hi bro can u help in answering this case study 3 question…..
Application Case 12–1
Benefits Are Vanishing
Ray Brice expected to retire from United Airlines (UAL) and receive a $1,200-a-month pension. Suddenly hope ran out for Ray Brice and 35,000 other UAL retirees. The government Pension Benefit Guaranty Corp (PBGC) announced it would not guarantee the
bankrupt airline’s loans––virtually assuring that if the airline’s parent company is to remain in business it will have to chop away at expensive pension and retiree medical benefits. The numbers are daunting. UAL owes $598 million in pension payments in the next six months and a total of $4.1 billion by the end of 2008, plus an additional $1 billion for retiree health care benefits, obligations the ailing airline can’t begin to meet. And if United finds a way to get out of its promises, competitors American Airlines (AMR), Delta Air Lines (DAL),
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and Northwest Airlines (NWAC) are sure to try to as well. UAL workers are about to find out what other airline employees already know: The cost of broken retirement promises can be steep. Of the airline’s many crises, the biggest was
the pilots’ pension plan, a sinkhole of unfunded liabilities.
Why are retirees being left out in the cold? An unsavory brew of factors has come
together to put stress on the retirement system like never before. First, there’s the simple fact that Americans are living longer in retirement, and that costs more. Next come internal corporate issues, including soaring health care costs and long-term underfunding of pension promises. Perhaps most important, in the global economy, long-established U.S. companies are competing against younger rivals here and abroad that pay little or nothing toward their workers’ retirement, giving the older companies a huge incentive to dump
their plans. “The house isn’t burning now, but we will have a crisis soon if some of these
issues aren’t fixed,” says Steven A. Kandarian, who ended a two-year stint as the executive director of the Pension Benefit Guaranty Corp. (the little known federal agency that insures private pensions) in February. Kandarian is not optimistic about how that crisis might play out, either. “By that time it will be too late to save the system. Then you just play triage.”
As industry after industry and company after company strive to limit, or eliminate, their so-called legacy costs, a historic shift is taking place. No one voted on it and Congress never debated the issue, but with little fanfare we have entered into a vast reorganization of our retirement system, from employer funded to employee and government funded, a sort of stealth nationalization of retirement. As the burden moves from companies to individuals—who have traditionally been notoriously poor planners—it becomes near certain that in the end, a bigger portion will fall on the shoulders of taxpayers. “Where the vacuum develops, the government is forced to step in,” says Sylvester J. Schieber, a vicepresident at benefit-consulting firm Watson Wyatt Worldwide. “If we think we can walk away from these obligations scot-free, that’s just a dream.”
Evidence of the shift is everywhere. Traditional pensions—so-called defined-benefit
plans—and retiree health insurance were once all but universal at large companies. Today experts can think of no major company that has instituted guaranteed pensions in the past decade. None of the companies that have become household names in recent times have them: not Microsoft, not Wal-Mart Stores, not Southwest Airlines. In 1999, IBM, which has old-style benefits and contributed almost $4 billion to shore up its pension plans in 2002, did a study of its competitors and found 75 percent did not offer a pension plan and
fewer still paid for retiree health care.
Instead, companies are much more likely to offer defined-contribution plans, such as 401(k)s, to which they contribute a set amount. In 1977, there were 14.6 million people with defined-contribution benefits; today there are an estimated 62.5 million. Part of their appeal has been that a more mobile workforce can take their benefits with them as they
hop from job to job. But just as important, they cost less for employers. Donald E. Fuerst, a retirement actuary at Mercer Human Resource Consulting LLC, notes that while even a well-matched 401(k) often costs no more than 3 percent of payroll, a typical defined-benefit plan can cost 5 percent to 6 percent of payroll.
Despite the stampede to defined-contribution plans, there are still 44 million Americans covered by old-fashioned pensions that promise a set payout at retirement. All told, they’re owed more than $1 trillion by 30,000 different companies. Many of those employers have also promised tens of billions of dollars more in health care coverage for retirees. Even
transferring a small part of the burden to individuals or the government can have a profound impact on the corporate bottom line. The decision by Congress to have Medicare cover the cost of prescription drugs, for example, will lighten corporate retiree health care obligations by billions of dollars. Equipment maker Deere & Co. estimates that the move will shave $300 million to $400 million off its future health care liabilities starting this year.
