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In 2005, General Motors spent $5.4 billion for health-care benefits, with 70 percent of the cost going to cover retirees. This overhead adds more than $1,500 to the sticker price for each vehicle GM produces--making health insurance more costly than the steel used to build the car.

Before winning concessions from labor unions late last year, the company faced an unfunded liability of $57 billion for future retiree health-care costs. That's more than the entire annual budget for Poland or Indonesia. While size puts General Motors in a class of its own, the company is far from alone. Ford is grappling with more than $3 billion in annual health-care costs. IBM, Hewlett-Packard, Verizon and Motorola have all recently frozen retiree benefits to address rising costs. Delphi, the largest auto-parts maker in the country, has filed for bankruptcy as part of a plan to get out from under union-bargained commitments--including $10 billion in unfunded retiree benefits.

Usually, the future obligation of companies to retirees is an out-of-sight, out-of-mind issue that rarely captures public attention. But the Financial Accounting Standards Board is working on plans to require companies to move the unfunded liability for retiree health benefits from an obscure footnote in their annual reports to an integral item on their quarterly balance sheets. That means that, at least on paper, today's profits will be consumed by future debt--unleashing a tidal wave of red ink that may drive more companies to desperate measures.

TIME FOR A NEW GAME PLAN

There's no denying that companies are being squeezed from all sides. Retiree health-care costs are rising by double digits at the same time that the ratio of current workers to retirees is dropping. Global competition drives prices down and makes slashing expenses mandatory. Shareholders demand stronger performance and higher profit margins. Government is busy changing the rules, on one hand creating a massive new Medicare prescription drug program that complicates company retiree benefits and, on the other hand, imposing new financial reporting requirements.

To cope with these pressures, companies have two choices. They can do what they've always done, but trim around the edges in hopes of making an incremental difference. Many are doing just that. Between 2004 and 2005, 71 percent of companies increased retiree contributions to health-insurance premiums, 34 percent increased health-care cost-sharing and 24 percent raised deductibles.

The second choice? Turn to a new strategy, one that transforms retiree health benefits from a volatile quarterly liability to a stable annual cost.

A bit of history to understand why this strategy shift is necessary: In the past, active employees far outnumbered retirees, life spans were shorter and Medicare covered most of the medical care an elderly person needed. Then it made sense for a company to broaden its health-care pool of covered participants by keeping retirees and workers in the same plan.

But today, the majority of health-care dollars are consumed later in life by expensive pharmaceuticals that may be taken for years. So today, instead of lowering the overall health-insurance tab, retirees are at the core of soaring costs.

The solution is to "carve out" retirees. This means placing them in a separate, fully insured plan that provides needed coverage, while stabilizing the financial obligation that otherwise threatens to overwhelm company balance sheets and alarm shareholders.

THE BENEFITS OF CARVING

Removing retirees from the health plan that covers active employees brings multiple benefits:

Eliminating uncertainty. By moving retirees into a fully insured plan, a company's cost is converted from unknown costs stretching into an uncertain future to a fixed annual premium cost that can be negotiated each year. Health-care coverage for retirees becomes just one more cost of doing business.

Spreading risk. Typically, claims for retirees are much higher than claims for employees, driving up the cost of providing coverage to active workers. By putting retirees into a nationwide plan, the high-cost risk is shared across a larger pool of people with similar health-care status.

Reducing costs. Freed from expensive claims for retirees, companies often see a dramatic drop in covering health-care costs for active employees. In addition, the administrative burden of managing a high-claim insurance portfolio also declines. For nationwide companies, the headache of tracking separate plans and HMOs that cover retirees in small pockets across the country disappears when their health care is consolidated in a single plan.

Off-loading customer-service responsibility. Human resources departments often report that some of their most time-consuming contacts are with retirees seeking help to manage their health-care problems and understand their benefits.

By turning this function over to a national administrator, companies gain access to accountable customer service centers that have the expertise to deal with this population, both sensitively and effectively.

Reducing Medicare Part D complexity. Companies are just beginning to realize the burden that participating in the Medicare Part D subsidy imposes on them. Taking the federal government's 28 percent subsidy to continue existing prescription drug coverage exposes companies to federal audits and annual actuarial studies, as well as forcing them to track retiree choices and spending patterns.

In addition, many companies are at or near caps that they have placed on retiree medical contributions, making integrating their plans with Medicare Part D requirements even more difficult. Contracting out for retiree health care shifts both the risks and the administrative obligations while continuing to protect retirees.

Employers today provide health-insurance coverage to 12 million retirees who are 65 or older and another 3.6 million early retirees who have yet to reach Medicare age.

While some are backing away from retiree coverage, many companies are looking for creative, cost-effective ways to take care of the workers who spent decades in their service.

With the ground rules changing and medical costs surging, it's time for companies to explore strategies that wouldn't have made sense in earlier times. Carving out retirees and addressing their health-coverage needs in a separate, more economical context is a winning solution that many companies should be considering.

SAMUEL H. FLEET is president and CEO of National Employee Benefit Companies, one of the country's leading group-benefits wholesalers and third-party administrators.

April 15, 2006

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