Companies that provide health benefits to retirees have understandably become ever more cognizant of the costs involved in recent years. According to the U.S. Department of Health and Human Services, the cost of health care for a person over age 65 is, on average, 3.3 times higher than the cost of health care for a working-age person. These costs are only expected to grow.
An additional burden is imposed by the accounting standard commonly known as FAS 106, which requires public companies to account for their future retiree medical obligations in filings with the Securities and Exchange Commission. Depending on the size of the company and the pool of covered individuals, the cost of such benefits can run well into the millions — or even billions — of dollars.
Today, two decades after the Financial Accounting Standards Board introduced that accounting requirement, only 45% of employers provide medical benefits to current retirees and 22% include retiree medical as a benefit for new hires, according to consulting firm Towers Watson. The number of companies with these offerings will continue to decline as many are in the process of changing their benefit programs. According to a recent survey, approximately 43% of companies currently offering retiree medical benefits are planning to reduce or eliminate them.
The major health-reform legislation passed by Congress in 2010, the Patient Protection and Affordable Care Act, imposes new taxes on certain retiree medical plans, including those providing particularly generous benefits. These new tax restrictions provide an opportune time to revisit retiree medical benefits and how they are structured.
Many of the companies that have gone through the process already have had to go through legal action, since retiree medical benefit plans are generally governed by the Employee Retirement Income Security Act (ERISA). These benefits are generally unfunded, meaning that companies have not set aside money to pay future benefits. And retiree medical benefits differ from traditional pension or 401(k) benefits in that they often are not legally vested, meaning they can often be reduced or terminated.
The key legal issue is whether the benefits have vested under the terms of the applicable plan. If the benefits are vested, that creates a lifetime right to a certain level of retiree medical benefits. In that case, the benefits cannot be changed or eliminated without the retirees’ consent. Whether benefits are vested is a legal question that depends on the interpretation of the relevant contracts and documents. Careful due diligence and legal analysis are required before the company can implement changes.
Once a company decides to change benefits, it has various ways to reduce future costs. Common approaches include instituting a cap on employer contributions, instituting or increasing co-pays and deductibles, or establishing an independent VEBA (voluntary employees’ beneficiary association), a trust the company funds initially but that eliminates the company’s obligation to provide retiree medical benefits going forward.
Many companies have found that, notwithstanding the risk and cost of potential litigation, substantial long-term cost savings are possible from changes to retiree medical benefits. Companies in industries as wide-ranging as manufacturing (United Dominion Industries, now a part of SPX), insurance (AXA Equitable Life Insurance, formerly the Equitable Life Assurance Society of the United States), and consumer products (Pabst Brewing) have successfully eliminated retiree medical coverage, and those changes were upheld through litigation.
Just as common are settlements in which companies still end up with cost savings. Goodyear Tire & Rubber is an example of a company that was involved in a highly publicized case involving the reduction of retiree medical benefits. For decades, Goodyear had provided generous health-care benefits to tens of thousands of union retirees and their beneficiaries. But faced with significant pressures from competitors with more-favorable cost structures, Goodyear announced in 2006 that it would shift a large part of the cost of health care to retirees. Despite litigating within the U.S. Court of Appeals for the Sixth Circuit, a jurisdiction considered “pro-retiree,” Goodyear achieved a settlement that reduced its retiree medical obligations by approximately $200 million.
Other examples include Dana, which agreed to a settlement that reduced its retiree health-care obligations by approximately $300 million, and Navistar, which sharply reduced its retiree health-care obligations from $2.6 billion to $1 billion. In 2009 Ford Motor reduced its retiree medical obligations from $23.7 billion to $13.2 billion through negotiation, litigation, and the use of a VEBA structure. Using a similar approach, Chrysler reduced its retiree medical obligations by more than $7 billion prior to its bankruptcy.
To be sure, changes to retiree medical benefits do not always result in litigation. Depending on the scope of the changes and the jurisdiction in which the case is likely to be heard, retirees and their potential counsel may conclude that the risks of litigation outweigh the potential benefits. Alternatively, if there are relevant stakeholders (such as a union), the company can in some cases negotiate a settlement in advance without the need for litigation.
Nancy G. Ross and John A. Litwinski, partners at the law firm of McDermott Will & Emery LLP, practice in the area of employee benefits class-action litigation and counseling under ERISA.