1978, there have been 160 airline bankruptcy filings, 

20 of which have occurred in the last 5 years. Airlines fail at a higher rate 

 4

U.S. Government Accountability Office, COMMERCIAL AVIATION: Legacy Airlines Must 

Further Reduce Costs to Restore Profitability (GAO-04-836) August, 2004. 

5

We found all relevant data for assessing the financial condition of the airline industry, 

analyses of the effects of bankruptcy on the industry as a whole and six case studies of hub 

markets affected by airline bankruptcy or service withdrawals, interviews with industry 

and subject area experts, and analyses of SEC and PBGC data to be sufficiently reliable for 

our purposes. 
Page 3 GAO-05-835T 

than most other types of companies, and the airline industry historically 

has the worst financial performance of any sector. This inherent instability 

that leads to so many bankruptcies can be traced to the structure of the 

industry and its economics, including the highly cyclical demand for air 

travel, high fixed costs, and few barriers to entry. The available evidence 

does not suggest that airlines in bankruptcy contribute to industry 

overcapacity or that bankrupt airlines harm competitors by reducing fares 

below what other airlines are charging. The history of the industry since 

deregulation indicates that past liquidations or consolidations have not 

slowed the overall growth of capacity in the industry. Studies conducted 

by others do not show evidence that airlines operating in bankruptcy 

harmed other competitors. Finally, while bankruptcy may appear to be a 

useful business strategy for companies in financial distress, available 

analysis suggests it provides no panacea for airlines. Few airlines that have 

filed for bankruptcy protection are still in business today. Bankruptcy 

involves many costs, and given the poor track record, companies are likely 

to use it only as a last resort. 

• While bankruptcy may not harm the financial health of the airline industry, 

it has become a considerable concern for the federal government and 

airline employees and retirees because of the recent terminations of 

pensions by US Airways and United Airlines. These terminations resulted 

in claims on PBGC’s single–employer program of $9.6 billion and plan 

participants (i.e., employees, retirees, and beneficiaries) are estimated to 

have lost more than $5 billion in benefits that were either not covered by 

PBGC or exceeded the statutory limits. At termination in May 2005, 

United’s pension plans promised $16.8 billion in benefits backed by only 

$7 billion in assets (i.e., it was underfunded by $9.8 billion). PBGC 

guaranteed $13.6 billion of the promised benefits, resulting in a claim on 

the agency of $6.6 billion and an estimated $3.2 billion loss to participants. 

The defined benefit pension plans of the remaining legacy airlines with 

active plans are underfunded by $13.7 billion (based on data from the U.S. 

Securities and Exchange Commission, or SEC), raising the potential of 

more sizeable losses to PBGC and plan participants. These airlines face 

$10.4 billion in pension contributions over the next 4 years, significantly 

more than some of them may be able to afford given continued losses and 

their other fixed obligations. Spreading these contributions over more 

years, as some of these airlines have proposed, would relieve some of this 

liquidity pressure but would not necessarily keep them out of bankruptcy 

because it does not fully address the fundamental cost structure problems 

faced by legacy airlines. 
Page 4 GAO-05-835T 

We have previously reported that the Congress should consider broad 

pension reform that is comprehensive in scope and balanced in effect. 

Under current conditions, the presence of PBGC insurance may create 

“moral hazard” incentives to not fund pensions knowing that PBGC will 

assume the payments in the future. In considering various proposals to 

reform pension requirements, the impact on airlines, PBGC, and plan 

participants will vary. Nevertheless, effective reform would at a minimum 

include meaningful incentives for sponsors to adequately fund their plans, 

provide additional transparency for participants, and ensure 

accountability for those firms that fail to match the benefit promises they 

make with the resources needed to fulfill those promises. 

Since 2000, legacy airlines have faced unprecedented internal and external 

challenges. Internally, the impact of the Internet on how tickets are sold 

and consumers search for fares and the growth of low cost airlines as a 

market force accessible to almost every consumer has hurt legacy airline 

revenues by placing downward pressure on airfares. More recently, 

airlines’ costs have been hurt by rising fuel prices (see figure 1).6

 This is 

especially true of airlines that did not have fuel hedging in place. 

Externally, a series of largely unforeseen events—among them the 

September 11th terrorist attacks in 2001 and associated security concerns; 

war in Iraq; the SARS crisis; economic recession beginning in 2001; and a 

steep decline in business travel—seriously disrupted the demand for air 

travel during 2001 and 2002. 

 6

Legacy airlines’ fuel costs as a percentage of total operating costs doubled from 11.5 

percent during the 4th quarter of 1998 to 22.9 percent during the 4th quarter of 2004. Fuel 

costs for these airlines were $5 billion higher in 2004 than in 2003 – an amount roughly 

equal to their net operating losses. 

