General Motor Case Study
Introduction
Voluntary Employees’ Beneficiary Association (VEBA) is tax free welfare plan that is formed by employees of an organization and funded through an arrangement between the employer and employees (Connolly, 2006). It caters for the health expenses of employees and their dependents during retirement years. This plan can be used to cater for personal medical expenditure including; insurance premium, prescriptions and ambulance hire.
When an employee enrolls to VEBA he or she is given an account (Bernstein, 2008). The participant may contribute to this account directly through deduction from payroll or indirectly from sickout, vacation and other accrued benefits. The individual builds up assets in this account which is later used to reimburse this individual or his dependants in times of sickness, death and accidents.
Why UAW may have agreed to administer the Fund
UAW agreed to administer the fund because this form of funding employees’ benefits has various advantages over the traditional approach of funding. One of these benefits is that VEBA gives the union greater control over the funds and autonomy to make decisions concerning how the funds will be utilized (Connolly, 2006). In the traditional pension plan, organizations had complete control over the payment of employee benefits. This was a disadvantage to the employees as these funds were the first to be affected when the company runs into problems. However, VEBA entrust the employees’ benefit funds into the hands of the employees.
Another benefit that may have motivated UAW to agree to an under funded VEBA is that, this plan offers a greater sense of security to workers concerning their health and life benefits. One characteristics of this plan is that it requires the employee to pre-fund the plane and once trust funds have been committed the plans become irrevocable. This means that the employers can not retract and withdraw the funds that were already committed to the employees’ benefits.
In the traditional pension and healthcare plan organization funded retiree obligation and other benefits through unfunded liabilities which were reported in the company’s financial statement. This gave organizations an avenue for changing employees’ benefits in times of financial difficulties or when the organization is going bankrupt. Organizations were free to redirect these funds into the core activities of the business during trouble time.
During bankruptcy employees stand to lose their entire benefits. However, VEBA plans limits organizations from redirecting the employees fund from the established trust and protects employees from losing their benefits during bankruptcy. The pre-funded nature of the plan ensures that employees would still have their funds regardless of future performance of the organization. This fund is also protected from General Motors creditors. VEBA assets are protected from creditors. This means that the employees fund will be protected even when the organization is unable to meet its liabilities.
Establishment of VEBA for GM employees would see the retirement plan drop by a massive $16 billion. While this may be viewed as a loss to the employees, it presents long term benefits to the present and retired employees. Since 2008, GM and other automakers have been struggling to remain afloat in the automotive market. The competitiveness of these companies has been hindered by huge cost of production. This has resulted in huge losses for the companies. If the status quo is maintained the companies may be forced to move for drastic measures such close down of some plant, huge employee layoffs in order to reduce cost.
However, the VEBA plan has presented another alternative to saving cost. It is estimated that a VEBA plan would save GM approximately $200 million annually thus improving the company’s competitiveness (AARP, 2010). This is likely to return the company into profitability thus saving the employees from drastic measures such close down of plants of employee lay off. Saving the company from closure would also be beneficial to retirees. It is estimated that the current plan secures employees benefits for the next 80 years, thus protecting them from losses that would arise in case of the company’s bankruptcy.
Another benefit associated with VEBA to employees is that, it is an efficient way of saving for present and future expenses. Funds invested in this plan are used to reimburse the account holders or his beneficiaries in times of sickness, death or accident. This is an efficient plan that ensures that an employee and/ or his dependants do not become impoverished as a result of death, sickness or accident. VEBA may also be used to fund other benefits including payment of vacation and other recreational activities. This implies that VEBA is not only an effective way of securing future uncertainty but also a flexible option since this fund can cater for different benefits. Another benefit of VEBA to employees is tax exemption.
Contribution to VEBA schemes are tax deductible. This means employee get a tax refund for making a contribution to this plan. The interests earned by this fund are also not taxable. This makes VEBA a viable way of investing funds that are not in use since little expenses are involved. Currently, there are no laws limiting the amount of contribution that an employee can make towards a VEBA account. This means that the employees can invest as much resources to the plan and enjoy the benefit of tax-exemption. Health benefits paid to retirees from VEBA plan may also be tax deductible.
Risks for Employees
VEBA presents numerous benefits to General Motor employees and retirees. However, this plan also presents certain risks to these people. One of these risks is that employee benefits may be eroded if the fund set aside becomes inadequate (Moran, 2008). It has already been mentioned that VEBA is a pre-fund trust that cannot be revoked. While this presents the employees with the benefit of secure funding of benefit, it does not cater for future uncertainty. The distinct funds established by the employer to cater for employees benefit may become inadequate incase of changes in future cost, thus eroding the benefits that employees and retirees are entitled to.
