Promises, Promises

Retiree health coverage is a sweetener fewer companies are willing to offer.

John Devine is well known on Wall Street for his candor, and during last October’s earnings conference call, the CFO of General Motors Corp. didn’t disappoint. Yes, he acknowledged, retail incentives and rising operating costs continued to erode GM’s bottom line. “But frankly,” Devine added, “the larger drag we’re getting on our profitability in North America comes from health-care costs and overall legacy costs.”

Although GM stopped promising retiree medical benefits to new workers in the early 1990s, the automaker still carries an enormous liability. In 1997, soon after the Financial Accounting Standards Board required companies to put their promises for retiree medical care on the books, GM set up a dedicated trust to cover its obligation. The trust balance now stands at $16.5 billion, with $5 billion added in 2004 alone. But the annual cash outlay for the benefits has outstripped contributions to the trust almost every year, rising from $2.3 billion in 1998 to $3.6 billion in 2003.

GM is hardly the only company facing crippling retiree health obligations. About 60 percent of large U.S. employers still offer retiree medical benefits, a number that is likely to go down as more companies look to get out from under their onerous retiree health-plan obligations. Certainly few companies have enough assets to offset the liabilities, because they are not legally required to do so. The S&P 500′s OPEB (other postretirement employee benefits) obligations were only 12 percent funded in 2003, according to Credit Suisse First Boston analyst David Zion, leaving companies with unfunded liabilities of $339 billion at the end of that year.

Thanks to the Securities and Exchange Commission, the problem is going to get even worse. The agency is now reviewing the assumptions GM and Ford Motor Co. used in calculating future health-care liabilities. The scrutiny is spurring many companies to look harder at their own assumptions, which generally “have simply not kept pace with reality,” says Mark Oline, managing director of Fitch Ratings. Most businesses have used projections that health-care costs would increase between 8 percent and 11 percent in 2004, declining gradually to about 5 percent over a five-year period, according to Oline’s research. In fact, health-care costs have been increasing more than 10 percent per year for the past four years, and are likely to continue at that rate for 2005.

Trustworthy?

To reduce costs, an increasing number of corporations—8 percent in 2004—are following GM’s example and simply eliminating retiree health benefits for new hires or current employees. As for current retirees, companies are delicately chipping away at those benefits as well. Some 79 percent in 2004 raised the portion of the premium they expect retirees to pay. Thirteen percent went so far as to shift the full cost of premiums onto retirees. Meanwhile, over half simply capped what they will spend per retiree.

For employers with the means to prefund their obligations, recent developments provide some hope. In general, the trusts that GM and others use—so-called voluntary employee benefit associations, or VEBAs—have offered few advantages. For nonunion employees, annual tax-free employer contributions are capped at the level of annual expenses, making it hard to get ahead. Plus, asset gains are taxable, and the cash is irrevocably locked into the account, even if the liabilities turn out to be lower than initially thought.

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