Legacy Airlines Must 

Reduce Costs to 

Restore Profitability 
Page 5 GAO-05-835T 

Figure 1: Average Annual Spot Price for Gulf Coast Jet Fuel, 1998-2005 

Note: 2005 prices reflect average through June 7. 

Low fares have constrained revenues for both legacy and low cost airlines. 

Yields, the amount of revenue airlines collect for every mile a passenger 

travels, fell for both low cost and legacy airlines from 2000 through 2004 

(see figure 2). However, the decline has been greater for legacy airlines 

than for low cost airlines. 

0.0

0.2

0.4

0.6

0.8

1.0

1.2

1.4

1.6

1998 1999 2000 2001 2002 2003 2004 2005

In dollars per gallon

$0.40

$0.50

$0.85

$0.73

$0.68

$0.82

$1.15

$1.47

Source: GAO analysis of Department of Energy’s Energy Information Administration data.
Page 6 GAO-05-835T 

Figure 2: Percentage Change in Passenger Yields Since 2000 

Legacy airlines, as a group, have been unsuccessful in reducing their costs 

to become more competitive with low cost airlines. Unit cost 

competitiveness is key to profitability for airlines because of declining 

yields. While legacy airlines have been able to reduce their overall costs 

since 2001, these were largely achieved through capacity reductions and 

without an improvement in their unit costs. Meanwhile, low cost airlines 

have been able to maintain low unit costs, primarily by continuing to grow. 

As a result, low cost airlines have been able to sustain a unit cost 

advantage as compared to their legacy rivals (see figure 3). In 2004, low 

cost airlines maintained a 2.7 cent per available seat mile advantage over 

legacy airlines. This advantage is attributable to lower overall costs and 

greater labor and asset productivity. 

-18

-16

-14

-12

-10

-8

-6

-4

-2

0

Low cost airline yields

Legacy airline yields

2000 2001 2002 2003 2004

Percentage change 

Source: GAO analysis of Department of Transportaion (DOT) Form 41 data.
Page 7 GAO-05-835T 

Figure 3: Legacy vs. Low Cost Airline Unit Cost Differential, 1998 2004 

Weak revenues and the inability to realize greater unit cost-savings have 

combined to produce unprecedented losses for legacy airlines. At the 

same time, low cost airlines have been able to continue producing modest 

profits as a result of lower unit costs (see figure 4). Legacy airlines have 

lost a cumulative $28 billion since 2001 and are predicted to lose another 

$5 billion in 2005, according to industry analysts. 

0.06

0.07

0.08

0.09

0.10

0.11

0.12

Low-cost airlines

Legacy airlines

1998 1999 2000 2001 2002 2003 2004

In dollars per available seat mile

0.00

2004 Unit Cost Difference

0.8¢ Labor (28%)

0.4¢ Pensions (15%)

0.5¢ Fuel & Oil (17%)

1.0¢ Other (40%)

2.7¢

Source: GAO analysis of DOT Form 41 data.
Page 8 GAO-05-835T 

Figure 4: Airline Operating Profits and Losses, 1998-2004 

Since 2000, as the financial condition of legacy airlines deteriorated, they 

built cash balances not through operations but by borrowing. Legacy 

airlines have lost cash from operations and compensated for operating 

losses by taking on additional debt, relying on creditors for more of their 

capital needs than in the past. In the process of doing so, several legacy 

airlines have used all, or nearly all, of their assets as collateral, potentially 

limiting their future access to capital markets. 

In sum, airlines are capital and labor intensive firms subject to highly 

cyclical demand and intense competition. Aircraft are very expensive and 

require large amounts of debt financing to acquire, resulting in high fixed 

costs for the industry. Labor is largely unionized and highly specialized, 

making it expensive and hard to reduce during downturns. Competition in 

the industry is frequently intense owing to periods of excess capacity, 

relatively open entry, and the willingness of lenders to provide financing. 

Finally, demand for air travel is highly cyclical, closely tied to the business 

cycle. Over the past decade, these structural problems have been 

exacerbated by the growth in low cost airlines and increasing consumer 

sensitivity to differences in airfares based on their use of the Internet to 

purchase tickets. More recently airlines have had to deal with persistently 

-10

-8

-6

-4

-2

0

2

4

6

8

Low cost airline

Legacy airline 

1998 1999 2000 2001 2002 2003 2004

In billions of dollars

Source: GAO analysis of DOT Form 41 data.
Page 9 GAO-05-835T 

high fuel prices—operating profitability, excluding fuel costs, is as high as 

it has ever been for the industry. 

Airlines seek bankruptcy protection for such reasons as severe liquidity 

pressures, an inability to obtain relief from employees and creditors, and 

an inability to obtain new financing, according to airline officials and 

bankruptcy experts. As a result of the structural problems and external 

shocks previously discussed, there have been 160 total airline bankruptcy 

filings since deregulation in 1978, including 20 since 2000, according to the 

Air Transport Association.7

 Some airlines have failed more than once but 

most filings were by smaller carriers. However, the size of airlines that 

have been declaring bankruptcy has been increasing. Of the 20 bankruptcy 

filings since 2000, half of these have been for airlines with more than $100 

million in assets, about the same number of filings as in the previous 22 

years. Compared to the average failure rate for all types of businesses, 

airlines have failed more often than other businesses. As figure 5 shows, in 

some years, airline failures were several times more common than for 

businesses overall. 

