Underfunded Pension? Just Add Stock

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The U.S. Department of Labor has granted struggling Northwest Airlines (Nasdaq: NWAC) permission to contribute stock from a subsidiary in lieu of cash to its underfunded pension plans.

So, instead of the $223 million scheduled funding requirement for Northwest's pension coming this year in cash, it will all be satisfied with stock of a closely held subsidiary, Pinnacle Airlines. Other companies that have massive pension liabilities are bound to be watching this with great interest. The Labor Department is calling this action at Northwest exactly what it should be known as: an exemption.

Some pension experts have pointed to this as another in an unnerving set of moves by companies to avoid putting cash into their pension plans. Northwest has received some dispensation to delay large components of its scheduled contribution for 2003. But by opting to pay other due amounts in stock, Northwest Airlines keeps from falling further behind on its funding requirements. It's just using a source that is normally unqualified to keep up.

Northwest has plans to take Pinnacle public, but at its present implied valuation, Northwest's pension fund will own more than 60% of the company. Under the Employee Retirement Income Safety Act, or ERISA, companies are generally prohibited from making in-kind contributions, but can be granted exceptions if they appoint independent fiduciaries. In this case, Aon Consulting (NYSE: AOC) is managing the grant, and can force Northwest Airlines to buy back the stock if its value drops too low. Of course, all bets are off in the event of Northwest going bankrupt.

This seems to be a dangerous precedent, as in-kind assets are generally less secure than good old cash, and provide the pension administrator substantially less flexibility in determining asset mixes. Northwest's pension manager cannot easily sell a 60% stake in Pinnacle, except back to Northwest. On the other hand, pension realities are pushing companies to the breaking point. Given the choice between taking an illiquid security into pension and the threat of the company collapsing, I suspect most people would accept Column A, even if it's not necessarily ideal.

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