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Good Article on History of Subsidized Healthcare
Corporate Board Member
November/December 2006
Feature Story
The Complex Pain of Cutting Retiree Health
Benefits
by Susan Littwin
As former employees struggle to pay bills they never expected, companies
defend themselves by citing rising medical cost and obligations to shareholders.
Directors can no longer duck this fraught issue.
John Devitto spent 39 years at Lucent Technologies’ corporate predecessors,
Western Electric and AT&T Network Systems. An engineer and supervisor, he moved
his wife and children from Maryland to Pennsylvania and then to Ohio so he could
serve the company where he was most needed. In 1995 he retired, half a year shy
of 60, believing that he had full health benefits for himself, his wife, and his
youngest child.
Three years later the benefit cuts began. Devitto, now 70, is paying over $700 a
month in health-insurance premiums for his wife and teenage son. He’s also
carrying the cost of a $200-per-month life-insurance policy whose premiums the
company stopped covering. “I’m paying $1,000 a month more than I expected,”
Devitto says. “I’m not on welfare. But my wife has gone to work, I’ve given up
my golf membership, and we don’t go away on vacations.”
Had he known 11 years ago that the company would renege on its promises, “I
would have worked longer,” he says. “And my wife might have gone to work when
she was younger and gotten a better job.”
In 1988 two-thirds of all large employers offered health insurance to retirees,
according to a survey by the Kaiser Family Foundation and the Health Research
and Educational Trust. By 2005, according to the survey, the share had declined
to one-third. Says Michelle Kitchman Strollo, principal policy analyst at the
Kaiser foundation: “We have also found, among companies that still offer
benefits, that they have been reducing their generosity. This comes in the form
of higher copays at the point of service, increases in deductibles, and, most
striking, between 2004 and 2005 seven companies out of 10 increased the amount
the retiree must contribute to the insurance premiums.”
Nevertheless, cutting retirees’ health benefits is the corporate act that dare
not speak its name, the issue board members and corporate officers will talk
about only in whispers and in private. Corporate Board Member’s
attempts to get more than 40 directors to discuss the issue yielded only six
on-the-record interviews. (Lucent director Daniel S. Goldin, 65, said typically,
“If you wish to have that discussion, I suggest you call media relations at
Lucent. I can give you the number.”) And repeated calls to seven companies that
have modified benefits to retirees—including Delphi Corp., 3M, and
Verizon—resulted in no corporate officers who would be interviewed. “I’m sorry
to disappoint you,” Robert S. Miller, 64, chairman and CEO of Delphi, said
affably. “But we’re in the middle of labor negotiations, and I can’t discuss
that.” Caterpillar Inc., a defendant in a lawsuit brought by retirees over its
reduction in benefits, issued this statement: “We will not comment on the status
of health-care benefits of either current or retired employees due to the
pending litigation.”
Leading the list of major companies that have reduced benefits is General
Motors, the world’s largest private provider of health care for employees and
retirees. GM is now requiring its more than 475,000 retirees to pay part of
their own premiums, at an annual cost of as much as $752 per family. In addition
to Caterpillar, Delphi, GM, Lucent, 3M, and Verizon, major companies that have
made cuts include International Flavors & Fragrances and Unocal (now part of
Chevron).
“This is a topic that is on the horizon for all of us,” says Bruce Stender, 64,
CEO of Labovitz Enterprises, an investment firm in Duluth, Minnesota, and lead
director at Allete, a Midwest utility and real estate company. “We’re looking at
a changing business landscape.”
Just what is the picture that directors confront when they’re asked to sign off
on benefit cuts? The savings are obvious and large. The GM cuts, for instance,
will amount to as much as $1 billion. But how steep is the downside? Did
corporations enter into a sacred promise, or at least a social contract, when
they offered benefits to employees like Devitto? What are the risks of lawsuits,
damage to the morale of current employees, and injury to corporate image? And
how do directors balance these risks against the interests of their
shareholders—including, in some cases, the need to avert bankruptcy?