 7

Airlines may file for two types of bankruptcy. Chapter 7 of the bankruptcy code governs 

the liquidation of the debtor’s estate by appointed trustees of the court. Chapter 11 of the 

code governs business reorganizations and allows, among other things, companies to reject 

collective bargaining agreements and renegotiate contracts and leases with creditors with 

the approval of the court. Companies may also convert from a Chapter 11 reorganization 

into a Chapter 7 liquidation or may liquidate within Chapter 11. 

Bankruptcy is 

Common in the 

Airline Industry, but 

There is No Evidence 

that it is Harmful to 

the Industry or 

Competitors 
Page 10 GAO-05-835T 

Figure 5: Comparison of Airline and Overall Business Failure Rates, 1984-1997 

Note: Dun & Bradstreet data were only available through 1997. 

With very few exceptions, airlines that enter bankruptcy do not emerge 

from it. Of the 146 airline Chapter 11 reorganization filings since 1979, in 

only 16 cases are the airlines still in business. Many of the advantages of 

bankruptcy stem from legal protection afforded the debtor airline from its 

creditors, but this protection comes at a high cost in loss of control over 

airline operations and damaged relations with employees, investors, and 

suppliers, according to airline officials and bankruptcy experts. 

Contrary to some assertions that bankruptcy protection has led to 

overcapacity and under pricing that have harmed healthy airlines, we 

found no evidence that this has occurred either in individual markets or to 

the industry overall. Such claims have been made for more than a decade. 

In 1993, for example, a national commission to study airline industry 

problems cited bankruptcy protection as a cause for the industry’s 

14.9%

8.4%

1.2%

5.7%

4.0%

1.1% 1.2% 1.0% 1.0% 0.7%

8.6%

4.3%

2.9%

4.1%

2.6% 2.2%

4.1% 3.8%

4.4%

1.1% 1.1% 1.1% 0.7% 0.9% 0.8% 0.8% 0.9%

5.4%

Failure percentages

0

2

4

6

8

10

12

14

16

Airline failure rate

Overall failure rate

1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997

Year

Source: GAO analysis of DOT and Dun & Bradstreet data.
Page 11 GAO-05-835T 

overcapacity and weakened revenues.8 More recently, airline executives 

have cited bankruptcy protection as a reason for industry over capacity 

and low fares. However, we found no evidence that this had occurred and 

some evidence to the contrary. 

First, as illustrated by Figure 6, airline liquidations do not appear to affect 

the continued growth in total industry capacity. If bankruptcy protection 

leads to overcapacity as some contend, then liquidation should take 

capacity out of the market. However, the historical growth of airline 

industry capacity (as measured by available seat miles, or ASMs) has 

continued unaffected by major liquidations. Only recessions, which curtail 

demand for air travel, and the September 11th attack, appear to have 

caused the airline industry to trim capacity. This trend indicates that other 

airlines quickly replenish capacity to meet demand. In part, this can be 

attributed to the fungibility of aircraft and the availability of capital to 

finance airlines. 

 8

The National Commission to Ensure a Strong Competitive Airline Industry, Change, 

Challenge, and Competition, A Report to the President and Congress, August 1993. 
Page 12 GAO-05-835T 

Figure 6: Growth of Airline Industry Capacity and Major Airline Liquidations Billions of ASMs, Moving Quarterly Average, 

1978-2004 

Note: Figure does not show liquidations of smaller airlines. 

Similarly, our research does not indicate that the departure or liquidation 

of a carrier from an individual market necessarily leads to a permanent 

decline in traffic for that market. We contracted with Intervistas/GA2, an 

aviation consultant, to examine the cases of six hub cities that 

experienced the departure or significant withdrawal of service of an 

airline over the last decade (see table 1). In four of the cases, both local 

origin-and-destination (i.e., passenger traffic to or from, but not 

connecting through, the local hub) and total passenger traffic (i.e., local 

and connecting) increased or changed little because the other airlines 

expanded their traffic in response. In all but one case, fares either 

decreased or rose less than 6 percent. 

Source: Bankruptcy filings, media reports, and DOT Form 41 data.

Recession

Billions of available seat miles, 4 quarter moving average

0

50

100

150

200

250

300

350

1978

1980

1982

1984

1986

1988

1990

1992

1994

1996

1998

2000

2002

2004

Quarter

Air Florida

People’s 

Express

Pan Am

Midway

Western 

Pacific

Reno Air

Braniff Eastern

911

TWA
Page 13 GAO-05-835T 

Table 1: Case Examples of Markets’ Response to Airline Withdrawals 

Market Year Airline Effect on passenger traffic 

Change in 

fares

Nashville, TN 1995 American Airlines 

eliminated hub 

Other airlines’ traffic 

increased. Origin and 

destination traffic increased. 

