The new Treaty of Detroit

I have been doing some work recently concerning the recent agreement between the United Auto Workers and the Detroit Big Three auto companies regarding retiree health insurance. So, I thought I might try a post summarizing what happened and giving the reasons why the new employee VEBAs are attractive to the Union.

A few decades ago, the Union and the Big Three negotiated retiree health insurance. In return for less in wage increases the Big Three ageed to provide employees with health insurance after they retire. At the time, this benefit was not expected to be expensive and was structured by the Big Three on a pay-as-you-go basis.

The Big Three created funds, which are designated in the tax code as a Voluntary Employee Benefits Association (VEBA). The Big Three received tax breaks for putting money into the fund. These VEBAs were administered by the Big Three who remained ultimately responsible for paying for the benefits.

As health care costs have soared, and as the number of retirees entitled to benefits has incrased, the cost to the Big Three of retiree health insurance has become prohibitive. This has resulted in the Big Three wanting to either terminate retiree health insurance altogether or to substantially reduce benefits.

One obstacle to this is the retirees, who stand ready to file lawsuits challenging the right of the Big Three to terminate or reduce benefits. The retirees will argue that they received legally enforceable promises from the Big Three that retiree health insurance would be provided. There was a contract. A deal is a deal. The Big Three will claim that the retiree health insurance was provided with the understanding that it was a mere gratuity which could be terminated or modified at will by the Big Three. Litigation on this question in other industries has been inconsistent, with the employees sometimes winning and other times with the company winning.

One problem for the retirees is that even if there was a contract to provide retiree health insurance, that contract would do the retirees little good if the Big Three declared bankruptcy. Bankruptcy allows a company to not pay its creditors or to py them pennies on the dollar. If the Big Three declared bankruptcy, the retirees would have to get in line with the rest of the creditors, and would likely see their benefits terminated or substantially reduced. Of course the Big Three don’y want to declare bankruptcy for all sorts of reasons.

The agreement struck by the Unin and the Big Three involves the creation of an employee VEBA. Unlike the old VEBAs, the new employee VEBA would be controlled entirely by the employees and the Big Three would have no involvement. In exchange for an agreement to terminate the Big Three’s liability for retiree health insurance, they would hand over enough money to the new employee VEBA to prefund the benefits. The Big Three wold be freed of their responsibility to provide retiree health insurance. And, the retirees would receive a lump-sum payment sufficient, in theory, to pay for their benefits.

Of course, everything depends on how much money the Bog Three hand over to the employee VEBA and whether it is really sufficient to prefund the benefits. In calculating the amount of money that the Big Three must hand overThe Union, the Union and the Big Three used fairly optimistic assumptions about future increases in health care costs and future returns on investment. If those assumptions prove to be too optomistic, then the fund will evenually have to reduce benefits or run out of money altogether. Another problem is that part of the payment to the employee VEBA will come in the form of stock in the Big Three. There is no guarantee that the stock will be worth anything in the future.

So why would the Union agree to this? First, money in hand is better than empty and possibly unenforceable promises. There was no guarantee that the Big Three wouldn’t terminate or substantially reduce retiree health benefits on their own despite the risk of litigation (or that a judge wouldn’t rule in favor of the Big Three in the ensuing litigation). Second, the Big Three are teetering on the brink of bankruptcy, with the legacy costs of retiree health insurance being one of the thngs that might tip them over all the way into bankruptcy. If the Big Three do go into bankruptcy, the retirees will almost certaily loose their health insurance. The new employee VEBA is independent of the Big Three, so even if they do eventually wind up in bankruptcy the retirees will not loose the benefits. Third, even though the Big Three would no longer be responsible for retiree health benefits, the Union might still negotiate further payments to the employee VEBA in the future if it turned out that the fund needed more money. The Union would not be able to legally compel the Big Three to make such payments, but the Union has a lot of leverage with the Big Three independent of the legal system.

This is a pretty good outcome for the retirees. While it seems likely that the employee VEBA is not fully funded, so that reductions in benefits will be necessary in the future, the retirees are certainly better off with a one-time payment of moeny that does’t quite fully fund the employee VEBA than they were with a mere contract for the benefits.

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