Retiree Health Care Benefits In Jeopardy
By RALPH P. CRAVISO

Retiree health care in the United States has become a topic of concern to all stakeholders involved: employers, employees, current retirees, and government at the state and federal levels. The present is in an environment in which many corporations are scaling back their coverage, shifting costs to retirees who are the least able to afford it. Many of these employers are providing benefits under collectively bargained agreements. As the economic pressures to reduce this benefit grow, the implications for the labor-management community and for future collective bargaining are troubling.

Examining the drivers that jeopardize retiree health care will enable the labor-management community to better understand what options they face and can provide informed input into the public-policy debate that must soon occur. This article outlines some of the key issues, but the examination that America needs must involve the entire labor and employment-relations community.

Out of Control

There are many reasons why there is a question about whether corporations and the public sector are capable of sustaining the current level of retiree health care, including some reasons that may not be immediately apparent. The following are among the major reasons why the ability to provide such benefits is eroding.

The Cost of Care. The cost of health care, particularly for the aged who depend most heavily on prescription drugs (where price escalation has been concentrated), continues to increase at alarming rates that significantly exceed the rate of inflation. Despite the joint efforts of labor and management—including creative responses developed at the collective-bargaining table—the cost of care continues to skyrocket. 1

Competing with Pensions for Cash. Federal legislation currently pending in the Congress will significantly alter the calculation for liabilities associated with defined-benefit pension plans. These changes will increase employers' cash investment requirements in order to secure the funding that can support current pension obligations at corporations providing defined-benefit plans. (The cash drain will be even greater in the event that labor-management negotiations lead to increases in future pensions payments.) Corporations will find that this requirement for additional cash outlays to secure pensions will further erode the affordability of retiree health care.

In future bargaining, labor and management will have to weigh the impact of increased pension costs, which will be required to provide higher future pension payments for current employees, against the relentlessly increasing cost of continued retiree health care for current retirees—a Hobson's choice. 2 Employers will be unable to fund both. Indeed, a growing trend among companies is to freeze defined-benefit plans for those employees currently accruing service credit. This caps an employer's liability and, consequently, additional cash requirements.

Many corporations have also excluded new hire employees from eligibility for defined-benefit plans, substituting defined-contribution plans. In this way, employers can avoid any additional liability or cash funding under the revised rules contained in pending legislation. Many of the same corporations scaling down pension benefits for new hires have discontinued retiree health care benefits for the same workers.

Public Sector Challenges. The public sector faces its own health-care cost challenges. Federal and state governments are experiencing major cost increases because they both provide financial support for retiree health care. The support is provided in two ways: the public sector is an employer (and a large number of government retirees are younger than age 65, which means their costs are usually not yet subsidized by Medicare/Medicaid) and states and the federal government are providers of Medicare/Medicaid. Moreover, on January 1, 2007, state and municipal governments will begin to recognize retiree health care liabilities the same as the private sector does today (see the corporate accounting discussion below). This will generate new requirements for liability recognition, which will impact the financial stability and borrowing power of these government entities.

Over time, the amount of tax dollars that can be generated to support retiree health care will be adversely affected by the retirement of large numbers of currently employed workers, whose tax dollars now support Medicare and Social Security. The problem will be exacerbated because funding requirements for Social Security are projected to increase substantially. As a result, the public sector will be forced to find new sources of tax dollars; scale back benefits levels; or resort to deeper deficit financing.

Given this picture, the health care commitments many corporations and state and municipal entities have made to their employees and retirees must change. For some older companies with large retiree population bases, the cost of retiree health care already approaches or exceeds $1 billion a year.

Impact on Retirees

In the next twenty years, large numbers of baby boomers will be moving from employment to retirement. Many employers have provided health care coverage to those who retiree before age 65, bearing the entire cost until the retiree becomes eligible for Medicare. Any reductions to employer-provided coverage and public programs will increase the burden on retirees, and the burden will likely dramatically increase as the cost of health care rises each year. Since most retirees live on fixed incomes, they will likely be looking for solutions to deal with that growing burden.

Implications for Corporate Accounting

In 1989, a federal accounting standard was adopted that requires U.S.-based corporations to account for the liabilities they accepted for retiree health care (FAS 109). This added billions of dollars of liability to the balance sheets of many companies, adversely affecting their total net worth and ability to borrow for operations or investments.