-10.2%

Greensboro, 

NC 

1995 Continental Lite 

eliminated hub 

Other airlines’ traffic 

increased. Origin and 

destination traffic decreased. 

+5.5%

Colorado 

Springs, CO 

1997 Western Pacific 

moved operations 

to Denver 

Other airlines’ traffic 

decreased Origin and 

destination traffic decreased. 

+43.6%

St. Louis, MO 2001 TWA acquired by 

American Airlines 

Other airlines’ traffic 

decreased. Little change in 

origin and destination traffic. 

+5.4%

Kansas City, 

MO 

2002 Vanguard Airlines 

suspended 

service 

Little change in other airlines’ 

traffic. Little change in origin 

and destination traffic. 

+4.2%

Columbus, 

OH 

2003 America West 

eliminated hub 

Other airlines’ traffic 

increased. Little change in 

origin and destination traffic. 

+3.6%

Source: Intervistas/GA2. 

Note: Little change in traffic means that traffic increased or decreased less than 5 percent and that 

origin and destination traffic increased or decreased less than 10 percent. Changes in passenger 

traffic and fares are measured from 4 quarters prior to the airline departure to 8 quarters after. 

We also reviewed numerous other bankruptcy and airline industry studies 

and spoke to industry analysts to determine what evidence existed with 

regard to the impact of bankruptcy on the industry. We found two major 

academic studies that provided empirical data on this issue. Both studies 

found that airlines under bankruptcy protection did not lower their fares 

or hurt competitor airlines, as some have contended. A 1995 study found 

that an airline typically reduced its fares somewhat before entering 

bankruptcy. However, the study found that other airlines did not lower 

their fares in response and, more importantly, did not lose passenger 

traffic to their bankrupt rival and therefore were not harmed by the 

bankrupt airline.9

 Another study came to a similar conclusion in 2000, this 

time examining the operating performance of 51 bankrupt firms, including 

 9

Do Airlines In Chapter 11 Harm Their Rivals?: Bankruptcy and Pricing Behavior in 

U.S. Airline Markets National Bureau of Economic Research Working Paper 5047, Severin 

Borenstein and Nancy L. Rose, February 1995. 
Page 14 GAO-05-835T 

5 airlines, and their competitors.10 Rather than examine fares as did the 

1995 study, this study examined the operating performance of bankrupt 

firms and their rivals. This study found that bankrupt firms’ performance 

deteriorated prior to filing for bankruptcy and that their rivals’ profits also 

declined during this period. However, once a firm entered bankruptcy, its 

rivals’ profits recovered. 

Under current law, legacy airlines’ pension funding requirements are 

estimated to be a minimum of $10.4 billion from 2005 through 2008.11 These 

estimates assume the expiration of the Pension Funding Equity Act 

(PFEA) at the end of this year.12 The PFEA permitted airlines to delay the 

majority of their deficit reduction contributions in 2004 and 2005; if this 

legislation is allowed to expire it would mean that payments due from 

legacy airlines will significantly increase in 2006. According to PBGC data, 

legacy airlines are estimated to owe a minimum of $1.5 billion this year, 

rising to nearly $2.9 billion in 2006, $3.5 billion in 2007, and $2.6 billion in 

2008. In contrast, low cost airlines have eschewed defined benefit pension 

plans and instead use defined contribution (401k-type) plans. 

However, pension funding obligations are only part of the sizeable amount 

of debt that carriers face over the near term. The size of legacy airlines’ 

future fixed obligations, including pensions, relative to their financial 

position suggests they will have trouble meeting their various financial 

obligations. Fixed airline obligations (including pensions, long term debt, 

and capital and operating leases) in each year from 2005 through 2008 

exceed total cash balances of these same legacy airlines by a substantial 

amount. Legacy airlines carried cash balances of just under $10 billion 

going into 2005 (see figure 7). These airlines fixed obligations are 

estimated to be over $15 billion in both 2005 and 2006, over $17 billion in 

2007, and about $13 billion in 2008. Fixed obligations in 2008 and beyond 

will likely increase as payments due in 2006 and 2007 may be pushed out 

 10The Effect of Bankruptcy Filings on Rivals’ Operating Performance: Evidence From 51 

Large Bankruptcies, Robert E. Kennedy, International Journal of the Economics of 

Business; Feb. 2000; pp. 5-25. 

11These estimates include only legacy airlines that continue to sponsor defined benefit 

pension plans and reported their estimated pension obligations to PBGC. Pension law 

provisions prohibit publicly identifying the airlines that have reported this information. 

