Promises, Promises

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

A 2003 tax court ruling may make VEBAs more viable, however. The ruling, in response to a dispute brought by Wells Fargo & Co., eases the annual restriction on companies setting up new trusts, allowing employers to contribute large lump-sum amounts for current retirees and take the full tax deduction.

Life insurance policies could also make the trusts more attractive, says Peter Neuwirth of Clark Consulting. Under this arrangement, a VEBA uses a portion of its assets to pay for life insurance policies on its retirees, then collects the proceeds of the policy tax-free when a retiree dies. Trust-owned life insurance policies “work well because they mature at death and the preponderance of health-care costs are incurred in the year that the individual dies,” says Neuwirth. One company exploring this option is Whirlpool Corp., which is currently petitioning the Department of Labor to allow it to reinsure the policies through a captive insurance company in hopes of getting further tax benefits.

Still, such tax advantages for advance funding will not stem the current cash drain that many companies face. A brighter prospect for many companies is the Medicare Prescription Drug, Improvement and Modernization Act of 2003. The act, which offers qualifying employers a 28 percent subsidy for the cost of any drugs they help Medicare-eligible employees pay for, could slice up to 15 percent off total retiree medical costs, says Frank McArdle, head of the Washington, D.C., office of Hewitt Associates.

The promise of subsidies has enabled some businesses to take the costs out of future liabilities with FASB’s blessing, adding much-needed dollars back to net income. GM, for one, subtracted $4 billion from its OPEB obligation as a result. Savings are not insignificant, either: Lucent Technologies expects to save $65 million in cash annually starting in 2007.

Exactly how the subsidy will work—and how companies will maximize the benefits to employees—is still uncertain. Experts warn that providing coverage that wraps around the Medicare plan can be tricky, thanks to the “doughnut hole” that is built into the benefit. Medicare does not cover a retiree’s out-of-pocket drug expenses if they fall between $2,250 and $5,100; above that point, catastrophic coverage kicks in. Employer dollars would not count against employee out-of-pocket expenses.

Meanwhile, about 8 percent of companies have simply dropped their prescription-drug coverage since the Medicare reform act was passed.

Shape of The Future

Increasingly, companies are trying to find ways to encourage employees to save their own money for medical costs in retirement. The new health savings accounts (HSA) established by the 2003 Medicare Drug Act are one option. They allow employees to save up to $2,650 pretax per year for medical care. The employee-owned accounts are portable and allow funds to accumulate tax free.

HSAs, though, can’t do much for those in or near retirement. Cara Jareb, director of retiree medical consulting at Watson Wyatt Worldwide, says she is seeing “a newfound interest” in health reimbursement arrangements for retirees, which allow employers to credit a discrete amount of money toward retiree medical benefits to individual employees over any length of time.

The accounts cannot be tapped before retirement and typically do not vest until then, meaning they do not require continuous funding. The approach may not reduce liabilities, but it does limit cash outflow in a more appealing way than a cap on benefits. “It gives employees a lot more flexibility,” says Jareb, “and it sends a more positive message to tell retirees how much money they have, rather than how much they have to kick in.”

Considering the current lack of choices for maintaining retiree medical benefits, the real message may be that employers are doing their level best to live up to promises made to workers.

Alix Nyberg is a contributing editor of CFO.

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