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Cost Peril in Health Care Retiree Benefits Are Worrying Investors

Posted on: Wednesday, 27 July 2005, 12:01 CDT

As double-digit inflation in health care siphons an increasing amount of cash from companies with generous benefits, big investors are growing wary.

"Rapidly rising health care costs depress the returns of our pension fund," said George Diehr, a health benefits official at the California Public Employees' Retirement System, the largest U.S. public pension fund, with more than $180 billion in assets

General Motors brought the issue to the fore last month, when its chief executive, Rick Wagoner, warned that "the health care crisis is putting our future at stake." And last Wednesday, discussing GM's second-quarter loss, its chief financial officer, John Devine, said in a conference call with analysts that health care remained the company's biggest cost issue.

But GM is hardly alone. Financial professionals say health costs are also a big drag on the investment value of the stocks and bonds of many other companies in heavy industries, as well as airlines, railroads, telecommunications and others. The companies under pressure are ones that promised medical coverage to their employees and retirees, in many cases long before the surging prices of new drugs and procedures sent costs spiraling upward.

David Zion, an accounting industry analyst at Credit Suisse First Boston, estimated that companies in the Standard & Poor's 500-stock index spent $30 billion on health care and other nonpension benefits for retirees in 2004.

"It's a cash-flow issue for a lot of these companies," he said, "a cost that may be growing faster than the underlying business."

While the financial risks of corporate pension obligations have been better publicized, portfolio managers and their advisers say health costs may pose even greater uncertainty. Compared with their pension safeguards, however fragile, most companies have no reserve funds to cover future health outlays.

Zion has analyzed pension commitments, as well as the health care promises that are listed as "other post-retirement employee obligations" on Securities and Exchange Commission filings.

"Time and again we noted that these 'other' plans were in worse shape than the pension plans," he said.

Because of the soaring costs of health care coverage, an estimated 40 percent of companies with more than 5,000 employees no longer offer retiree health benefits. Among those that do, many finance employee and retiree health care on a pay-as-you-go basis.

"Credit analysts see those promises as just more debt that a company owes," said Ed Heilbron, a consultant with Mercer Investment Consulting. "And stock prices do reflect this."

Larry Puglia, the lead portfolio manager of the Blue Chip Growth fund at T. Rowe Price, said that health obligations influence his investment strategy.

"We typically would not have big exposure to General Motors and some of the manufacturers that have big pension and health care liabilities," he said.

Puglia's fund, for example, does not include Boeing, which estimated its retiree health and other nonpension obligations at $8.14 billion at the end of last year and has assets of less than $100 million to cover them.

The T. Rowe Price fund does have a big position in General Electric, mainly because GE is growing robustly, despite having reported $9.25 billion in retiree health obligations. The company has set aside assets of $1.65 billion toward covering those future benefits and says it plans to add $710 million this year

Zion, the analyst at Credit Suisse First Boston, says that as health costs continue to outpace average corporate revenue growth, companies have dwindling options.

"Either they keep covering these benefits, or try to cut the costs, pass more of costs to retirees, for example, or try to get the taxpayer to help through government subsidies," he said.

Source: International Herald Tribune

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