• Sep 20, 2006

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.

The legacy costs have their roots in the concept of "cradle-to-grave" care provided to industrial workers by their lifelong employers. Such a system utilized employer-funded pensions to provide retirement income and catastrophic injury coverage for employees, and also ensured workers that they would receive a high level of health care coverage upon retirement. This arrangement minimized the burden on government-funded social security programs and provided significant incentive for loyalty on behalf of the employee, but also depended on steady growth within the manufacturing sector - an assumption that, as we now see all too clearly, turned out to be wrong.

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.



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    • 1 Second Ago
  • 29 Comments
      • 8 Years Ago
      In the past (and present) working for one of the domestics was a dream job -- huge wage, huge benefits.

      Some people get mad at GM and Ford and go on and on about wonderful Toyota and it efficiency. Well trading 811,000 amazing jobs for 4500 low benefit low wage jobs -- where almost all the profits leave the country is not something to be happy about.

      You know those jobs were so good -- huge wage, benefit, and low productivity -- we would all dream about jobs and an economy that could support that. It was not bad people -- it was heaven and you gave it up to Japan.

      You know .. the one Comaro plan in Canada they are saying saved 6500 jobs up here .. one plant. Incredible.

      People who buy foreign are winning the battle but will loose the war. Self centred, short sightedness -- people all living in a bubble.
      • 8 Years Ago
      Comparing car insurance to healthcare is a pretty lame argument. If I dent my car then I can either drive it dented, bum a ride or take the bus. If you break your leg you pretty much have to see a doctor, and god forbid you come down with ALS or diabetes. No insurance? Welcome to bankruptcy town and a ruined life for both you and your entire family.

      Oh, and speaking of Florida and hurricanes, flood insurance is backed by the federal government anyway. Without that government backing you likely wouldn't be able to get it at all.

      One of these days we'll wise up and decide to get on the same page as the rest of the industrialized universe and demand equal healthcare for all. The fact that it's 2006 and we're even debating this in this country is a disgrace.

      • 8 Years Ago
      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.
      • 8 Years Ago
      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.
      • 8 Years Ago
      Nice try Puffy. Homeowners insurance was what I was talking about. It is not backed by the federal government. Only flood insurance is. You think if we somehow nationalized health care the politicians would stop there? No they would claim that we need national auto insurance, first for the "poorest amoung us" because they are the hardest hit, don't ya know? And they would claim that the car is a "necessity" just like your health. Of course this would come after they expand whatever the original health care plan would be. Like first it would be catastrophic and preventitive. Then it would be treatments for obesity, smoking, etc. All good causes mind you, but based on someones bad choices and behaviour and you and I would end up paying for it. Then finally we would get (pay for) coverage of things like nose jobs, breast implants, LASIC, hair transplants, and sex change operations. And speaking of LASIC, you know why the procedure does not cost $20,000+? And why they are continuously making great improvements in the technology? Because of competition. They don't get paid by insurance companies, so they have to deliver a good product at a reasonable price. Imagine that. Don't flame me about the price of LASIC, you will pay 5 times that for a bimmer without batting an eye. How valuable is your sight?
      • 8 Years Ago
      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
      • 8 Years Ago
      Eric Bryant,

      This really is an excellent post!
      • 8 Years Ago
      Socialized medicine means that the system is operated by the government. Socialized insurance is operated by private parties and paid by the government.
      • 8 Years Ago
      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.
      • 8 Years Ago
      "4. Dude, I don't feel sorry for GM or Ford one bit."

      V for Vendetta?
      • 8 Years Ago
      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.
      • 8 Years Ago
      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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