12Pension Funding Equity Act of 2004 (P.L. 108-218, April 10, 2004). The PFEA also changed 

the interest rate used to calculate future liability from the 30-year Treasury bond to a 

corporate bond rate, which effectively reduces future liabilities. 

Legacy Airlines Face 

Significant Near-term 

Liquidity Pressures, 

including $10.4 Billion 

in Pensions 

Contributions over 

the Next 4 Years 
Page 15 GAO-05-835T 

and new obligations are assumed. If these airlines continue to lose money 

this year as analysts predict, this picture becomes even more tenuous. 

Figure 7: Comparison of Legacy Airline Year-end 2004 Cash Balances with Fixed 

Obligations, 2005-2008 

The enormity of legacy airlines’ future pension funding requirements is 

attributable to the size of the pension shortfall that has developed since 

2000. As recently as 1999, airline pensions were overfunded by $700 

million based on Security and Exchange Commission (SEC) filings; by the 

end of 2004 legacy airlines reported a deficit of $21 billion (see figure 8), 

despite the termination of the US Airways pilots plan in 2003. Since these 

filings, the total underfunding has declined to approximately $13.7 billion, 

0

5

10

15

20

Other obligations

Operating leases

Capital leases

Long term debt

Pension obligations

Cash at end of 2004

2004 2005 2006 2007 2008 

In billions of dollars

Source: PBGC and SEC filings.
Page 16 GAO-05-835T 

due in part to the termination of the United Airline plans and the 

remaining US Airways plans.13

Figure 8: Funded Status of Legacy Airline Defined Benefit Plans, 1998-2004 

Note: The termination of the United Airlines and remaining US Airways defined benefit pension plans 

in 2005 reduced the total shortfall to approximately $13.7 billion, based on 2004 year-end data. 

The extent of underfunding varies significantly by airline. At the end of 

2004, prior to terminating its pension plans, United reported underfunding 

of $6.4 billion, which represented over 40 percent of United’s total 

operating revenues in 2004. In contrast, Alaska reported pension 

underfunding of $303 million at the end of 2004, or 13.5 percent of its 

 13SEC data and PBGC data on the funded status of plans can differ because they serve 

different purposes and provide different information. The PBGC report focuses, in part, on 

the funding needs of each pension plan. In contrast, corporate financial statements show 

the aggregate effect of all of a company’s pension plans on its overall financial position and 

performance. The two sources may also differ in the rates assumed for investment returns 

on pension assets and in how these rates are used. As a result, the information available 

from the two sources can appear to be inconsistent. PBGC data also are not timely. For 

more information, see GAO, Private Pensions: Publicly Available Reports Provide Useful 

but Limited Information on Plans’ Financial Condition (GAO-04-395) March 31, 2004. 

-25

-20

-15

-10

-5

0

5

1998 1999 2000 2001 2002 2003 2004

In billions of dollars

Source: GAO analysis of SEC filings.
Page 17 GAO-05-835T 

operating revenues. Since United terminated its pensions, Delta and 

Northwest now appear to have the most significant pension funding 

deficits—over $5 billion and nearly $4 billion respectively—which 

represent about 35 percent of 2004 operating revenues at each airline. 

The growth of pension underfunding is attributable to 3 factors. 

• Assets losses and low interest rates. Airline pension asset values dropped 

nearly 20 percent from 2001 through 2004 along with the decline in the 

stock market, while future obligations have steadily increased due to 

declines in the interest rates used to calculate the liabilities of plans. 

• Management and labor union decisions. Airline management has funded 

their pension plans far less than they could have. For example, PBGC 

examined 101 cases of airline pension contributions from 1997 through 

2002; these cases covered 18 pension plans sponsored by 5 airlines.14

During this time, $28.2 billion dollars could have been contributed to these 

pension plans on a tax-deductible basis; actual contributions amounted to 

$2.4 billion, or about 8.5 percent of what they could have contributed, 

despite earning profits in 1997-2000 (see figure 9)15 The maximum 

deductible contribution was made in only 1 of the 101 pension 

contribution cases examined by PBGC. In addition, management and labor 

have sometimes agreed to salary and benefit increases beyond what could 

reasonably be afforded. For example, in the spring of 2002, United’s 

management and mechanics reached a new labor agreement that 

increased the mechanics’ pension benefit by 45 percent, but the airline 

declared bankruptcy the following December. 

 14Of 108 possible cases, 4 were eliminated because the carrier was in bankruptcy; in 3 cases 

data was missing. 

15Pension funding rules permit sponsors to choose the interest rate used to determine the 

maximum deductible pension contribution permitted from an interest rate “corridor” – a 

limited range of interest rates. In calculating the maximum deductible contribution, a 

higher interest rate produces a lower contribution limit. In the 101 cases PBGC examined 

from 1997 through 2002, airlines used the highest interest rate permitted in 86 cases, and 

the lowest interest rate permitted in 1 case. Using the interest rates chosen by the airlines, 

the maximum deductible contribution was calculated to be $9.1 billion for these 101 cases. 

