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New GM Slogan Viva the VEBA

October 18, 2007
Related Topics: Benefit Design and Communication, Health and Wellness, Featured Article
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The bold deal that brought an end to a two-day walkout by the United Auto Workers at General Motors plants across the nation is being hailed as a landmark. But for the deal to last, the union will have to be extraordinarily nimble both in managing health care costs and investing a huge pile of money.

    At the heart of it all is an agreement that, for the first time, puts responsibility for administering the health care benefits of some 340,000 GM retirees (or surviving spouses) on the shoulders of the union rather than on the company.

    Under the proposed contract, GM will place about $30 billion into a trust known as a voluntary employees beneficiary association, or VEBA, which the UAW will then oversee.

    Within the past year, Dana Corp. and Goodyear Tire & Rubber Co. have established and funded such trusts that unions will use to pay for health care for their retirees, but these plans must still be approved by the courts.

    The GM arrangement will allow the automaker to remove some $51 billion in unfunded retiree health care benefit obligations from its balance sheet—a liability that had dragged down GM’s debt ratings and share price. But the financial risks the union is assuming seem substantial.

    In taking over management of the VEBA, the UAW will also be responsible for absorbing any price increases in health care costs into the future. And the funding for the VEBA falls short of that $51 billion estimate of the cost of the obligations.

    The $30 billion that GM is providing to the trust will be supplemented by cost-of-living adjustments and a 2008 wage increase for active workers that are to be diverted into the VEBA. GM has also committed to ponying up as much as another $1.6 billion of "backstop" payments if the VEBA threatens to run short of funds. And while GM will fund the VEBA at the start of 2008, it will continue paying for retiree health care through the end of 2009, at an estimated cost of $5.4 billion, giving the vehicle a couple of years to earn returns on the GM funding.

    David Lipsky, director of the Scheinman Institute on Conflict Resolution at Cornell University, noted that the calculations that went into setting up the VEBA, like projecting retirees’ health care costs for decades, required the UAW to make many assumptions about things like longevity and health care cost inflation.

    "If they’re wrong, for example, about the rate of increase in health care costs, then they could be woefully wrong on how long this fund will be solvent," Lipsky said. The UAW has estimated the VEBA’s funding will last 80 years.

    There are also risks around investing the VEBA’s assets, which could be depleted if its investment managers make bad decisions or the stock market takes a bad turn.

    In fact, another VEBA that was negotiated with the UAW not too long ago has already gone south. Earthmoving-equipment maker Caterpillar established a VEBA to manage its retirees’ health care costs in 1998, paying a reported $32.3 million into it. That VEBA ran short in 2004, after just six years, and has now spawned a rash of lawsuits, with retirees suing to keep Caterpillar from increasing their share of health care costs and Caterpillar in turn suing the UAW. The lawsuits remain unresolved.

    But from the UAW’s perspective, the financial risks involved in overseeing the VEBA apparently look good when compared with the prospect that a GM bankruptcy could result in the disappearance of all retiree health benefits.

    In a letter to GM retirees, UAW president Ron Gettelfinger pointed out that GM’s obligation to pay retiree medical benefits is "largely unfunded" and that if the company filed for bankruptcy, "retiree medical benefits could be cut or eliminated entirely."

    "We have seen thousands of retirees at other companies lose their retiree medical benefits completely when the employer that promised to pay them sought ‘protection’ in the bankruptcy courts," Gettelfinger wrote. "We do not ever want to see UAW GM retirees in that position."

    The agreement between GM and the UAW has yet to be approved by all union members. By late last week, at least seven local union shops had approved the deal, but workers at a New York engine plant that’s set to close next year rejected it.

    The UAW is expected to consider similar arrangements on retiree health care in the contracts it will now negotiate with Ford and Chrysler. Given the size and stake of the UAW’s member base—1.1 million current and retired workers from the three automakers—the VEBA deal it struck with GM has some health care experts pondering the move as a potential catalyst for real health care reform in a sector that badly needs it.

    "The big news here isn’t the financial vehicle [the VEBA]; the real story is the transfer of responsibility for these health care costs from the company to the union," said Brian Klepper, director of the Center for Practical Health Reform in Atlantic Beach, Florida. "Whoever owns the risk will have an opinion on how to manage that risk."

    For example, Klepper explained, when GM was managing retirees’ health care costs, the UAW negotiators could take a hard line and gripe over workers not getting 100 percent medical coverage or open-ended access to specialists. Now that the UAW will own the risk of managing such costs, union leaders’ perception of what expenditures are truly important could change, and force behavioral change on provider and consumer alike.

    And some health care experts see reasons that GM’s VEBA could turn out better than Caterpillar’s. For one, Caterpillar only funded its trust with cash to cover just 10 percent of its total obligation, practically "setting up the fund for failure," as one consultant, who asked not to be identified, told Financial Week. GM is providing funding equal to more than 60 percent of its liabilities. GM’s timing may also be better. Health care costs were surging back in the late 1990s, when Caterpillar established its VEBA, but since then, the pace of health care inflation has slowed. The Segal Co., a benefits consulting firm in New York, expects annual medical costs to decelerate for the fifth consecutive year in 2008, from a 12 percent increase in 2007 to an 11 percent increase for 2008.

    This cost slowdown "is expected to continue in future years," according to Cara Jareb, an actuary who runs the retiree medical valuation practice at consulting firm Watson Wyatt. "There are other things in the marketplace that have evolved since [2005] that might help the situation," she added.

    For starters, Jareb sees advantages in a raft of better—and cheaper—Medicare products now available to retired workers as a result of the Medicare Modernization Act of 2002, like Medicare Advantage PPOs and Medicare Advantage Private Fee for Service plans. Not only are the products "much more cost-effective than old Medicare, meaning they’re more affordable to retired workers, they’re also more widely available," she said. "Medicare HMOs were geographically limited."

    The Medicare Prescription Drug Plan of 2006 will also be a boon, because retirees can now get their medicine through their health plans, she said.

    Every little thing that Medicare covers is one less expense for the UAW to cover out of the VEBA trust.

    With a cache of money available to cover its retirees’ care, the UAW’s test will be whether it can make that cash stash last. Jareb and Klepper suggested that the UAW will either learn from the lessons of managed care, or it won’t. If open-ended doctor access is important, the UAW can decide to deliver it. The question will be, can it be an effective fiduciary and still do that?

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