Board members willing to be interviewed cite the evident reasons for reducing
benefits. The first is the soaring cost of health care. According to surveys by
the Kaiser Family Foundation and Hewitt Associates, the cost of retiree health
benefits increased by 12.7% in 2004 and another 10.3% in 2005. “If you look at
the millions of baby boomers marching toward retirement and their greater life
expectancy, the cost of caring for them is going up dramatically,” says John T.
Cardis, a retired senior partner at Deloitte & Touche and a director of Edwards
Lifesciences, Energy East Corp., and the office-supplies company Avery Dennison.
Anthony W. Schweiger, 64, CEO of the consulting firm Tomorrow Group, whose
directorships include insurance provider Radian Group Inc., is among those who
believe the benefits were ill conceived to begin with. “I can’t rationalize, as
a director, how the company can be held responsible for open-ended
postretirement benefits they have no control over,” he says. “The company must
continue to maintain a viable enterprise, or every bit of the retirees’
insurance will be jeopardized. Something is better than all of nothing.”
Directors also emphasize companies’ obligations to their several constituencies.
“You have to look at it holistically,” says Gordon R. Parker, 70, a former CEO
of Newmont Mining Corp. and, at the time of this interview, in his last week as
a director of Caterpillar. “I’m a retiree, and I’m totally opposed to cutting
benefits.” But he voted “with a pang of regret” for Caterpillar’s reductions,
which in 2000 capped retiree health benefits at their 1999 level and required
everyone who had retired after January 1992 to pay a monthly premium making up
the difference between the 1999 rates and the current costs. “You have to take a
total approach to the success of the business. I think of it as a readjustment
of wages and benefits so the business can survive. You have to do the right
thing for your shareholders. You must look after your employees, your vendors,
your customers. And sometimes the balance is, you have to cut.”
Retired steelworkers from Bethlehem Steel and LTV Steel know about getting
nothing. After those companies closed their doors, 49% of retirees under 65 and
therefore not eligible for Medicare said that they or their spouses had gone
back to work because they had lost health benefits. Even among the
Medicare-eligible, 10% reported that they had taken jobs to pay for insurance
that covered some expenses not paid by Medicare.
Stephen Skvara, 59, is among them. Badly injured in a 1997 automobile accident,
Skvara retired on disability from LTV Steel in Indiana after three decades as an
electrical repairman. He took with him full health benefits for himself and
coverage at $138 a month for his wife and youngest son. In 2002 LTV Steel went
bankrupt, and though pieces of the company were acquired, the obligations to
retirees were not. As required by law, Skvara’s pension was assumed by the
federal Pension Benefits Guarantee Corp., but it was reduced from $1,900 a month
to $1,200 and his $360-a-month special disability payment was eliminated. No law
protected health benefits, so his and his family’s vanished. Skvara managed to
find insurance that would cover what his Medicare disability payments didn’t, at
$295 a month. His wife, a substitute teacher, and son, then 16 years old, were
uninsured—and remain so. “I went into the steel industry right out of high
school,” Skvara says. “I thought I’d have a comfortable life and provide for my
family. Health care is a basic necessity, and it really hurts that I can’t
provide it for them.”
A third reason that board members cite for the cuts is global competition.
According to Thomas Getzen, the director of the International Health Economics
Association and a professor of health insurance at Temple University in
Philadelphia, the U.S. is the only major industrialized country that doesn’t
provide universal national health insurance. Some employers in other countries
offer private insurance as an extra—with benefits such as special access to
doctors—but American dependence on employer health insurance is unique, and a
direct cost foreign competitors don’t bear.
American companies that have fared badly in the global market have done so for
reasons well beyond the burden of generous health care. But benefits are an easy
target for cost-cutters, perhaps even a scapegoat. GM often blames its
obligations to retirees for its competitive problems, but the pension funds for
the company’s rank-and-file workers are bulging, with $9 billion more than is
needed to pay out projected pensions for the foreseeable future. GM’s unfunded
obligations to the retirement of executives, however, burden it with an annual
$1.4 billion liability—largely offset by the annual $1 billion saved with cuts
in retiree health-care benefits.
