Explaining the burden of "legacy costs"
With all the discussion about the domestic automakers' future lately, a few of our readers have left comments requesting some additional background on the situation; primarily, the history of the oft-touted "legacy costs" and how they affect the Big 3's survival.
Follow the jump for a breakdown on what automakers could do to address the burden of legacy costs and what they actually are doing.
In addition to requiring a steady base of active employees, pension plans also depend on deft actuarial footwork, and frankly most plans have not adapted well to the increased longevity of retirees. As stated in the Wikipedia entry for pensions, "Because of the J-shaped accrual rate, the cost of a defined benefit plan is very low for a young workforce, but extremely high for an older workforce. This age bias, the difficulty of portability and open ended risk, makes defined benefit plans better suited to large employers with less mobile workforces, such as the public sector." Put into fewer words, an older, shrinking active workforce dramatically increases the cost of employer-funded pension plans. Roll soaring health-care costs into the equation, and a huge drain is placed on profitability.
Membership in the United Auto Workers has declined to about a third of its peak in the late 1960s. General Motors, in the span of twenty years (1985 to 2005), went from 811,000 employees to only 324,000, giving GM 2.5 retirees per active worker (Chrysler lies on the other end of the spectrum, with slightly less than one retiree per employee). It is this shrinkage of the active workforce and the decline in revenue - brought on by the continued loss of market share and the consequential drop in production - that has placed the Big 3 into such a conundrum.
So, what can be done? Well, considering that two-thirds of health-care costs go to retirees and that there is no contractual obligation to provide this care to retirees, the automakers could simply stop paying for it. This would almost assuredly cause a massive strike, so it's not likely a practical solution in the short term. The UAW has allowed a reduction in retiree health care benefits in the last year, but cuts above and beyond what have already been yielded by the union seem unlikely at this time. There is also no easy way to decrease the pension liabilities, short of declaring bankruptcy and dumping the pension plan on the federal Pension Benefit Guarantee Corporation. In fact, Congress is working on plans to tighten pension rules, which stands to wipe out the market capitalization of the Big 3 and would place an even larger burden on future profits.
The best approach at this point is likely what the automakers are already doing - reduce other fixed costs via worker buy-outs and a retooling of labor contracts, and working on recapturing market share (or at least arresting the slide) such that revenues can be maintained. Once this is accomplished, it's a waiting game, as the problem eventually fades away as retirees pass on from this life. The question, of course, is whether the Big 3 can survive long enough, and we likely won't know the answer to that for several years. The focus still comes back around to the product side of the equation, though, as showroom success is absolutely essential to dealing with this problem.
Reader Comments (Page 1 of 2)
Michael Westfall 9:06AM (11/12/2008)
POLITICIANS, MEDIA TALKING HEADS AND UAW OFFICIALS BETRAY AMERICA’S RETIREES
Breaking retirement promises to the elderly dependent retirees.
Not protecting the standard of living or vesting the benefits over past decades of trusting retirees who built America.
http://unionreview.com/insights-analysis-uaw-betrays-autoworkers
http://michaelwestfall.tripod.com/id44.html
http://www.umflint.edu/library/archives/westfall.htm
http://westfallmike.tripod.com/
http://michaelwestfall.tripod.com/id50.html
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Ryan 3:10PM (9/20/2006)
"General Motors, in the span of twenty years (1985 to 2005), went from 811,000 employees to only 324,000, giving GM 2.5 retirees per active worker"
HOLY CRAP!
I honestly never knew it was THAT bad, that really is shocking to me.
My mind is made up, my next car will be American or as American as you can get them now.
Don't read into me and my "American car" theory, I just think it's time for me to buy one!
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The other Bob 3:24PM (9/20/2006)
Ryan, you're a smart man. Fortunately GM and others are also delivering some of the best cars they have ever made, so you should be very satisfied. (Let the flames begin.)
One also needs to realize that for every GM assembly worker, there are at least 6, but as many as 9 workers supported elsewhere in the economy. This includes everything from the parts suppliers to the burger joint across the street from the plant.
So, while all those 487,000 (811,000 - 324,000) workers were probably not just assembly workers, you are looking at a loss of at least 2.9 million auto-related jobs. That’s more than half of the size of the workforce of Michigan.
FYI- decent piece on legacy costs. More people need to understand what we are really up against.
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rwdmtparkingonly 3:25PM (9/20/2006)
The US already has national healthcare for those over 65 (Medicare), and it's much MORE EFFICIENT than private insurance. About 2 to 3 percent of the money that goes through Medicare is consumed in overhead, while 12-15 percent is consumed in overhead with private insurance (http://www.kucinich.us/floor_speeches/hl_sm_bus_fair_act26jul.php?print=y). Why not expand Medicare to everyone? Because Republicans own the companies that do the private insurance, and for their support Bush lets them put this overhead tax on health care. Sitting in an office and getting paid six figures to screw people on their insurance is the Republican’s welfare, and they will fight hard to keep it.
