Honest Balance Sheets, Broken PromisesLarry Light
Accounting rules, an abstract realm known to few, have introduced a harsh new reality into Clifford Davis' retirement. Navistar International Corp., where Davis worked as a maintenance man for 32 years, has long picked up the medical bills for its 40,000 pensioners. But starting Jan. 1, an accounting-rule change requires many large companies to include on their balance sheets immense sums for these ever-more-costly health benefits.
So the Chicago-based truckmaker wants to cut back its two-decade-old plan, forcing Davis and fellow retirees on fixed incomes to fork over a hefty chunk of money for their coverage. Money-losing Navistar says it will go bust if former workers don't pick up part of their health costs. Yet Davis, who lives in a trailer in McCordsville, Ind., and is not yet 65, contends that he would have to shell out 25% of his monthly $1,400 pension check. Says Davis: "I can't afford to pay."
Lots of other corporations are axing or curtailing retiree health benefits (table), hoping to minimize the financial broadside of the so-called 106 rule, as well as curb runaway health costs in general. The rule was adopted in 1990 by the Financial Accounting Standards Board, the overseer of U.S. accounting criteria. As FASB sees it, failing to recognize the steadily growing health-care liability misleads investors about a company's financial condition.
Some large companies with strong balance sheets that can afford the hit are simply taking a one-time earnings and net worth write-off. But others, often less robust outfits like Navistar, are finding ways to circumvent the full force of 106 at their retirees' expense.
McDonnell Douglas Corp. is replacing its health plan for white-collar retirees by giving each a one-time payment of $18,000, using surplus pension-fund money. This will halve the St. Louis planemaker's liability under the FASB rule, to $700 million. But after 1996, most bets are that payments to new retirees will be eliminated. According to a survey by the consulting firm A. Foster Higgins & Co., almost two-thirds of U.S. companies will have scaled back or eliminated the benefits by next year. "Employers are backpedaling like crazy from their commitments to workers," complains Clare Hushbeck, a senior analyst at the American Association of Retired Persons.
Certainly, retirees are the easiest target: They can't strike or quit for another job. Management "is picking on a group that can fight back the least," says Jerry Feldscher, a pensioner at Unisys Corp., which intends to phase out its plan entirely by 1995.
Retirees slammed with health-care cuts do have an option. Many are fighting back in court, although too few cases have been decided to discern a trend. Thus far, the key legal issue is how explicit the company has been in promising medical benefits (box). As a result, most employers steer away from cutting programs for union retirees because those plans are usually written into labor contracts. General Motors Corp., for instance, imposed 80% reimbursement limits on white-collar pensioners' bills but left United Auto Workers retirees alone.
MISCALCULATION. Navistar is bolder. Aiming to save 71% on retiree health-care costs, it tried to ram through the benefits reduction for both union and nonunion pensioners. But the UAW launched a legal counterstrike that threatened to tie the company up in court for years. As a compromise, the union and the truck manufacturer have agreed to reopen their contract now, a year before the pact expires, to negotiate health issues.
Retiree health plans first came into vogue in the late 1960s and early 1970s, after medicare was enacted. The idea was that the plans would take care of areas not covered by the federal medical program for the elderly: prescription drugs, home nursing care, and hospital stays beyond 90 days. "They thought the cost to supplement medicare would be small," says Richard Ostuw, a vice-president at consultant Towers Perrin Foster & Crosby. Wrong. For the past few years, the cost of corporate retiree health plans has been surging at a 15% annual clip.
Employers have two unappetizing choices under the new rule. They can either amortize the cost of the benefits over 20 years or take the entire charge to earnings in the first year. IBM took its $2.6 billion earnings hit in the first quarter of 1991. Analyst Philip C. Rueppel of Sanford C. Bernstein & Co. says Big Blue wanted to show that the rule "wouldn't be a big deal for them." Despite rocky times, IBM has not announced any benefit reductions.
But the most vulnerable companies are waiting until the last possible minute to reveal how they will stomach the 106 rule. Consider the desperate situation at GM: a potential charge ranging from $16 billion to $24 billion. The carmaker plans to say how it will handle the problem in February. Most analysts expect it to spread the shock over 20 years. After all, the higher figure would gobble up most of GM's net worth. The auto giant, which is mired in red ink as well as unfunded pension liabilities, could much more easily withstand the slow nibbling of amortization, at $800 million to $1.2 billion per year.
`SOFT NUMBER.' Saving the day, of course, would be some form of national health insurance to bridge the gaps left by medicare. President-elect Bill Clinton wants to widen the availability of health-care coverage, and the Democratic-controlled Congress seems receptive to the notion. Whether the legislative process will get to the plight of corporate retirees is an open question. Still, McDonnell Douglas hopes that by 1996, when its $18,000 subsidies to retirees will likely end, some government measure will be in place. "We don't know what will happen by then, but we can hope," says spokeswoman Barbara Anderson.
Meanwhile, the FASB rule will drag down corporate performance across the board in 1993. Shearson Lehman Brothers Inc. figures that without the rule, Standard & Poor's 500-stock-index companies would enjoy a 17% boost in earnings per share next year. With it, the S&P 500 may climb only 10%. On the plus side, no money for health-care liabilities need be immediately diverted from operations or capital spending. "This is the ultimate soft number," says Solomon Samson, S&P's managing director for corporate finance.
Eventually, though, affected companies must come up with cold cash. That's why, bean-counting contrivance or no, the rule has led companies to limit the liability by slicing retiree health plans. And that's how the abstract art of accounting has a real and painful impact.