PBGC recalculated the maximum deductible contribution in each case using the lowest 

interest rate the airline could have chosen to determine the maximum deductible 

contribution of $28.2 billion. 
Page 18 GAO-05-835T 

Figure 9: Comparison of Legacy Airline Pension Maximum and Actual 

Contributions and Operating Profits, 1997-2002 (Billions of dollars) 

• Pension funding rules are flawed. Existing laws and regulations 

governing pension funding and premiums have also contributed to the 

underfunding of defined benefit pension plans. As a result, financially 

weak plan sponsors, acting within the law, have not only been able to 

avoid contributions to their plans, but also increase plan liabilities that are 

at least partially insured by PBGC. Under current law, reported measures 

of plan funding have likely overstated the funding levels of pension plans, 

thereby reducing minimum contribution thresholds for plan sponsors. And 

when plan sponsors were required to make contributions, they often 

substituted “account credits” for cash contributions, even as the market 

value of plan assets may have been in decline. Furthermore, the funding 

rule mechanisms that were designed to improve the condition of poorly 

Fiscal year

In billions of dollars

Source: PBGC and DOT.

-10

-5

0

5

10

15

Operating profit/loss

Maximum possible

Actual contribution

1997 1998 1999 2000 2001 2002
Page 19 GAO-05-835T 

funded plans were ineffective.16

Other legal plan provisions and amendments, such as lump sum 

distributions and unfunded benefit increases may also have contributed to 

deterioration in the funding of certain plans. If large numbers of 

participants in an underfunded plan elect to receive their pension benefits 

in a lump sum, it can create the effect of a “run on the bank” and 

exacerbate the possibility of a plan’s insolvency as plan assets are 

liquidated more quickly than expected. Plan funding can also be worsened 

by unfunded benefit increases. When a pension plan is underfunded and 

the plan sponsor is also in poor financial condition, there is an incentive, 

known as moral hazard, for the plan sponsor and employees to agree to 

pension benefit increases because at least part of the benefit increases 

may be insured by PBGC.17

Finally, the premium structure in PBGC’s single-employer pension 

insurance program does not encourage better plan funding. While PBGC 

premiums may be partially based on plan funding levels, they do not 

consider other relevant risk factors, such as the economic strength of the 

sponsor, plan asset investment strategies, the plan’s benefit structure, or 

the plan’s demographic profile.18 In addition, current pension funding and 

pension accounting rules may also encourage plans to invest in riskier 

assets to benefit from higher expected long-term rates of return.19

The cost to PBGC and participants of defined benefit pension terminations 

has grown in recent years as the level of pension underfunding has 

deepened. When Eastern Airlines defaulted on its pension obligations of 

 16For further information, see U.S. Government Accountability Office, PRIVATE 

PENSIONS: Recent Experiences of Large Defined Benefit Plans Illustrate Weaknesses in 

Funding Rules, GAO-05-294, (Washington, D.C.: May 31, 2005). 

17Currently, some measures exist to limit the losses incurred by PBGC from newly 

terminated plans. PBGC is responsible for only a portion of all benefit increases that the 

sponsor adds in the 5 years leading up to termination. 

18The current premium structure relies heavily on flat-rate premiums, which are unrelated

to risk. PBGC also charges plan sponsors a variable-rate premium based on the plan’s level 

of underfunding; however, not all underfunded plans are required to pay it. 

19In determining funding requirements, a higher expected rate of return on pension assets

means that the plan needs to hold fewer assets in order to meet its future benefit 

obligations. Under current accounting rules, the greater the expected rate of return on plan 

assets, the greater the plan sponsor’s operating earnings and net income. However, with 

higher expected rates of return comes greater risk of investment loss. 
Page 20 GAO-05-835T 

nearly $1.7 billion in 1991, for example, claims against the insurance 

program totaled $530 million in underfunded pensions and participants 

lost $112 million. By comparison, the US Airways and United pension 

terminations cost PBGC $9.6 billion in combined claims against the 

insurance program and reduced participants’ benefits by $5.2 billion (see 

table 2). 

Table 2: Airline Pension Termination Information (in millions of dollars) 

Airline 

Fiscal year of 

plan 

terminations

Benefit 

liability

PBGC 

liability 

Net claim 

on PBGC

Estimated 

participant 

losses

Eastern 1991 1,686 1,574 530 112 

PanAm 1991, 1992 1,267 1,212 753 55 

TWA 2001 1,729 1,684 668 45 

US Airways 2003, 2005 7,900 5,926 3,026 1,974 

United 2005 16,800 13,600 6,600 3,200 

Source: PBGC. 