Medicare is not "socialism" in the sense of government owned hospitals or government employed doctors. Medicare neither owns hospital nor employs doctors; it simply operates much more efficiently than private healthcare in insuring people.
Poor "welfare addicts" are covered by Medicaid, so this has nothing to do with them. Expanding Medicare would:
-Allow poor people to seek better jobs because they would no longer need to stay poor enough to qualify for Medicaid.
-Allow middle class people to seek optimal employment without fearing gaps in insurance coverage.
-Encourage entrepreneurialism by getting rid of the huge healthcare costs that small businesses face.
Let the fun begin.
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Brocktoon 11:09AM (9/21/2006)
Dude, I don't feel sorry for GM or Ford one bit. They did these deals to buy labour peace in the past, now they have to pay for that privilege like any other, such as the use of machines and capital costs. I don't see what the difference is other than you can bully workers better than you can bully a bank that lent you money for machines.
The auto buying pubic has known for years that American products were less and less appealing, the boardrooms did not. Why? GM and Ford still think they are building a commodity, not a fashion product. Who's fault is that? The autoworkers? buck stops upstairs for this one guys.
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Frank 3:35PM (9/20/2006)
When you are old enough to be on Medicare you will sadly find out that it's not all it's cracked up to be as I have found out from talking to my older relatives. Most studies have indicated that it and Social Security are the two main programs that will bankrupt the government, because they grow faster than the rate of inflation and faster than the rate of productivity growth of the American worker.
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KT 4:06PM (9/20/2006)
Good write up on legacy costs. I know very few understand the scope of these costs and how they effect aspect of producing an automobile. This is a good start for those who are really interested in learning about the domestic automotive industry.
Thanks.
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BJ 4:08PM (9/20/2006)
"4. Dude, I don't feel sorry for GM or Ford one bit."
V for Vendetta?
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rwdmtparkingonly 3:56PM (9/20/2006)
Medicare does need reform to recognize preventative care and to recognize the replacement of medical proceedures with medications. However, without large manufacturing companies to negotiate with insurers and deliver the care it seems like the best solution.
There is a huge economic "moral hazzard" because only sick peolpe want to buy insurance privately, which creates a vicious cycle of driving up rates.
Covering everyone is also a good way to prevent the demographic problems associated with covering only the elderly.
The surveys I've seen show that those over 65 are pretty happy with Medicare, but most of them would be uninsurable otherwise so it's definitely good for the elderly.
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Richard Warren 4:00PM (9/20/2006)
What a lot of the younger set here does not seem to understand is that what was offered was not that much different than what these workers got. I've got 3 pension plans, all in trust from defunct companies that will be paid out to me at age 65. The pension plans in many companies mirrored what the UAW workers got. My father worked at Lockheed got his full benefits until he passed away (They were lucky, he died at 68) my mother who also worked at Lockheed is still getting her pension and healthcare coverage, she just turned 80, they have been paying for 15 years. My mother-in-law has a pension from HP and retired befor the whole 401k, managed healthcare thing.
During the same period of time we are talking about my grandfather had a pension that matched what the UAW had and he worked in a non union laundry.
Then lets talk about retired military on pension, post office, how about the President a 4 year stint, retirement, healthcare security, and more for life.
Those jobs lost need to be looked at, not just the total number, some of that came from attrition, some outsourcing, some from spinoff, Delphi. So while the number may be large (it is) a good portion of that may actually be still working in the same building under a different name.
Heathcare costs,longer life,loss of market share poorly funding the pensions all that has conspired to create this problem. Those who think market share is the only answer need to think again, it's not. It would help but it's not the answer. For those that think the government should not help, consider this, we as taxpayers will pay, one way or the other, so if the President would get off his dead ass and talk, it might just save us all money in the long run. Who do you think funds the Pension Benefit Guarantee Corporation? It's already in trouble thanks to Corps taking the easy way out BK, I appluade GM and Ford for not just laying it on us through bankruptcy.
Ryan, Well said.
The other Bob, same to you.
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Tom 4:19PM (9/20/2006)
Those legacy costs will be the first to go on the chopping block if GM or Ford file bankruptcy and restructure. Good luck to those retirees or future retirees employees expecting checks.
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Frank 4:14PM (9/20/2006)
Richard,
Didn't the president try and do something about Social Security? He got shut down not just by democrats but by republicans as well. He tried to take on something BEFORE it became a crises and what did he get for it? Grief. The dems even went around saying that there was NO problem with Social Security and everything was fine! That's like the captain of the Titanic saying everything things is cool, go back to your cabins.
