A Deal that Could Save Detroit

Handing the UAW a chunk of long-term health-care liabilities is a radical plan but may be the one that works

by David Welch and Nanette Byrnes

Just a few weeks ago, United Auto Workers President Ron Gettelfinger had nothing but contempt for the "strip-and-flip" private equity investors bidding for Chrysler Group DCX. So most people expected him to come out slugging when Cerberus Capital Management agreed to buy the struggling automaker on May 14. Instead, Gettelfinger embraced Chrysler's new owner. "The status quo is off the table," he declared.

Attitudes are evolving rapidly in Detroit these days, and it is clear that the arrival of the bare-knuckle financial wizards from Cerberus is only going to hasten the pace of change in town. Managers and UAW leaders alike appear to accept that a time of reckoning is at hand. As they look ahead to landmark labor talks this summer, both sides finally appear set to face up to the most vexing problem of all: unsustainably high health-care costs. Thanks to luxe benefits handed over during the golden age of corporate largesse in the 1950s, the Big Three will have an estimated $120 billion in long-term medical liabilities, a crippling burden that puts them at a nearly insurmountable disadvantage to global rivals.

But General Motors (GM), Ford Motor (F), and Chrysler's new owners at Cerberus believe they may have a cure for Detroit's epic health-care woes. Their idea: to propose handing over the companies' long-term liability to an independent fund managed by the UAW, which would be financed by a huge one-time injection of cash and stock. Union workers would probably contribute more toward their own coverage costs but would gain protection from the devastating prospect of bankruptcy.

The automakers, meanwhile, would wall off a risk that terrifies investors—and earn perhaps their final shot at becoming competitive again. "I think an independent health-care fund has to happen," says Sean McAlinden, chief economist at the Center for Automotive Research in Ann Arbor, Mich. "Ron Gettelfinger may even be resigned to doing it."

Big Costs, Big Hopes

This radical idea already has some precedent in Detroit. In 2005 GM and the UAW created a so-called voluntary employee benefits association (VEBA) trust, for a small portion of the company's retiree health-care expenses. The union has also consented to VEBA funds for individual plants belonging to a few parts suppliers. Over the past few months, managers at all three car manufacturers have been closely studying a similar deal struck between the United Steelworkers and Goodyear Tire & Rubber (GT) in December that relieved the tiremaker from most of its medical obligations without stiffing union workers.

While the Big Three have not been trumpeting the VEBA trust plan, expect to hear more about it as this summer's labor talks approach. Creating such a trust "for the whole industry [is the] primary objective of this year's round of bargaining," says one investment banker well-connected in Detroit. "That's clearly what the Big Three want."

To see why Motown executives are so excited, take a look at how GM would benefit from such a trust. The company has UAW health-care liabilities of $52 billion, not including $18 billion for white-collar workers, according to JPMorgan Chase (JPM) analyst Himanshu Patel. The company's first step would be to reduce its liability by asking current and former workers to fork over more for their own health coverage. Then GM would set up a trust fund. Because it would be invested to grow over time, the fund could be valued at, say, 60% of the liabilities, around $31 billion. That may sound risky for the union, but there are risks on both sides of the equation. Unlike pensions, retiree medical benefits are not guaranteed by law and would not be protected in a bankruptcy, a big worry with the U.S. car companies floundering.

How in the world would GM come up with so much money? The company could start with the $15 billion in VEBA money already set aside in some existing trusts. Patel thinks GM could then afford to take a further $8.2 billion in cash from its coffers and sales of some assets, plug in some equity, and borrow about $5 billion. Add it up, Patel contends, and GM could fund all of its union health-care obligations.

Quick Bounce

Setting up the fund would add debt and drain cash, but it would yield big benefits immediately. Patel estimates that such a deal would boost pretax profits by $900 million in the first year and save GM about $700 million in cash. Accounting for inflation, GM's health-care expenses would drop by about $200 million a year and cash flow would improve by $400 million a year. Ford's health-care expense would drop by $800 million the first year and cash flow would improve by $200 million. Patel thinks the growing improvement to cash flow would help the Big Three narrow the gap with Toyota (TM) on product and research and development spending. Right now Toyota dedicates almost 12% of its revenue to capital expenditures and R&D. GM spends just 8.4% of its revenue.