Employer-paid health care appears to be an accident of U.S. history. During
World War II wages were frozen and labor was scarce, so employers offered health
care in lieu of raises to attract and keep workers. The National War Labor Board
ruled in 1943 that health-care contributions were tax-exempt for workers and
tax-deductible for employers, and by the end of the war the number of workers in
the U.S. with health insurance had tripled. According to a June 2006 report by
the Employee Benefit Research Institute, the popularity of employee health
coverage was driven mostly by continuing labor shortages—but the tax breaks
didn’t hurt. The Revenue Act of 1954 affirmed the deductibility of employer
health-care contributions. Health-benefit increases became a popular bargaining
chip for both labor and management, and companies were amenable to making
provisions for retiree health benefits because they were the equivalent of a
long engagement—a zircon ring on the finger and nothing to pay now.
But a marriage of sorts did take place. The benefits may not have been taxable
income, but workers came to regard them as part of their compensation, as money
bargained for and earned. It became the American way: Employers paid for health
insurance.
Among the reasons for reducing those benefits now, says Nell Minow, editor of
the Corporate Library, a corporate governance watchdog based in Maine, is “a
dirty little secret. Certainly benefits are getting very expensive, but we are
aware of and interested in the juxtaposition between cuts in benefits and
increases for top executives. They cut benefits to make the balance sheet look
stronger. The executives then reap the benefit of the stronger balance sheet by
paying themselves better.” The cure for that, Minow says, “is that increases in
executive compensation should be for operational growth rather than
balance-sheet growth.”
The median pay package for chief executives of the largest U.S. companies was
$6.8 million in 2005, according to a study by Mercer Human Resource Consulting.
Patricia Russo, chairman and CEO of Lucent Technologies, which cut Devitto’s
benefits, landed among the top 11 examples in a Corporate Library study, Pay
for Failure: The Compensation Committees Responsible, which identified
chief executives paid over $15 million despite negative returns to shareholders.
(For more, see “Get Ready for the Next Spotlight on CEO Pay” in Corporate
Board Member’s September/October issue.)
The discrepancy does not go unnoticed by retirees. “Those things bother me,”
says Devitto. “Executives who didn’t do so well by the company left with big
golden parachutes. Retirees who made a major contribution to the company were
left holding the bag.”
The golden parachutes and hefty executive salaries in the face of benefit cuts
may be a tactical error. “Either they’re seeing a more complex picture than I
am, one that makes sense to them, or they’re tone-deaf,” says David W. Anderson
of the Toronto-based consulting firm Anderson Governance Group. “What I would
say to boards is, ‘It may be a correct business decision to take a difficult and
unpopular path, but you must communicate it clearly.’ An inconsistent message is
a real problem. For instance, they’re saying, in effect, ‘We must cut costs to
survive, so we’re cutting health benefits. But we need great executives, so we
give big bonuses.’ It may all be true, but it sounds inconsistent. Good leaders
know they have to lead by example. When executives gets perks and higher
salaries, it looks like favoritism.”
Thomas F. Donovan, 73, a retired bank executive who has served on at least eight
boards, including Amerigas’s, and is now a director of three private
foundations, says, “I’m troubled whenever I see benefits reduced to people who
gave good service in the past. I can’t say categorically that I would never
serve on such a board, but I would not sit by while benefits were reduced for
retirees while executive compensation for the chair was increased.”
Another cause of benefit cuts—and one avoided as a corporate talking point—is
changed accounting standards. The Financial Accounting Standards Board’s Rule
106, adopted in 1990, required companies to record on their balance sheets an
actuarial estimate of their entire health-benefit liability, instead of the
pay-as-you-go method many had been using. The rule left a host of thriving
companies looking, on paper at least, as if their heads were barely above water.
