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Results in Brief

Because of rising retiree health costs, companies now offering retiree health benefits will be under increased pressure to reduce liabilities, by either canceling the plans or shifting more of the costs of the plans to their retirees. In the past, employer reduction of retiree health benefits has been the subject of litigation. Although courts have indicated that, under certain circumstances, employers may reduce such benefits, commentators view the courts as being in general disagreement over their approach to such cases.

Companies that do not reduce substantially their future retiree health benefit liabilities are likely to be interested in funding that liability to insure the long-term security of promised benefits and stability of their financial situation. However, with respect to advance funding, federal tax law currently favors retiree health benefit plans less than pension plans. As a result, companies generally do not fund health benefit liabilities in advance (see app. III). The Congress may be faced with either giving companies greater tax breaks for advance funding of these benefits or seeing an increasing number of companies curtail or drop health insurance coverage for their retirees.

The nation's private employers have accumulated significant obligations to their current and retired employees for retiree health benefits. We estimate $227 billion or about one-fourteenth of the value of all companies' stocks in 1988 is owed. In addition, companies can anticipate $175 billion in future accruals for their active workers, for a total retiree health benefit liability of $402 billion.

But the impact on companies' financial statements is less under the FASB's proposed transition requirement that one-fifteenth, or, by our estimate, $15 billion in liabilities be stated annually. Advance funding of benefits, while costly at first, would secure benefits and stabilize companies' annual expenditures. If begun in 1988, by 2022 annual contributions for retiree health care under advance funding and the PAYG mechanism now generally used would be equal. Subsequently, PAYG funding would exceed advance funding on an annual basis.

Courts sometimes have allowed companies seeking to ease the growing impact of retiree health costs to cut benefits for current retirees or require them to share in costs. For current workers, a company probably can legally change the retiree health plan it has promised them. The rate of changes in retiree health plans by employers is increasing, although most companies probably wish to continue coverage. Recent legislation

generally prohibits companies that file for bankruptcy from changing or terminating such plans.

The Congress may wish to protect retirees' health care coverage by requiring employers to advance-fund such benefits or provide coverage that retirees can buy at group rates. Adding corporate tax breaks to protect retiree health benefits could increase the federal budget deficit while failing to give employers sufficient incentives to offset rising health care costs.

Total Retiree Health Liabilities Estimated at $402 Billion

As of 1988, American corporations had significant total liabilities (called "expected benefit obligations" by FASB) of $402 billion for retiree health benefits, we estimate. Of this, the accrued portion is $227 billion-about one-fourteenth of the value of the companies' stocks ($3.1 trillion) that year. About $100 billion of the "accumulated benefit obligations" (FASB's term) is owed for current retirees and $127 billion accrued (earned) by current employees (see fig. 1).

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disclosed on companies' balance sheets had (1) FASB's proposed standards always been in effect and (2) the method we used to calculate liabilities always been used. But the initial impact on company financial statements is drastically reduced in FASB's proposed transition obligation, which calls for one-fifteenth of the estimated accrued liability, or $15 billion, to be reported yearly.

Our liability estimates

are based on company retiree health plans in existence and retirees covered in 1988,

assume no changes in plan provisions (see apps. IV and V),

are not adjusted for any savings to companies from the Medicare Catastrophic Coverage Act of 1988,

are sensitive to the assumptions used in making them (see app. IV) (e.g., under different assumptions accrued liabilities in 1988 could range from $187 to $290 billion), and

are most sensitive to assumed rates of future growth in medical costs.

Funding in advance, as is now done for pensions, would stabilize companies' annual expenditures and make benefits more secure, but would be very costly. To start advance-funding their health benefit payments, for example, companies would have had to set aside an estimated $32 billion, which is 3 1/2 times PAYG costs. However, these PAYG costs would grow in 20 years from under $9 billion in 1988 to over $22 billion in 2008 (1988 dollars) if coverage and benefits did not change (see fig. 2). Annual contributions would be higher than PAYG costs until 2022, when both amounts would equal about $39 billion (1988 dollars). Thereafter, PAYG expenses would continue to rise while funding costs would level off.

Had companies contributed a tax-deductible $32 billion to a fund in 1988, we estimate that the tax revenue lost to the federal treasury in that year would be about $7 billion more than current revenue losses for retiree health benefits. These contribution amounts would be one-tenth of the estimated 1988 pretax profits of American corporations.

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In a general sense, federal court decisions indicate that, where retiree health benefits have not yet vested, companies may have latitude to modify such benefit plans and require retirees to pay more of plan costs. At 29 companies, officials told us that they believe companies have the right to modify or terminate benefits for active workers and retirees.2 Of the 29 companies, 27 had language in their plans reserving the right to modify or terminate plans.

Companies now appear to be changing plans at an increasing rate. According to a recent survey on retiree medical coverage, employers are introducing changes in plan provisions that not only reduce coverage

2Employee Benefits: Company Actions to Limit Retiree Health Costs (GAO/HRD-89-31BR, Feb. 1989).

but also continue to shift a portion of costs to retirees.3 About 40 percent of employers in the survey's sample changed their plans' provisions in 1988 as opposed to 17 percent in 1986. But companies have a long-term view of employee relations, some analysts note, and most want to continue to provide medical care insurance, though at less-generous levels.

While companies may have some latitude to change retiree health plans,
recent legislation has placed restrictions on such changes once a com-
pany declares bankruptcy. In July 1986, one of the largest companies in
the United States, the LTV Corporation, filed for reorganization under
U.S. bankruptcy laws. LTV took the position that these laws allowed the
company to terminate retiree health benefits to over 78,000 retirees.
Almost immediately following LTV's filing, the Congress enacted tempo-
rary legislation that required LTV to continue to provide health benefits
to its retirees. To replace the temporary legislation, the Congress
enacted the Retiree Benefits Bankruptcy Protection Act of 1988, which
became law in June of that year. This act prohibits companies that file
for chapter 11 bankruptcy from modifying retiree health benefits,
unless, based on specified conditions, the bankruptcy court orders such
modifications or the trustee in bankruptcy and the retirees agree to such

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The Congress can set the stage for protecting promised retiree health insurance by legislative action if it so decides. Several congressional options are available, ranging from

requiring advance funding by companies under a full pension-type model regulated by comprehensive legislation such as the Employee Retirement Income Security Act of 1974 (ERISA) to

requiring that retirees be allowed to buy health insurance at group rates from their former employers at little or no direct cost to companies.

Many companies may urge that the Congress provide additional tax incentives to encourage advance funding of retiree health benefits. However, any broadening of tax preferences will create near-term additional tax losses for the federal treasury at a time when closing the budget deficit is both difficult and important. Even with additional tax advantages, the increasing annual costs that many employers will have to bear

3The Wyatt Company, "Retiree Medical Plans: Problems on the Horizon," The Compensation and Benefits File, Jan. 1989, pp. 5-11.

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