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What to do about retiree health care.

The time to act is now because, for most employers, the liability grows every day if no action is taken.

Retiree health care is one of the biggest financial challenges currently facing Corporate America. This problem is of concern to the private sector as well as the federal government because of the size and rapid increase in health care costs and the resulting adverse effects on the ability of American business to compete in world markets. The problem is further complicated by the conflicting interests of employers, employees, retirees, physicians, hospitals, other health care providers, insurance companies, and others involved in the delivery of health care services. In summary, everyone wants unlimited health care but no one wants to pay for it!

There are many dimensions to the retiree health challenge. First of all, retiree health benefits are critical to those employees who have worked for years in anticipation of receiving them. Many people see these benefits as an important factor in their effort to ensure that they have a reasonable standard of living and quality of life in their retirement years.

Despite the importance of these benefits to individuals, they are not subject to many of the federal protections applicable to retirement plans and, consequently, they do not provide retirees with the same level of protection. This allows employers to substantially modify or, in some cases, even cancel these programs without violating federal law.

The general economy as well as the recent changes resulting from the 1980s merger and acquisition activity and the spate of bankruptcies within the United States have produced a number of legal uncertainties. Many companies are attempting to shift the cost of these benefits to employees, either through plan revisions or cancellation of all or part of their current programs. This produces considerable differences between the company's commitment and retirees' expectations. Such differences can be a precursor to litigation and/or congressional action.

The cost of retiree health plans are far greater than what most companies initially anticipated. Most of these retiree health promises were made many years ago when the anticipated cost of these benefits was considered to be insignificant. While few pension plans index benefits to the overall cost of living, many retiree health care programs promise employees benefits that are fully indexed with health care inflation. In addition, similar benefits are provided to CEOs and janitors alike. Further, there is no actuarial adjustment in benefits (as in pension plans) for providing benefits to early retirees, retiree spouses, and, in some cases, dependents.

At the same time, health care costs continue to escalate at unprecedented rates. In 1990, the U.S. spent approximately $662 billion on health care, up 14.2% from 1989. Total health care expenditures in 1990 represented approximately 12.2% of our nation's gross national product, up from 8.6% in 1979. These rates are far above what any other industrialized nation (including those with socialized medicine) spent on health care. It has been estimated that we will be dedicating 17% of GNP to health care in the year 2000. The increases in health care costs are attributable to, among other things, increasing utilization, changing technology, an aging society with longer life spans, earlier retirement ages, Medicare cost shifting, malpractice costs, and health care inflation, which far exceeds increases in the consumer price index (CPI).

Demographics indicate that we have an aging society in which individuals are living longer. In 1970, the average major employer had 15 workers for each retiree. The current ratio is approximately four workers per retiree and is projected to decline to just over two workers for each retiree in the year 2020.

Shorter period of employment

Furthermore, the average retirement age for Americans is continuing to decline, and lower retirement ages result in significantly higher retiree health costs, especially for pre-Medicare, eligible early retirees. Thus, employees are earning greater benefits for a shorter period of employment.

Retiree health programs are in far worse financial shape then pension plans. Private-sector retirement plan assets in the U.S. exceed $2 trillion. Current estimates of the cumulative health benefits obligation in the U.S. have ranged from $300 billion to $2 trillion, of which less than $40 billion is funded.

Last but not least, the recent changes in the accounting treatment for retiree health care benefits have focused corporate attention on this "ticking time bomb." Although accountants have been blamed for creating this problem, in reality they have simply highlighted a growing, but often unrecognized, crisis.

Absent any changes in plan design, under the new accounting rules, which go into effect for most companies in 1993, the annual expense for retiree health costs at many companies will increase more than tenfold, and will ultimately result in a large decline in the net value of Corporate America because of the recognition of this growing liability. The accounting rules do not, however, require funding of retiree health benefits, nor do they mandate any plan design changes, although both should be considered and may be prudent.

Taking initial steps

Virtually all employers who offer these benefits have begun to take initial steps designed to address the retiree health challenge. Many have run preliminary numbers based on the new accounting standards. Most do not like the results and are exploring what to do about it. (See sidebar for a selection of questions that employers must address.)

Although it is still too early to tell, it is likely that the vast majority of employers will take steps designed to better control and manage their retiree health care obligations and, at the same time, ask employees to assume a greater share of the related costs. To be sure, many employers will make plan design changes. Most likely, these changes will have a greater effect on current employees than on retirees. Furthermore, only a small percentage of employers are likely to cancel their programs outright, and those who do may exempt their current retirees.

Other actions that companies could take would be to provide incentives to encourage employees to work longer and to consider other retiree incentives and approaches (e.g., cutting back workload rather than retiring). Some employers will seek to utilize the current limited forms of tax-favored funding as a means to accumulate assets to ensure the ultimate payment of these benefits to employees.

Congress as a wild card

Employers need to act now to address the retiree health issue in a comprehensive manner because, for most employers the liability grows every day if no action is taken. In addition, there is always a possibility that Congress could come under pressure to limit employers' ability to terminate or amend their retiree health care programs. These actions are more likely than new significant tax-favored methods because they would not have adverse implications on the federal budget deficit, whereas additional tax-favored funding methods would.

The retiree health problem is a multi-dimensional and acute business challenge of greater proportions than many first realized. However, by taking timely actions, making tough decisions, and communicating them properly, employers can succeed in dealing with this issue in a manner that results in programs that are rational, affordable, competitive, and appreciated.

The Questions To Be Faced

The first step in dealing with the problem of retiree health care obligations is to assess the company's liability based on the current plan design. This involves analyzing the nature and extent of the promise and gathering extensive information necessary to perform the required actuarial calculations. Frequently, this data is not readily available or maintained by the company in the proper format.

But running the numbers is only the first step in the process of addressing this issue. Some of the other questions that employers must address include: * What are the estimated financial statement effects and other implications (e.g., debt covenants, incentive compensation arrangements, stock price)? * When and how should the new accounting rules be adopted? * Does the current plan design make sense in light of the company's financial condition, employee demographics, and coordination with other company benefit plans? * Can the company afford the program? * Does the company have the right to make changes to the current program, either unilaterally or through collective bargaining? * What changes in plan design make sense? * What health care management approaches should be explored? * Should the net obligation be funded and, if so, how? * How should any related plan design changes and other actions be communicated in order to prevent adverse employee reaction and possible litigation? * What portion, if any, of the incremental cost can the company recover?

These are only some of the issues that the company must concern itself with in order to properly address the retiree health care issue. In the end, employers must take steps to ensure that their retiree health care programs are rational, affordable, competitive, and appreciated. Alan A. Nadel is the Managing Partner of Arthur Andersen & Co.'s worldwide Compensation and Benefits practice, located in New York. David M. Walker is the National Director of the firm's Compensation and Benefits practice, and he is based in the Washington, D.C., office.
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Title Annotation:Chairman's Agenda: Managing Health Care Costs; includes related article
Author:Nadel, Alan A.; Walker, David M.
Publication:Directors & Boards
Date:Jan 1, 1992
Words:1510
Previous Article:Cost containment as a stimulative force.
Next Article:Shareholder litigation and the board.
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