Although this accounting standard was similar to an earlier one that requires accounting for pension liabilities (FAS 87), the standard affecting retiree health care was less demanding. It allowed companies to recognize only the cost of retiree health care explicitly provided in existing collective-bargaining agreements. Labor and management, in negotiating contracts, “capped” their liability for such health care, essentially recognizing an obligation for retiree health care costs that rose by the rate of inflation anticipated during the life of the collective-bargaining agreement. If the rate of inflation exceeded the cap, many agreements required companies to increase their obligation by the difference, which would require an accounting adjustment. Invariably, in every successive bargaining round, the parties repeated the pattern so that, upon the ratification of a new agreement, corporations were required to make upward adjustments to their liabilities.

Over the course of fifteen years, auditors became uneasy allowing companies to cap their liability in this way. Beginning around 2004, auditors required companies to recognize liability for retiree health care as if they were uncapped, which often added billions of dollars in liabilities. 3 In addition, upward liability adjustments were already being made as a result of runaway health care costs.

The only way corporations could avoid these growing liabilities was to show auditors that they either eliminated retiree health care coverage or introduced measures resulting in substantial and documented cost shifting to retirees. The result: the movement of a financial burden to retirees least able to afford it. Some corporations negotiated such cost shifting to avoid financial obligations that would have made remaining in business impossible.

Use of Chapter 11 Bankruptcy

Recent experience demonstrates that many employers have been unable to continue providing retiree health benefits while under intense pressure to reduce costs. As a result, a number of corporations in troubled industries (steel, airlines, and automotive parts, for example) have filed for reorganization under Chapter 11 of the U.S. bankruptcy code. This forum has permitted many of these companies to avoid their health-care coverage obligations, some of which had been collectively bargained. A clear trend is emerging: troubled companies unable to negotiate retiree health-care cost relief from their unions are resorting to the bankruptcy courts.

Retiree Health Care as a Competitiveness Issue

There is an additional dynamic in the private sector: many large corporations are now viewing the cost of retiree health care as a competitiveness issue. Domestically, many corporations have emerged with the advance of new technologies and the creation of markets for new products. These new companies have no retirees, do not provide retiree health coverage for their current employees, and can offer their products and services without embedded cash requirements, legacy expenses and accounting liabilities. Older, established companies that do provide such benefits for retirees must set aside cash and account for this liability on their balance sheets, hindering their ability to compete. Examples of newer companies competing with older companies abound, especially in steel, telecommunications (services and equipment), airlines, and the automobile industry.

Globally, U.S.-based corporations with legacy costs compete with foreign-based companies that operate in an economic context where their governments provide pensions and health care for all retirees, freeing those corporations from the costs and the accounting liabilities.

The Unfolding Public Policy Debate

American citizens and policymakers are about to engage in a new public-policy debate. While recent efforts by the Bush Administration to address perceived financial shortfalls in Social Security failed to alter the current financing model, that same Administration adopted a costly prescription drug plan that expands health-care cost coverage for retirees. Inflation projections for drug costs suggest the gap in Medicare and Medicaid funding – and the cost of healthcare – is growing exponentially. The shortfall in retiree health care funding by the federal and state governments will soon dwarf the financial problems projected for Social Security.

Further, as corporations hit the wall of benefits affordability and begin to pass more and more costs on to present and future retirees, it will be increasingly difficult to assume that retirees can and should bear that growing burden. As these developments unfold, the country will be thrown into a major health care crisis—one that promises to have a profound economic, political and social impact.

Implications for Collective Bargaining

Neither management nor unions can afford to ignore these issues and simply hope the coming crisis will vanish of its own accord. Short-term solutions can be reached in collective-bargaining negotiations, but both sides must recognize that the current benefit levels cannot be sustained. Dialogue among leaders in labor, management and the academic community can promote education on the issues and allow a climate in which new options can emerge and receive serious consideration. Government will have to play a role and must be a part of that dialogue; partisan politics must be set aside to allow all possible solutions to be examined and judiciously evaluated.

NOTES

1. For an illustration of how management and labor have worked together to contain health care costs at the enterprise level, see Schneider, Thomas J. 2005. “Tackling the Cost of Healthcare Benefits: Cinergy and the IBEW,” Perspectives on Work (Vol. 9, No. 2), pp. 26-28. For a discussion of the skyrocketing cost of such benefits in the United States , see Atchison , Amy. 2006. “Retiree Health Benefits: Trends and Outlook,” Perspectives on Work (Vol. 10, No. 1), pp. 17-19.

2. In the long run, of course, the obligations associated with a defined-benefit plan remain unchanged; still, in the short run companies face a tradeoff between devoting more for pensions or more for health care.

3. For the sake of clarity, it should be noted that an increased liability caused by a change in accounting standards is not the same as an increase in health care costs or employer contributions to a benefits plan. Liabilities can change while the underlying costs and contributions remain unchanged.

Ralph P. Craviso is the senior director, Workforce Effectiveness in Human Resources at Yale University

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