Note: “Benefit liability” is the full value of the benefits promised to participants and their beneficiaries 

immediately prior to plan termination. “PBGC liability” is the amount that PBGC pays after agency 

limits are imposed. “Net claim on PBGC” is the difference between the PBGC liability and the assets 

PBGC obtains from the plan. “Estimated participant losses”, the difference between the Benefit 

Liability and the PBGC liability, and equals the value of the benefits that plan participants and their 

beneficiaries lose when PBGC takes over a plan. 

In recent pension terminations, active and high salaried employees 

generally lost more of their promised benefits compared to retirees and 

low salaried employees because of statutory limits. For example, PBGC 

generally does not guarantee benefits above a certain amount, currently 

$45,614 annually per participant at age 65.20 For participants who retire 

before 65 the benefits are even less; participants that retire at age 60 are 

currently limited to $29,649. Commercial pilots often end up with 

substantial benefit cuts when their plans are terminated because they 

generally have high benefit plans and are also required by FAA to retire at 

age 60. Far fewer nonpilot retirees are affected by the maximum payout 

limits. For example, at US Airways fewer than 5 percent of retired 

mechanics and attendants faced benefit cuts as a result of the pension 

 20This guarantee level applies to plans that terminate in 2005. The amount guaranteed is 

adjusted (1) actuarially for the participant’s age when PBGC first begins paying benefits 

and (2) if benefits are not paid as a single-life annuity. Because of the way the Employee 

Retirement and Income Security Act of 1974 (ERISA), as amended, allocates plan assets to 

participants, certain participants can receive more than the PBGC guaranteed amount. 
Page 21 GAO-05-835T 

termination. Tables 3 and 4 summarize the expected cuts in benefits for 

different groups of United’s active and retired employees. 

Table 3: United Airlines Active Employee Pension Termination Benefit Cuts 

 Extent of benefit cut 

Plan 

Active 

employees 

in plan

Actives 

employees 

with 

benefits 

cuts 

1% to 

<25% 

>25% to 

< 50% >50% 

Management, 

Administrative, and 

Public Contact 

Employees 20,784 19,231 1,696 15,885 1,650

Ground Employees 16,062 16,062 11,448 3,441 1,173

Flight Attendants 15,024 11,109 1,305 7,067 2,737

Pilots 7,360 7,270 3,927 2,039 1,304

Source: PBGC. 

Note: Calculation estimates made with 1/1/2005 seriatim data 

Table 4: United Airlines Retiree Pension Termination Benefit Cuts 

 Extent of benefit cut 

Plan 

Retirees in 

plan

Retirees 

with 

benefits 

cuts 

<1% to 

<25% 

>25% to 

<50% >50% 

Management, 

Administrative, and 

Public Contact 

Employees 11,360 2,996 2,816 104 76

Ground Employees 12,676 4,961 4,810 121 30

Flight Attendants 5,108 29 27 1 1

Pilots 6,087 3,041 1,902 975 164

Source: PBGC. 

Note: Calculation estimates made with 1/1/2005 seriatim data 

It is important to emphasize that relieving legacy airlines of their defined 

benefit funding costs will help alleviate immediate liquidity pressures, but 

does not fix their underlying cost structure problems, which are much 

greater. Pension costs, while substantial, are only a small portion of legacy 

airlines’ overall costs. As noted previously in figure 3, the cost of legacy 

airlines’ defined benefit plans accounted for a 0.4 cent, or 15 percent 
Page 22 GAO-05-835T 

difference between legacy and low cost airline unit costs. The remaining 

85 percent of the unit cost differential between legacy and low cost 

carriers is attributable to factors other than defined benefits pension 

plans. Moreover, even if legacy airlines terminated their defined benefit 

plans it would not fully eliminate this portion of the unit cost differential 

because, according to labor officials we interviewed, other plans would 

replace them. 

Widely reported recent large plan terminations by bankrupt sponsors such 

as United Airlines and US Airways and the resulting adverse consequences 

for plan participants and the PBGC have pushed pension reform into the 

spotlight of national concern. The effect of various proposals to reform 

pension requirements on airlines, PBGC, and plan participants will vary. 

The funding relief afforded by PFEA will expire at the end of this year and 

many agree that the current rules are flawed and must be fixed. Various 

proposals have been made to correct these rules and shore up the PBGC 

guaranteed plans, and these proposals are still being debated. The 

administration has proposed tightening the funding rules among other 

changes. Some of the legacy airlines with large shortfalls have endorsed 

another bill in the Senate for a 25-year payback period if current plans are 

frozen. However, one legacy airline that has better funded its plan, while 

supporting a longer payback period, opposes freezing their plan. 

While the airline industry was deregulated 27 years ago, the full effect on 

the airline industry’s structure is only now becoming evident. Dramatic 

changes in the level and nature of demand for air travel combined with an 

equally dramatic evolution in how airlines meet that demand have forced a 

drastic restructuring in the competitive structure of the industry. Excess 

capacity in the airline industry since 2000 has greatly diminished airlines’ 

pricing power. Profitability, therefore, depends on which airlines can most 

effectively compete on cost. This development has allowed inroads for low 

cost airlines and forced wrenching change upon legacy airlines that had 

long competed based on a high-cost business model. 

