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Airlines' excess pensions baggage

In the cut-throat world of air transport, one of the biggest upheavals has been the arrival of the no-frills airlines. But it is not only in ticket pricing where these airlines have been able to undercut the national carriers. They have far lower pension costs too. And these add to the competitive pressures they can exert on the traditional carriers.

“Obviously the carriers with legacy defined benefit (DB) schemes have more of a pensions burden, because the low-cost carriers have been able to avoid these schemes as they have only been in existence a relatively short time,” says John McGurk, special adviser, research and policy, British Airline Pilots Association. “The traditional carriers most affected are those which are not generating a large enough cash flow to offset their liabilities.” But these carriers can use contingent assets, and the airline industry is a very asset rich industry.

McGurk says that the action taken by governments and regulatory organisations has made it more expensive to retain DB schemes in the medium term. But he says: “Although DB schemes are more expensive than defined contribution schemes, they bring more benefits in terms of staff retention, especially when there is a worldwide shortage of pilots.”

The larger European airlines are however at a distinct disadvantage compared with US airlines, which can file for Chapter 11 bankruptcy.

“This provides a mechanism for shifting responsibility for pensions to the Pension Benefit Guaranty Corp, the US central insolvency fund,” says David Blake, principal at Mercer’s London office.

US Airways, Northwest and United have all done so in recent years, and have more competitive cost structures as a result.

The pensions headache comes as other factors common to all airlines are biting into yields, or are expected to do so in the near future. These include hikes in taxes (which have the effect of depressing demand), increasing restrictions on carbon emissions and rising fuel and labour costs.

The extent to which the pensions burden affects different airlines can be seen from the table below, which is made up of data from the latest sets of accounts (year ending 2005 or 2006) with the exception of SWISS and Aer Lingus, whose figures are for 2004.

 

We have compared the relative costs of retirement provision with the overall staff remuneration costs, by adding together the retirement benefit and social insurance (ie, national insurance) costs and dividing this by the figure for total remuneration.

For Lufthansa and Iberia the breakdown of pension and social insurance provision was not available.

The figures show how much bigger the pension burden is generally for the national flag carriers, compared with the budget airlines. The biggest relative pension costs are for the national carriers, with the exception of Luxair, which is at the lower end of the scale between easyJet and Ryanair.

One of the most remarkable observations is that three of the national carriers had pension costs of over a quarter of their total remuneration bill.

The airline with the biggest relative pension costs is the Air France/KLM group, whose pension provision is 32.4% - or nearly one-third - of its total remuneration bill. Next comes SAS Group, with 30.45%, followed by Alitalia, with 26%, and British Airways with 23.5%.

One of the reasons for Air France’s relatively high ratio is that under the French national insurance system, a large part of the contributions into the first pillar (ie, state) pension system are made through the employer.

In contrast, Alitalia has a much lower level of second pillar provision - €11m - reflecting the relatively low level of employer’s provision in Italian companies as a whole.

The remaining national carriers for which figures are available - SWISS, Aer Lingus and Luxair - come a long way behind.

For SWISS, pension costs make up only 18.9% of its total wage bill. This has presumably been influenced by the recent restructuring of the airline following Swissair’s demise in 2002. It should also be noted that SWISS is part of the Lufthansa Group.

The other exception is Aer Lingus, where the ratio is 16.6%. The airline is now effectively operating as a hybrid between a traditional and a budget carrier. It describes itself as “a leading low-cost, low-fares Irish airline” but its business model contains elements associated with traditional carriers. For example, it has a mixed fleet of aircraft (budget carriers tend to use one type to get maximum utilisation), operates both long-and short-haul routes, and uses expensive airports.

In contrast with the traditional carriers, the budget airlines had much lower relative pension costs than the big airlines, the highest being easyJet with 15.2%. This was followed by Luxair with 14.8% and Ryanair, with 10.9%.

The gap between the traditional carriers and the budget airlines is also seen in the figures for total pension costs per employee (social insurance costs plus retirement benefit costs divided by total employees).

BA had the highest pension costs per employee, €15,790, followed closely by AF/KLM with €14,899. Some way behind were SAS, with €10,531 and SWISS, with €9,103.

The airlines with the lowest pension costs per employee were Ryanair, with €5,376 and easyJet, with €7,225.

Blake says that airlines, along with companies in other sectors, are now addressing the pensions problem
seriously.

He says: “It is only recently, with IAS 19 and the emergence of pension deficits, that board meetings have started to include the subject of pensions. Broadly speaking, the bigger the liability and/or deficit in relation to the market capitalisation, the more serious the board discussion. Although the problem is now better appreciated, relatively few UK companies have begun to de-risk their pension schemes in a significant way, such as by adopting liability-driven investment schemes, although this is becoming more common in some other European countries, such as Germany and the Netherlands, partly because of legislation.”

British Airways of course has announced steps towards plugging its well-publicised pension deficit, while retaining its defined benefit scheme.

The actuarial deficit on its main pension scheme, the New Airways Pension Scheme (NAPS), has risen from £928m (€1.3bn) in 2003 to £2.1bn, despite a doubling of BA’s contributions and a stock market recovery.

BA and the pension scheme trustees have now agreed in principle a 10-year funding plan to tackle the deficit and keep NAPS as a final salary scheme.

The airline will make a one-off cash injection of £800m and pay up to £50m a year for the next three years, subject to its year-end cash balances remaining above £1.8bn, and staff accepting future benefit reductions.

 

hese include raising the normal retirement age to 65, a lower accrual rate, inflation capped pensionable pay increases, capped pension increases on retirement and sharing life expectancy.

BA says its contribution to NAPS last year was £235m - the equivalent of five times members’ contributions. Without future benefit changes, it says contributions would have to increase to £497m per annum.

On advice from Price Waterhouse Coopers, the trustees have said BA could not afford contributions much above current levels and could not use all its cash reserves to pay off all the deficit because it would put the “long term viability of BA in jeopardy”.

“BA has got a major deficit, but we are hopeful we will get a solution and funding plan in place in the New Year,” says McGurk.

For any airline, one potential factor exerting pressure against the wholesale downsizing of pension schemes is pressure from the unions.

Blake says: “Our understanding is that, generally, there is significantly less union involvement with the budget airlines than with the traditional airlines. However, in continental Europe, all airlines must still comply with local legislation concerning works councils and employee representation. Budget airlines cannot escape from these requirements.”

Meanwhile, McGurk says: “We find a lot of companies are retaining their final salary schemes because of the regulatory obligations. And there are also chances for employees to get into a DB scheme where hybrid schemes have been developed instead.”

And he adds: “Pension costs have been a critical factor in airline costs but they can be contained, in consultation with employees. Members are paying more for the problems of the national carriers - they are just another risk.”

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