GM’s Get-Well Plan

Paying for health care means accepting uncertainty. Even with insurance, it’s impossible to know when a sudden illness or accident might turn a family’s finances inside out. Corporate America has learned its own version of that lesson. When General Motors first offered health-care benefits for its retirees in the 1960s–a perk matched by many other companies across a booming industrial landscape–it couldn’t have known that 40 years later, health-care costs would grow three times faster than inflation, that its retirees would one day outnumber current employees by more than 3 to 1 or that the cost of that promise would grow to more than $50 billion, a liability that threatens to undo the company altogether.

So the world’s largest automaker is desperately trying to hammer out a new contract that would shift the burden to the United Auto Workers (UAW), the union that represents 73,000 of GM’s employees and nearly 270,000 retirees. The company wants to fund a health-care trust, administered by the UAW, to pay for retirees’ medical needs. The union’s old contract expired Sept. 14, and the creation of that trust has emerged as the principal stumbling block to a new one. An eventual deal looks likely; the two sides are haggling furiously over exactly how much GM will pay into the fund. Its outcome could set a new course not just for the U.S. auto industry but also for every private and public employer facing onerous retiree costs as the population ages.

The trust that GM has in mind, called a voluntary employees’ beneficiary association (VEBA) according to the 1928 tax law that governs such trusts, would create an independent body, run by the UAW, with the sole responsibility of paying for the health care of GM’s retirees and their spouses. It won’t come cheap. Analysts estimate that GM could end up paying 60 to 70 cents on the dollar of its $50 billion obligation to establish the trust. But investors have been pushing for a VEBA since Goodyear set up a similar plan with the United Steelworkers last year. Wall Street, after all, hates uncertainty and loves cash flow, and a VEBA would once and for all limit how much GM spends on its retirees–a savings of about $2.5 billion a year–enough for GM to fund a new car program and a more efficient engine every year. “With the health-care burden gone, GM becomes a much more competitive company,” says David Cole, chairman of the Center for Automotive Research in Ann Arbor, Mich.

Could this deal save the U.S. auto industry? It would certainly help. Once GM sets up a VEBA, Ford will probably follow. Chrysler, which became a privately held company in August and has far fewer retirees, has so far balked. “It’s not our issue,” says a Chrysler official. The companies can use the freed-up cash to spend on developing and selling better cars to take on Toyota, which this year surpassed GM in sales. But that’s in the long run. In the short run, funding the trust could put carmakers in a tighter cash squeeze unless they raise the money by floating stock or issuing debt. “It’s not the best time to go out and raise money,” says GM CEO Rick Wagoner.

In a country where the number of people over 65 will nearly double from 35 million in 2000 to 69 million in 2030, the idea of a health-care trust fund may soon become a model for other companies, particularly those in other struggling Rust Belt industries with lots of retirees. “It’s not a bottomless pit, which is what employers are afraid of,” says Helen Darling, president of the National Business Group on Health, a health-care-policy group for FORTUNE 500 companies. That fear has pushed many companies out of providing retiree health benefits; only 33% of companies with more than 200 employees offer them, compared with 66% in 1988.

Those that do are eliminating the financial uncertainty. Darling says some young, growing companies see retiree health benefits as a useful recruiting tool. “It’s back on the table,” she says. But no company is willing to make open-ended promises. “They’ll say, We’ll give you an allowance or a fixed subsidy–as long as we can afford it–but we’re not going to give you retiree health benefits,” Darling explains. “There’s a big difference.” It’s a shift similar to the one that transformed retirement, replacing the defined lifetime benefit of a pension with a defined contribution to a 401(k). The risk becomes the employee’s, not the company’s.

In this case it’s the unions that will have to bear the risk of hikes in health-care costs. The UAW will have to face the same hard choices the automakers do: balancing rising expenses with limited funds and a promise to cover everyone. “They cannot control it. They can’t,” says Uwe Reinhardt, an economist at Princeton University and an expert on health policy. “The union will just lose that deal.” And before long, he says, the UAW will find itself having to limit choices, reduce costs and ask members to contribute money to keep the plan afloat–the same cuts proposed by carmakers that union negotiators have fought off for years.

Those concerns are weighing heavily on UAW members, who are very much aware that VEBAs at Caterpillar and Detroit Diesel have gone bankrupt. Three former UAW executive board members recently signed a letter criticizing the VEBA plan as “knowingly placing members at risk.” The other option, though, is losing retiree health benefits entirely. “If you don’t go along with a VEBA, the automakers may reach a point where the only alternative is to file Chapter 11,” says Eric Merkle of IRN Automotive Intelligence. “The UAW has to take on more of the risk.”

It’s not just a corporate problem either: the weight of retiree health-care costs could crush state and local governments. The largest employers in the U.S., state and local governments sign the paychecks for more than 16 million Americans, many of them with generous health benefits in retirement. Municipalities, unlike private companies, are not required to account for their unfunded retirement obligations, but they will be soon.

The results will not be pretty. “Look what happened in New Jersey,” says Stuart Altman, an economist and professor of national health policy at Brandeis and a longtime policy adviser on health care. The state recently revealed that it faces a $58 billion shortfall in funding for retiree health care, even larger than GM’s. To meet that gap, New Jersey has asked retirees to pay more in premiums, but the state may eventually have to scale back spending on services like public colleges and mass transportation. Some cities, such as New York and Duluth, Minn., have already set up health-care trust funds. Others may follow–or risk getting downgraded by bond-rating agencies.

Perhaps the greatest significance of the coming GM-UAW deal is that it’s another step in the decline of employer-sponsored health care. UAW president Ron Gettelfinger says he would prefer a single-payer system, which would relieve the burden for both GM and the union. That won’t fly, but presidential candidates will offer other ideas. The crisis in Detroit shows, in the extreme, that corporate paternalism in the form of health insurance has outlived its usefulness. GM’s biggest mistake may have been to assume that it would always be strong enough to handle the promises it made in its powerful prime. No company–and no worker–can afford to make that assumption anymore. This new reality requires a new covenant.