President &
CEO, Lance
Wallach

  • Member of the
    AICPA faculty of
    teaching
    professionals.
  • AICPA author,
    instructor &
    national speaker.
  • National Society of
    Accountants
    Speaker of the
    Year.
  • Writes financial
    articles for over 50
    national
    publications.
Brian J. O'Connor of The Detroit News Explains VEBA
Fall 2007

The historic new contract tentatively agreed to by General Motors Corp. and the
United Auto Workers has introduced a new phrase to the Motown vocabulary -- the
voluntary employees' beneficiary association, or VEBA for short.

Q . What is a
VEBA?
A . A VEBA is a specialized tax-free health care trust fund that will pay for the future
benefit costs of a company's current or retired workers. These trusts go back to the
1920s, when they were created after large employers defaulted on promised
benefits.

The idea is that employers set aside money today for promised benefits so that if the
company runs short of cash or even ends up driven into bankruptcy, the money still
will be on hand to pay for pensions, health care or other benefits. According to the
Internal Revenue Service, there were about 12,500 VEBA trusts in 2005.

Q . How does a VEBA work?
A . Employers make a tax-free contribution to a trust fund, which, in GM's case,
becomes the responsibility of the UAW. The union will have to set up a board to
oversee the trust, set policies and select managers to invest and oversee the money.
Dollars in a VEBA grow tax-free and are untaxed when used to pay benefits.

VEBAs all share a basic framework under the tax code, with lots of room to
customize each trust. We won't know exactly how the GM VEBA will work until details
are released to the public.

Q . Is this a good deal for GM?
A . Almost everyone connected with business or the auto industry says yes. The
VEBA allows GM to get out from under about $50 billion worth of future health care
costs for its union retirees -- at a discount. GM is expected to pay $35 billion -- still a
lot of cash, but less than $50 billion. In fact, there was no guarantee the bill wouldn't
go higher over the years.

Part of the health care issue for automakers is that deals signed decades ago didn't
anticipate today's longer life spans, expensive high-tech treatments and cures and
the rapid rise in health care costs. In 2006, for example, those costs rose by 6.9
percent -- twice the rate of inflation.

The VEBA also boosts GM stock by making the automaker look more profitable.
Recent changes to pension and tax laws require corporations to account for the
estimated future cost of health care commitments on their balance sheets today, and
that cost soon will vanish for GM. The company also won't have to pay out the actual
billions in cash that go for retiree health care each year, easing its cash flow and
adding to its bottom line.

Q . And what about the union?
A . The best thing about a VEBA is that it takes away uncertainty for union workers.
Don't forget, less than two years ago some analysts were using the words "GM" and
"bankruptcy" in the same sentence. If the General went belly-up, retirees could have
seen all their benefits wiped out.

It also means the union won't have to fight GM over retiree health benefit cuts, which
the automaker could have sought to save money on health care, such as requiring
co-pays, reducing coverage or capping expenses.

Q . Is there a down side?
A . You bet. The union is now in the health care financing business. Before, GM
offered a defined benefit plan. If a bunch of retired workers needed $1 million
hospital treatments, GM had to cough it up. Now the union's VEBA has to cover that
cost. If the money runs out, the VEBA can't go raising more cash like GM could by
converting shares of stock or selling off a bunch of new Malibus and Silverados.
The union will have to invest the money wisely for the long term, keep it safe from
union politics and -- if the money starts running short -- raise cash from members,
charge co-pays for service, cut benefits or do all three.

Q . Do VEBAs work?
A . Yes and no. Critics point to VEBAs at Caterpillar and Detroit Diesel that ran out of
cash. On the other hand, the VEBA at Navistar (formerly International Harvester) was
set up when the company was in bankruptcy in 1992, and still is going strong. Ford
already has a limited VEBA in place, and GM has one that was set up in 2005 to
cover some limited benefits costs. Retirees from the United Steelworkers of America
have VEBAs at four Pennsylvania steel mills and Brinks Co. set aside $200 million of
the $1.1 billion it got for the 2005 sale of its BAX division for a VEBA. Another plan
was set up by Goodyear last year for $1 billion.

Q . What are the reasons a VEBA works or fails?
A .
There are three key elements in any VEBA, said Lance Wallach, a financial
planner who has set up many plans and is president of VEBAplan.com
.

1) Funding:
The most important element is how much money is there to start with. Ideally, the
plan is 100 percent funded, Wallach said. In GM's case, the plan is 70 percent
funded. That means the money will have to grow to cover the costs (which rarely
happens, Wallach says) or the union will need to do a good job of managing the
trust's health care payouts.

2) Management: A VEBA needs a board that makes responsible decisions about
how to manage the fund and where to invest its assets. This usually isn't a problem
with professional investment advisers, Wallach said.

3) Plan structure: The final key is how the trust manages the care of its members
and works to reduce costs. The VEBA won't have any more leverage in getting
discounts from health care providers, drug companies and others, so the trust
should aim to actively manage the health care of its members. That could include
wellness incentives for members to lose weight, stop smoking and take better care
of themselves, or moving to managed care or other plans.

Q . Would GM have to bail out the union if the VEBA fell short or health care costs
rose by some tremendous amount?
A . Experts say that would be rare in a VEBA, but some reports say it could be in the
GM deal.

The point of creating the trust fund is that the future liability no longer belongs to the
company. Accounting rules require a company to carry expected costs on its books,
so if there was some chance GM would be putting up more money to guarantee a
VEBA, the company would have to take some kind of charge, which runs counter to
the goal of entirely wiping those costs off its balance sheet.

GM is paying now so that it doesn't have to pay later. Analysts say it's unlikely the
company would agree to pay twice for retiree health care when it argues that it
couldn't afford to pay even once.

Q . What if we get national health care or if the VEBA investments make a
tremendous amount? Would GM get some money back?
A . We won't know until we see the details, but typically when a union takes on all the
future risk, there would be no reason for it to share any unexpected gains. If,
however, GM guarantees the VEBA against some losses, it might want a share of
any excess gains in return.

On the other hand, GM is allowed to take cash out of the $20 established in 2005, a
fund created to run through 2011 with money from deferred UAW salary increases.
The deal on that VEBA allowed GM to withdraw cash equal to what the company
spent on health care for a period, which came to about $6 billion in 2005.

Q . Will GM just write a giant check for the VEBA?
A . VEBAs can be financed with cash, stock or a combination. In the union's case, it
probably wants an all-cash deal, or at least as much cash as it can get. That way the
union doesn't bear the risk of GM stock dropping if the automaker runs into more
trouble.

GM, however, would rather fund the VEBA with its stock, which would come out of the
company's treasury holdings and leave its cash supply untouched.

Q . Bottom line: Is this good or bad -- and for whom?
A . The VEBA gives the UAW insurance that its retirees get benefits -- and insurance
comes at a cost. In this case, that's giving 30 percent discount on GM's cash
contribution and taking on most or all of the risk and responsibility. On the other
hand, if GM tanks, the union's VEBA money stays in the trust fund, safe and sound.
The VEBA gives GM relief from a cash drain of more than $3 billion annually and
another $50 billion on its balance sheet.

Its stock will immediately gain and the cost of its labor will drop to be more
competitive with U.S. plants run by its nonunion Japanese rivals.

If it works out as planned, both sides can stop wrangling over retiree benefits,
concentrate on building good cars that sell at a good profit -- and keep all the
promises made to the loyal workers on the line. That's an outcome that would have
both GM and the UAW shouting, "Viva VEBA!"

You can reach Brian O'Connor at (313) 222-2145 or boconnor@detnews.com.
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