Last March the FASB put out for comment another proposed change that would
require companies to move certain pension and other retiree-benefit obligations
out of the footnotes and up front onto the balance sheet. “Current accounting
standards just don’t provide complete information about these obligations,” said
FASB member George Batavick at the time.
The new disclosures would be ugly for traditional unionized companies. An
analysis by Bear Stearns found that Ford Motor’s balance sheet for 2005 would
show about $20 billion more in benefit obligations, and GM’s about $37 billion
more.
The proposed accounting rule aims to protect shareholders from invisible risks.
Dennis R. Beresford, a former chairman of the FASB and now a professor at the
University of Georgia business school, points out that the requirement wouldn’t
change the real worth of a company, only its balance sheet. But it would make it
look bad to investors. “Sophisticated investors know what’s going on,” he says.
“They’ve been reading the footnotes.” But novices wouldn’t like the way things
looked. Nor would top executives whose compensation may be linked to net-worth
growth.
When he was on the FASB board, Beresford recalls, he was confronted by a CEO.
“He told me that if companies were forced to account for this expense, many of
them would be forced to take away the benefit, and that would be on my
conscience. That didn’t make me feel very good, but I said, ‘Sir, I’m not the
one who made those promises. You now have to measure your decision, whether to
cut back or cut out. We’re just making you own up to it.’”
For companies contemplating a cut, Lucent offers a cautionary corporate
narrative. In her 2004 book, Optical Illusions: Lucent and the Crash of
Telecom, Lisa Endlich writes: “This is the story of a financially sound
company steeped in world-class talent, dominant in one of the world’s
fastest-growing industries, that in the space of two painful years [2000 to
2002] found itself branded with a junk-bond credit rating, under investigation
by the SEC for its fraudulent accounting practices, fighting off rumors of
insolvency, and, hat in hand, begging its bankers for a little more time.”
Endlich traces hasty acquisitions, attempts at reinvention, and other corporate
missteps. Lucent’s stock price dropped by 99%, and job losses came to more than
half a million.
In 2003 Lucent eliminated death-benefit insurance for all management retirees
and cut reimbursement to retirees and their spouses for the Medicare Part B
supplement (outpatient care), leaving retirees with a cost of about $300 a
quarter. In 2004 the company stopped paying dental-insurance premiums for
retirees and eliminated the health-care-premium subsidy for dependents of
management employees who had retired after March 1990 with a salary of $87,000
or more; in 2005 it lowered the salary minimum for this last cut to $65,000.
Next, in January 2006, health-care premiums for management retirees were
increased.
Lucent was compelled to make the cuts, says spokeswoman Mary Ward, because of
the rising cost of health care and pressure from competitors. “We clearly
recognize and acknowledge what retirees did for the company,” she says, “and we
understand the impact this has on them. But it came down to what we could afford
to do and remain a viable company.”
In September Lucent was on the verge of a merger with the French
telecommunications company Alcatel, a deal that many regarded as an acquisition
by Alcatel. If the merger closed, Russo, who became CEO in 2002, could collect
at least $1.78 million in stock awards even if she remained chief executive at
the merged company. Lucent spokeswoman Joan Campion cited the pending merger as
the reason company officers and directors refused to discuss the cuts in
benefits.
Lucent retirees were much more forthcoming. The Lucent Retirees Organization was
chartered in 2003. Its original purpose was to help the troubled company however
it could, says president Ken Raschke, who retired as vice president for
manufacturing of a North Carolina facility that made transmission equipment.
Among other things, members offered to do clerical work for free. But when the
benefit cuts snowballed, the retirees’ organization turned against Lucent with
the energy its members had once put into designing cell phones.
The group brought five proxy proposals to annual shareholders’ meetings. At the
2006 meeting it proposed that executive compensation be more strictly tied to
performance. The proposal passed by 54%, but no action has been taken on it. The
retirees also called for federal scrutiny of the merger to ensure that they’d
still be collecting their pensions and remaining benefits. “No one should want a
foreign company to own a $34 billion pension fund—worth more than twice Lucent’s
market value—unless safeguards are in place to protect the pensions and benefits
of 235,000 retirees and their dependents,” Raschke says.