The historically high number of airline bankruptcies and liquidations is a 

reflection of the industry’s inherent instability. However, this should not 

be confused with causing the industry’s instability. There is no clear 

evidence that bankruptcy has contributed to the industry’s economic ills, 

including overcapacity and underpricing, and there is some evidence to 

the contrary. Equally telling is how few airlines that have filed for 

bankruptcy protection are still doing business. Clearly, bankruptcy has not 

afforded these companies a special advantage. 

Concluding 

Observations 
Page 23 GAO-05-835T 

Bankruptcy has become a means by which some legacy airlines are 

seeking to shed their costs and become more competitive. However, the 

termination of pension obligations by United Airlines and US Airways has 

had substantial and wide-spread effects on the PBGC and thousands of 

airline employees, retirees, and other beneficiaries. Liquidity problems, 

including $10.4 billion in near term pension contributions, may force 

additional legacy airlines to follow suit. Some airlines are seeking 

legislation to allow more time to fund their pensions. If their plans are 

frozen so that future liabilities do not continue to grow, allowing an 

extended payback period may reduce the likelihood that these airlines will 

file for bankruptcy and terminate their pensions in the coming year. 

However, unless these airlines can reform their overall cost structures and 

become more competitive with low cost competition; this will be only a 

temporary reprieve. 

As we have previously reported, the Congress should consider broad 

pension reform that is comprehensive in scope and balanced in effect.21

Revising plan funding rules is an essential component of comprehensive 

pension reform. For example, we testified that Congress should consider 

the incentives that pension rules and reform may have on other financial 

decisions within affected industries. Under current conditions, the 

presence of PBGC insurance may create certain “moral hazard” 

incentives—struggling plan sponsors may place other financial priorities 

above “funding up” its pension plan because they know PBGC will pay 

guaranteed benefits. Further, because PBGC generally takes over 

underfunded plans of bankrupt companies, PBGC insurance may create an 

additional incentive for troubled firms to seek bankruptcy protection, 

which in turn may affect the competitive balance within the industry. 

In light of the intrinsic problems facing the defined benefit system, 

meaningful and comprehensive pension reform is required to ensure that 

workers and retirees receive the benefits promised to them. Ideally, 

effective reform would incorporate many elements, among them: 

 21See GAO-04-90; GAO-05-108T; GAO, Pension Benefit Guaranty Corporation: SingleEmployer Pension Insurance Program Faces Significant Long-Term Risks, GAO-03-873T

(Washington, D.C.: Sept. 4, 2003); Pension Benefit Guaranty Corporation: Long-Term 

Financing Risks to Single-Employer Insurance Program Highlight Need for 

Comprehensive Reform, GAO-04-150T (Washington, D.C.: Oct. 14, 2003); Private Pensions: 

Changing Funding Rules and Enhancing Incentives Can Improve Plan Funding, 

GAO-04-176T (Washington, D.C.: Oct. 29, 2003). 
Page 24 GAO-05-835T 

• improving the accuracy of plan funding measures while minimizing 

complexity and maintaining contribution flexibility; 

• revising the current funding rules to create incentives for plan sponsors to 

adequately finance promised benefits; 

• developing a more risk-based PBGC insurance premium structure and 

providing incentives for sponsors to fund plans adequately; 

• addressing the issue of underfunded plans paying lump sums and granting 

benefit increases; 

• modifying PBGC guarantees of certain plan benefits; 

• resolving outstanding controversies concerning hybrid plans by 

safeguarding the benefits of workers regardless of age; and 

• improving plan information transparency for pension plan stakeholders 

without overburdening plan sponsors. 

The various proposals for comprehensive reform advanced by the 

Administration and various members of Congress could be a critical first 

step in addressing part of the long-term stability of the private defined 

benefits system. While we understand the legacy airline’s liquidity 

pressures and their request for assistance, the uncertain efficacy of 

industry-specific relief needs to be weighed against the potential effects on 

both the industry and the government. At this point, because of a lack of a 

thorough understanding of those effects, particularly as they might change 

under various specific legislative proposals, we would suggest proceeding 

carefully, relying on sound fiduciary principles as a guide. 

This concludes my statement. I would be pleased to respond to any 

questions that you or other Members of the Subcommittee may have at 

this time. 

For further information on this testimony, please contact JayEtta Hecker 

at (202) 512-2834 or by e-mail at heckerj@gao.gov; or Barbara Bovbjerg at 

(202) 512-7215 or by e-mail at bovbjergb@gao.gov. Individuals making key 

contributions to this testimony include Joe Applebaum, Paul Aussendorf, 

Anne Dilger, David Eisenstadt, Charles Ford, Charles Jeszeck, Steve 

Martin, George Scott, Richard Swayze, and Pamela Vines. 

(544108) 
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