Now you want him to take on pensions? What good would it do? The dems will oppose anything he wants to do and the repubs will be too afraid to support him. Why should he take on that? Remember all the talk about our addiction to oil? And his support for alternative fuels? Did it get him anything? Nope, everyone still says he's in with "big oil".
These problems will not be dealt with until it becomes a crises that cannot be ignored. That's the way it is will all politicians.
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lessgovtplease 4:13PM (9/20/2006)
Medicare is not as efficient as people claim it is. According to this economics blog:
"Accounting is so boring no one wants to talk about it, and yet it's crucial to get it right. And in cases like these, the studies are generally getting it very wrong. Comparing government numbers to private sector numbers isn't even apples to oranges; it's apples to fruitflies.
For starters, the private sector--whether they be charities or corporations--has to collect and track the money they spend. So does the government--but unlike the private sector, that figure doesn't get charged off against, say, Medicare; it gets charged to the auditor's office, the IRS, the Treasury, the justice department, and so forth. (Social security does track the money you send them, but the IRS, not their legal department, is the enforcer.)
Also, it is often very, very hard to tell what something costs a government agency. They don't pay cash prices for a lot of the services they get, and they don't do normal corporate things like accruing their pension liabilities, so it's hard to know what their true compensation costs are.
Government agencies also--obviously--don't have big finance sections to tell them how much they need to pay in taxes. That doesn't mean they're more efficient at delivering services; it just means that they don't pay taxes. We could achieve the same "efficiency"--and many others besides--by eliminating the corporate income tax."
http://www.janegalt.net/archives/009430.html
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rwdmtparkingonly 4:25PM (9/20/2006)
The private sector is more efficient at manufacturing and at providing most services, as long as strong competition exists.
Healthcare is unique because, by covering everyone, the main costs of marketing, and of evaluating and underwriting people to decide whether to cover them can be erased.
Show me some conservative analysis that actually shows that private insurance actually has lower overhead costs.
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Ryan 4:52PM (9/20/2006)
Eric Bryant,
This really is an excellent post!
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The other Bob 4:49PM (9/20/2006)
Wow! An intelligent conversation about the US auto industry on autoblog. Amazing. I wish we could have more.
rwdmtparkingonly : You know your health care stuff.
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Gardiner Westbound 5:10PM (9/20/2006)
1. Domestic automakers’ real legacy cost is consumers won’t buy their cars after being burned for decades by lousy product and worse warranty performance.
2. Like all government enterprises socialized medicine is mostly concerned about looking after the civil servants who operate it. Canadians routinely die waiting in the queue for treatment, or buy care in well-equipped and staffed U.S. hospitals.
3. Private pension plans are under funded because companies are permitted to defer their contributions. Workers contributions are fully paid up.
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rwdmtparkingonly 5:20PM (9/20/2006)
#16 - I'm not advocating the Canadian system, I'm advocating Medicare expansion. Do you know anyone that died waiting for Medicare?
Medicare functions with PRIVATE doctors and hospitals. A lot of private hospitals are having a hard time surviving now becuase of uninsured people.
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The other Bob 5:40PM (9/20/2006)
"Canadians routinely die waiting in the queue for treatment, or buy care in well-equipped and staffed U.S. hospitals."
That's long been discredited as a lie created by U.S. insurance companies. If the Canadian system sucks so bad, why did the CAW and GM recently write a joint letter of support for the current system to Canadian parliament? Why are Canadians so healthy?
It serves both workers and industry alike. That's why so many cars are still being built in Ontario.
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Lithous 5:48PM (9/20/2006)
"my mother who also worked at Lockheed is still getting her pension"
On a side note, I believe Lockheed *just* this year or last year stopped giving pensions for new employees.
"Domestic automakers’ real legacy cost is consumers won’t buy their cars after being burned for decades by lousy product and worse warranty performance."
Show me any realistic evidence that if GM and Ford wasn't around with their supposedly "bad" cars that we would have been better off with what the Japanese could build at any given time. Remember they are at full capacity now in 2006 and can't make enough cars to sell to the world and the U.S. by a long shot. Forget any housing boom twenty years ago, there were no large pickups for the contractors.
Think of the small picture or think of the big picture of how it was. Obviously the big picture is way too much to comprehend.
"Dude, I don't feel sorry for GM or Ford one bit. They did these deals to buy labour peace in the past,..."
Well yeah, you don't care about the American past... you spell "labor" as "labour". No offense, but I don't care very much about foreign industry and you don't care about foreign (to you American) industry.
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