Human Capital & Careers

How Benefit Shifts Boost Credit Ratings

A company's credit-rating metrics could improve if it can get unions to agree to take over retiree-benefit-plan obligations, says Moody's.
Marie LeoneJuly 11, 2007

Companies may get an added boost–beyond just a balance-sheet improvement–by transferring retiree heath-care benefits to workers. The move could have a modest brightening effect on company’s corporate credit metrics, says a new report from Moody’s Investors Service.

The liabilities, known as “other postretirement employee benefits” (OPEBs), are non-pension retiree health-care obligations that corporations carry on their balance sheets. For companies that are “financially challenged,” a deal like the recent one inked by Goodyear Tire & Rubber and the United Steelworkers’ Union could have a “mixed or neutral” effect on the metrics used by Moody’s to derive credit ratings, according to the rating agency.

Under the deal, Goodyear will remove all OPEB obligations from its balance sheet in exchange for a $1 billion lump-sum payment into a voluntary employee benefit association (VEBA), from which future benefits payments will be made.

The Goodyear transaction will have a positive impact on qualitative factors, says Wesley Smyth, lead author of the study and a Moody’s vice president and senior accounting analyst. The company, according to Moody’s, would offload the risk associated with funding OPEB plans.

While the report focuses mainly on Goodyear, it names other companies that may be in a position to negotiate a similar deal with their unions: Ford, General Motors, and Chrysler, AMR, UAL, Delta, Qwest, Alcatel, Lucent Technologies, Eastman Kodak, Consol Energy, and Dana Corp. All the companies cited by the report currently have OPEB obligations that exceed $1 billion and represent more than 5 percent of the company’s total assets.

Only a “small group” of companies will be in a position to reach agreement with their unions,” notes Smyth, explaining that the 5 percent mark is important because it indicates that OPEB obligations are a significant issue for the company. If that’s the case, unions may be more willing to negotiate a lump-sum payment with a company. Striking such a deal might be better than running the risk of “drastic reductions of OPEB benefits if the companies’ financial profile were to deteriorate further,” according to the report.

The credit-rating agency contends that companies with “large legacy OPEB liabilities to unionized workers are motivated to settle their OPEB obligations, if they can do so at [an] acceptable cost.” Smyth told, however, that Moody’s doesn’t expect to base a ratings change on an OPEB deal alone or think that a company or union would enter into such a transfer based solely on the potential credit-rating effect.

Smyth points out that most of the OPEB plans it looked at for the report are underfunded, and to settle that obligation, companies would need to borrow or use existing cash to fund a VEBA. Raising the funds would cause margins related to earnings before interest and taxes and other metrics to improve, while others, like debt metrics would decline. But the overall effect would be that the company would eliminate its exposure to risk associated with sponsoring an OPEB.

In October, the Financial Accounting Standards Board issued FAS 158, which required companies to recorded the funded status of retirement plans on their balance sheets. Included in that reported number are interest-rate effects, an ever-changing risk that some companies view as especially burdensome. The prospect of booking the obligation and its attendant interest-rate risk on their balance sheets sent some companies with less-than-stellar balance sheets scrambling for ways to unload the risk. VEBAs are one solution.

Under the Goodyear deal, the VEBA will assume the company’s $1.2 billion in OPEB liabilities for unionized workers, according to a December regulatory filing. (Goodyear’s total OPEB liability is more than $2.5 billion.) The company will fund the VEBA with existing cash, mostly drawn from a debt offering it issued last year in anticipation of a strike that eventually lasted 12 weeks.

The VEBA bears the financial risk associated with managing the plan and its assets. Once the fund is set up, the union gives up its right to negotiate retiree health-care benefits with Goodyear. Indeed, the deal stipulates that Goodyear has no legal obligation to ever again pay for retiree healthcare benefits for union employees.

Last week, auto-parts maker Dana Corp. announced a similar OPEB deal with its unions – the USW and the United Auto Workers – that would transfer $700 million in cash and $80 million on common stock into a VEBA. In exchange, the unions will allow Dana to terminate its non-pension retiree benefits and long-term disability obligations.

OPEB plans have been troubling companies since the 1980s, when companies began negotiating amendments to the plans, according to Moody’s. Over the years, management has introduced copayments, deductibles, and spending caps into their OPEB plans to stem the tide of rising health-care costs and help them cover the increasing number of workers who take early retirement and living longer.