Now That Wasn't So Bad, Was It?Larry Light
For a time, it seemed as big a threat to Corporate America as foreign competition or a deep recession: a change in accounting rules that could well deplete the net worth of many of the nation's largest companies. For years, employers habitually took care of their medical bills on a pay-as-you-go basis, with no regard for the future. But under a new accounting rule adopted last year, big companies are required, no later than 1993, to set aside large sums for a decade or two's worth of retiree health benefits (table). Companies with fewer than 500 workers get until 1995. Employers can either amortize the cost over 20 years or zap earnings in the first year. The total hit: up to $1 trillion.
That number, while awesome, now seems much less scary than anticipated. Most companies, after crunching the numbers, are finding the new rule to be a onetime problem easily shrugged off. And the markets are agreeing by not penalizing their stock prices.
SO WHAT? Despite initial complaints, most companies have come to accept the rationale for the new rule. To the Financial Accounting Standards Board, which oversees U. S. accounting standards and promulgated the so-called 106 rule, the pay-as-you-go approach is irresponsible. "Significant promises have been made to employees," says FASB research director Timothy S. Lucas. "You shouldn't report as income the money that is meant for their health care." FASB is worried that corporate health care costs will continue to burgeon -- they were up 14% in 1990, and a double-digit increase is expected this year. A survey by consulting firm William M. Mercer Inc. found that 91% of companies with more than 5,000 workers offer retiree medical benefits. General Electric Co. is among the many companies that are easily handling billion-dollar hits. On Sept. 16, it announced an aftertax charge to earnings of $1.8 billion, or $2.07 per share. That was applied to the first-quarter financial report, resulting in a loss of $ 800 million. Although the charge will depress earnings for the entire year, GE stands poised for a rebound in 1992. After the announcement about the charge, GE's $70-per-share stock actually edged up by $2.
The reason for the market's so-what reaction is that the $1.8 billion is a noncash item. It reduces GE's net worth but doesn't affect the business' cash flow. No funds are diverted from operations, capital expenditures, or research and development. "Capital markets see through accounting contrivances," says Daniel J. Donoghue, group vice-president at ratings agency Duff & Phelps/MCM Investment Research Co. And the same seems to go for the raters. In the wake of the charge, GE has had no trouble keeping its AAA rating.
This isn't to say that everyone will be able to escape the FASB rule unscathed. There's a separate ring of hell for a small number of large, heavily unionized companies with charges so high that they endanger credit ratings. Thus far, General Motors Corp. is the only one in residence. On Nov. 8, GM, with 350,000 retirees, announced that its hit would range from $16 billion to $24 billion.
CREDIT WATCH. The nation's No. 1 auto maker hasn't indicated how it will deal with this tremendous charge, which will be from 57% to 86% of GM's net worth. The charge was one reason -- sputtering auto sales was the other -- that Standard & Poor's Corp. placed GM on its credit-watch list for a possible debt downgrade. "A charge that size has to put them at a competitive disadvantage," says Solomon Samson, S&P's managing director for corporate finance. In the week following the charge news, GM stock dropped 4.2%.
The No. 3 auto maker also is suffering. Chrysler Corp.'s many merger talks with potential buyers keep falling through, and Samson blames Chrysler's $6 billion charge, coupled with its $3.5 billion in unfunded pension liabilities, for scaring away purchasers.
American Telephone & Telegraph Co., with 123,000 retirees, has been rumored to be almost as badly off as GM. AT&T executives tried to reassure analysts on Nov. 19 that the charge won't be even close to GM's low-end $16 billion estimate, although the phone company isn't ready yet to release its figure.
The preferred way of taking the charge is all at once, so a company can leave it behind, like a bad dream, and not have earnings gouged for 20 years. "If a company's balance sheet is strong enough, it makes sense to take the hit at one time," says George B. Wagoner, a principal at Mercer, which estimates
that only half of U. S. corporations will be able to do that. GM, most experts agree, can't possibly take the onetime solution.
CUTBACK PITFALL. One side effect of the accounting rule is that companies are cutting back or scrapping retiree health benefits. This is particularly true for medium-size, nonunion employers. Capital Holding Corp., a Louisville insurance and financial-services outfit, took its relatively small charge of $80 million early, in 1989. It kept the health program going for retirees and left current workers over 55 years of age eligible but deep-sixed the plan for everyone else.
The cutback strategy has a pitfall, however: a court challenge. That's what GM got when it started charging its 84,000 white-collar retirees yearly deductibles of $300 and limiting reimbursements to 80% of the bill. Since this plan was not part of a union contract -- the United Auto Workers pact forbids such cost-saving steps for blue-collar retirees -- GM felt it was within its rights. "That's not fair, doing this after we retired," argues Leonard P. Moeller, an accountant who retired in 1982.
Still, for the small number of companies hammered by the FASB rule, there's hope that the predicament may not turn out to be as bad as it looks. National health coverage, now popular in Washington, may eliminate altogether the need for corporate retiree health schemes. Then -- hallelujah -- companies might be able to add back some of the charges they're taking now.
SOME BIG HEALTH COST HITS Potential charge Net to earnings worth* Billions of dollars CHRYSLER $6.0 $6.0 FORD 9.0 20.4 GE 2.3 20.9 GM 24.0 28.0 GOODYEAR 1.8 2.0 IBM 1.8 43.0 USX 3.0 5.3 *As of Sept. 30, 1991 DATA: COMPANY REPORTS