There are a lot of uncertainties concerning health cost and returns that can be made from investment of the funds. When returns fail to grow according to expectations the fund may become insufficient in meeting the demand of future retirees (Moran, 2008). Similarly, if medical costs rise faster than the projected cost, the fund may fail to sufficiently cover the increased expenses. This means that incase these uncertainty occur the future retirees will have to shoulder them.
It was estimated that the fund would grow at the rate of 9% and that health care cost would grow in double digit between 2010 and 2013 and then drop to 5% (AARP, 2010). The risk of having health care cost growing at double digit rate beyond 2013 is very real and this means that the growth of healthcare cost might surpass the project growth. This implies that future retirees may be required to meet a huge portion of their healthcare cost by them selves. This risk has been made worse by the information that the plan was under- funded from the start. General Motors agree to transfer $35 billion to the VEBA plan which was much less than the $51 billion figure of the existing liability of the company to the retirees (AARP, 2010). This means that the problem of under-funding may become chronic in case health care costs continue to rise.
Another risk in the GM deal is associated with the funding of the VEBA plan. It has been mentioned that VEBA present greater sense of security to GM workers because it is a pre-funded plan. However, the level of security will also be determined by the funding arrangement between the company and the union. If the funding arrangement is based on hard cash basis then the workers will be greatly protected from risks such as bankruptcy of the company. However, if the trust consists of other forms of fund such as company stocks and securities then the workers benefits are also at risk if the company goes into bankruptcy. This is because the plan would loose out on the entire value of the stocks that belonged to the company.
Benefits of VEBA to GM
VEBA has also presented various benefits to GM. One of these benefits is that it has helped GM to avoid a retirement plan that is already over funded. The VEBA negotiation will save General Motor from the $46.7 billion health obligation it owes to retires (Atkinson, 2008). This is a necessary measure for General Motor which has been under pressure to reduce cost. Since 2008, American automakers have been struggling to remain competitive in a market that has since declined due to the economic crises. One of the primary areas of focus for these companies was to reduce cost (Bernstein, 2008). Healthcare obligations to existing and retired employees consisted one of the largest cost component for General Motors.
It is estimated that retiree obligation accounted for 16% of costs for average American corporations. According the case, General Motors spends $1,400 per care on retiree healthcare expenses (AARP, 2010). In order to remain competitive, this organization must reduce its costs. Establishment of VEBA plan for GM employees would enable the company to transfer this obligation to the funds, and reduce the drain to the company’s resources.
VEBA is also an effective strategy for eliminating inflation in medical expenses. For along period, the US has been grappling with high health care cost. This problem has been partly attributed to the health financing system which involves financing of healthcare expenses by third parties (Atkinson, 2008). This has promoted a culture of extravagance among health care consumers. VEBA may be one of the strategies that may reduce extravagance among health care consumers. This plan shits health care risks and responsibilities to the employees. The employees’ healthcare expenditures are financed through their own fund thus encouraging cost consciences.
Establishment of VEBA plan has also enabled General Motor to shift risks associated with uncertain healthcare expenses to present and future retirees (Bernstein, 2008). VEBA involves setting up a pre-funded plan to cater for employee’s future benefits. The funds that have currently been availed by GM have not factored in uncertainties such increase in healthcare costs. This means that if these uncertainties occur, they will be shouldered by the employees and the retirees (Bernstein, 2008). This is because the fund is already established and pre-funded by the organization and the organization has no obligation to invest additional funds into the plan. This is unlike in the traditional pension and healthcare scheme where organizations have to shoulder risks of uncertainties as retiree benefits are funded in each financial period.
References
AARP (2010). “Retiree Healthcare”. July 26, 2012. http://assets.aarp.org/rgcenter/econ/i4_veba.pdf
Atkinson W. (2008). “VEBA’s Employers to Union”. Journal of Biotechnology Healthcare. 5 (4): 16- 26
Bernstein A. (2008). “Can VEBAs alleviate Retiree Health Care Problems?”. July 26, 2012. http://www.law.harvard.edu/programs/lwp/occasionalpapers_Ap9_fin2.pdf
Connolly D. (2006). “VEBA: A Tax Exempt Alternative for Reimbursement of Healthcare Cost”. Cpre Journal. 176: 18- 22
Levine K. (2010). “VEBAS, ERISA and other Cloaking Devices”. FORC Journal. 21 (1):
Moran A. (2003). “VEBAs: Possibilities for Employees Benefit Funding”. Employee Relational Journal. 29 (1): 83- 95
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