AMR Corp, the bankrupt parent of American Airlines, on Wednesday proposed a plan to freeze pensions covering many of its workers, retreating from an earlier proposal to terminate them and leave them to government insurers, which could result in lower payouts.

The proposal, which would avert the largest pension default in U.S. history, could move the third-largest U.S. airline a step closer to consensual deals with its major unionized work groups as its struggles to slash uncompetitive labor costs.

AMR, which filed for Chapter 11 on November 29, had been the only major airline to avoid bankruptcy in the last decade and is the only one that still has traditional, or defined benefit, pensions, the company said.

"Freezing the defined benefit pension plans would mean that employees would retain the full value of benefits accrued for service prior to the date the plan is frozen," said Jeff Brundage, AMR's senior vice president of human Resources, in a letter to employees.

"Freezing instead of terminating these plans of course would mean we will have significantly larger pension costs than contemplated in our business plan," Brundage said.

AMR has said it must cut 13,000 jobs as part of a plan to trim costs by $2 billion, including $1.25 billion in labor costs. AMR said it still must achieve the labor savings target and it would seek new capital to cover the incremental annual costs of funding frozen pensions.

AMR said in letters to employees that the pension proposal does not extend to its pilots because their plan includes provisions for a costly lump sum payout to retiring workers that other work groups do not have.

"Given the number of pilots who are eligible to retire, the company would be at significant operational risk if we emerge from Chapter 11 with a frozen plan that allows pilots to retire with a lump sum benefit," Brundage said. AMR still wants to terminate the pilots' plan unless it can get the lump sum matter resolved.

The Allied Pilots Association said in a letter to members that it would ask them to waive the lump sum option in the plans that feature it so that those pensions can be frozen as well.

"Our plan is the only one on the AMR property that includes the option of a lump sum and our experts have concluded that attempting to preserve a lump-sum option is not achievable," APA President David Bates said.

VICTORY FOR PENSION INSURER

AMR said in February that it would seek bankruptcy court approval to terminate traditional pension plans covering 130,000 workers and retirees. Those plans would be replaced with 401(k) plans with a company match.

Employer-financed defined benefit plans provide a fixed payout over time and are historically more generous than the 401(k) or other cash plans that mix employee and employer contributions that are more common today.

Traditional pensions are often still found in heavily unionized industries such as airlines, autos and aerospace.

AMR's pensions covering pilots, flight attendants and ground workers were underfunded by an estimated $10 billion when the company filed for bankruptcy. Underfunding is the difference between the assets in a plan and the amount of future obligations. United Airlines had the largest pension default in the United States at nearly $9 billion underfunded.

The decision is a victory for U.S. pension insurers, who waged a public campaign against plans by American to cancel its pensions in bankruptcy.

"Bankruptcy forces tough choices, but that doesn't mean pensions must be sacrificed for companies to succeed. We will continue to work with American and the other participants in the bankruptcy to ensure that success," Josh Gotbaum, director of the Pension Benefit Guaranty Corp, said in a statement.

The agency reported a record deficit of $26 billion in 2011 and is responsible for payouts to 1.5 million people. It paid more than $5 billion in benefits last year. In many cases, retirees get less in benefits when the government takes over the pensions of bankrupt companies.

The Transport Workers Union, which represents many of the ground workers at AMR, cheered the plan, saying an earlier proposal to terminate pensions was "totally unacceptable."

"I have to say that I do consider it a win because terminating is not an option," TWU President James Little told Reuters. "I think that would have been the most devastating."

He said that while TWU would rather keep its pension plans intact, a freeze is more palatable and advances the union's goal of reaching a deal with AMR.

The Association of Professional Flight Attendants said on its website that it has not responded to AMR's proposal and that it was "meeting internally to evaluate the proposal."

American has almost 74,000 full- and part-time employees and its regional carrier American Eagle has about 14,000 full- and part-time employees. The company has been leaning on its labor unions to agree to concessions.

Should AMR and its unions be unable to reach consensual deals, AMR could ask the bankruptcy judge to abrogate existing labor deals and allow the company to impose new terms.