The retirees’ organization has also provided documents and other support to the
lawyers of three plaintiffs who are suing Lucent over the cancellation of their
retiree health benefits. The lawsuits claim violations of the Internal Revenue
Code and the implied contract of the pension and benefit plans described to
employees in various letters and publications. “I signed hundreds of these
letters, congratulating people on their retirement and describing their
benefits,” says Raschke.
Should lawsuits like this one worry board members? So far the law is unclear.
Katherine Stone, a labor-law specialist at UCLA School of Law, says the suits
depend largely on the clarity of the contractual obligations to employees. “Was
there an unambiguous promise to provide benefits for life?” she says. “The more
usual situation is a plan that describes the benefits to employees and reserves
the right to modify, alter, suspend, or terminate the benefits.” The basis of an
unambiguous promise could be found in letters, booklets, or even speeches at
employee meetings.
ERISA, the Employee Retirement Income Security Act of 1974, does not mandate
benefits, says Georgeann Peters, a benefits attorney in the Columbus, Ohio,
office of Baker & Hostetler. Still, in a lawsuit by retirees against
Caterpillar, the complaint cites violations of sections of ERISA. Stone argues
that there is liability under ERISA “if the plan administrators knowingly
misrepresented the plan. For instance, if they promised lifetime coverage
knowing that it was not forthcoming, and employees relied on that promise and
took early retirement or neglected to get separate coverage of their own and
later found themselves ineligible.”
The Caterpillar and Lucent suits do not name board members as defendants. But
Stone notes that directors have a fiduciary duty to protect the company. “If the
firm is taking steps that open it up to liability, the board member might have
to examine what promises have been floating around,” she says. Directors must
also be aware of the image problem: Cutting medical insurance for retirees can
make a company seem like Darth Vader. Raising the issue of a broken moral
obligation, Ed Beltram, communications director of the Lucent Retirees
Organization, says, “Those of us in management were always told to tell
employees that their pay increases might not be so high, but they had secure
pension and health-care benefits.”
Board members need not worry, it seems, about the impact those cuts will have on
morale and recruiting. According to a 2004 survey by the EBRI, only 5% of
current workers consider retiree health care their most important benefit. “The
new economy is conditioning workers to see the landscape differently,” says one
director.
What can be done to help current and future retirees? The National Retirees
Legislation Network is a lobbying group representing more than two million
retired people. It has been pressuring Congress in favor of HR 1322, the
Emergency Retiree Health Benefits Protection Act, a bill that would give
ERISA-like protection to health benefits. But Network spokesman Jim Norby admits
that the act has no chance of passage today. A bill passed by Congress in August
provides greater protection for retirees’ defined-benefit pension plans, but not
their health benefits.
Allen Karp, 65, formerly CEO and chairman of Cineplex Odeon Corp. and currently
a director of Alliance Atlantis Communications Inc. and Teknion Corp., among
other companies, suggests that gradual reductions are possible for an outfit
that is in good financial shape. “The company can provide a less painful
transition for those who are most impacted,” he says, “and then take further
steps for those who have many years until retirement.” Karp also suggests
bringing everyone into the discussion: “Talk to the unions, the human-resources
team. Everyone is terrified of the unions, but you have to try to bring them
onto your side.” He cites GM’s cuts, which were negotiated with the United
Automobile Workers. “The union was realistic,” he says. “It’s not in the
employees’ interest to see the company become an uneconomical enterprise.”
But what about the valued former employee whose retirement is crimped and
penny-pinching because a chunk of his pension now goes to health-insurance
premiums—or, still worse, who doesn’t get the medical care he needs?
“We’ve all been around,” says Anthony Schweiger, the Radian Group director.
“Stuff happens. Life isn’t as fair as you’d like it to be. You gotta do what you
gotta do.”
You do…don’t you?
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