Will the Other Shoe Drop?

Companies are taking the knife to medical benefits, and they’re not just trimming the fat

While we all know about shortfalls in company pension plans, the underfunding of retiree medical costs is almost twice as deep. In a recent study, Standard & Poor’s found that pensions of companies in the S&P 500 were underfunded to the tune of $150 billion. However, other post-retirement benefits, which are mostly medical costs, were $292 billion short. Overall, pensions were 88% funded, which is alarming in itself, but the medical benefits were only 22% funded, indicating an enormous potential expenditure for these companies in the future.

Because most companies don’t have funds set up to pay for retiree medical costs, as they do for pensions, they are rapidly increasing pay-as-you-go programs for medical costs. Many companies have taken steps to limit their exposure to this expense. In the automotive industry, members of the United Auto Workers have actually negotiated with companies to reduce retiree medical costs and increase their own co-payments. This is an unusual concession, and we think it came about only because the workers believed that the very survival of their jobs depended on it.

Over the past several months, many companies have reduced their pension and medical benefit programs. These adjustments were not just for retirees, but also for current workers. Among the companies that have already taken these actions are International Business Machines (IBM; S&P investment rank 4 STARS, buy; recent price, $83), Verizon (VZ; 3 STARS, hold; $34), Hewlett-Packard (HPQ; 3 STARS; $34), Motorola (MOT; 5 STARS, strong buy; $22), and Sears Holdings (SHLD; 3 STARS; $135).

Cutting benefits is becoming more acceptable to the labor movement. S&P expects more companies to make such changes, both as a way to stay competitive with foreign producers and as a newly acceptable form of cost cutting.

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