The U.S. Treasury, on the other hand, pays and pays dearly. That drug benefit, which took effect in 2006, is expected to cost the government the equivalent of 1 percent of gross domestic product by 2010, and other potentially big taxpayer costs are looming, too. In mid-April, over the objections of the PBGC, Congress granted a two-year reprieve from catch-up pension contributions for two of the most troubled industries: airlines and steel. Congress also lowered the interest rate all companies use to calculate long-term obligations, lowering pension liabilities. While these moves lighten the corporate burden, they increase the chances taxpayers will have to step in. “The less funding required, the more risk that’s shifting to the government,” says Peter R. Orszag, a pension expert and senior fellow in economic studies at the Brookings Institution. “The question is: How comfortable are we with the risk of failure?”
Company-sponsored health care, which generally covers retirees not yet eligible for Medicare and supplements what Medicare will pay, is likely to disappear even faster than company pensions. Subject to fewer federal regulations, those benefits are easier to rescind and companies are fast doing so. It’s much harder to renege on pension promises. So instead, many profitable companies are simply freezing plans and denying the benefits to new employees. Last fall, Aon Consulting (AON) found that 150 of the 1,000 companies they surveyed had frozen their pension plans in the previous two years, a dramatic increase from earlier years. Another 60 companies said they were actively considering following suit.
The government bailout fund is $9.7 billion in the red, and Social Security and personal savings are hardly going to be enough .
The cost of honoring PBGC’s commitments could be higher than anyone is expecting. The government bailout fund has relied on having enough healthy companies to pony up premiums to cover plans that fail. But in a scenario of rising plan terminations, healthy companies with strong plans still in the PBGC system would be asked to pay more. For corporations already fretting that pensions have become a competitive liability and a turnoff to investors, this could be the tipping point. Faced with higher insurance costs, they could opt out, rapidly accelerating the system’s decline as the remaining healthy participants become overwhelmed by the needy. In the end, the problem would land with Congress, which could be forced to undertake a savings-and-loan-type bailout. It’s almost too painful to think about, and so no one does. But when the bill comes due, it will almost certainly be addressed to taxpayers. Most worrisome is the record number of pension plans in danger of going under. According to the PBGC, as of September 2003, there was at least $86 billion in pension obligations promised by companies deemed financially weak. That’s up from $35 billion the year before. And it’s on top of a record number of companies that managed to dump their troubled pension plans on the PBGC: 152. In 2003, a record 206,000 people became PBGC pensioners, including 95,000 from its biggest takeover ever, Bethlehem Steel
Corp. Companies are racing to cut or drop retiree medical benefits to give a quick boost to their bottom lines. Retiree health care coverage, which is easier to eliminate than pensions, is disappearing even faster. Unlike pensions, which are accrued and funded over time, retiree health care is paid for out of current cash accounts, so any cuts immediately bolster the bottom line. Estimates are that as many as half of the companies offering retiree health care 10
years ago have now dropped the benefit entirely. Many of those that have not yet slammed the door are requiring their former workers to bear more of the cost. Some 22 percent of the retirees who still get such benefits are now required to pay the insurance premiums themselves, according to a study by Hewitt Associates Inc. (HEW). Some 20 percent of employers told Hewitt that they might make retirees pay within the next three years. This hits hardest those who retire before 65 and are not yet eligible for Medicare. But even older retirees suffer when they lose supplemental health benefits like prescription coverage. It’s not just struggling companies, either. IBM, which is already fighting with retirees
in court over changes made to its pension plan in the 1990s, is now getting an earful from angry retirees about health care costs. In 1999, IBM capped how much retiree health care it would pay per year at $7,500 of each employee’s annual medical-insurance costs. Although IBM is certainly in no financial distress—the company earned $7.6 billion on $89 billion in sales last year—Big Blue says its medical costs have been rising faster than revenue.
Last year the company says it spent $335 million on retiree health care. This year, for the first time, many IBM retirees are beginning to hit the $7,500 limit.
Sandy Anderson, who worked as a manager at IBM’s semiconductor business for 32 years, and today is the acting president of a group of 2,000 retirees called Benefits Restoration
Inc., saw his own insurance bill triple this year. He suspects that the company is trying to make the perk so expensive that retirees drop it, a cumulative savings calculated by the group at $100,000 per dropout.
But more than that, Anderson is angry that as a manager, IBM encouraged him to talk to his staff about retirement benefits as part of their overall compensation. “The job market was tight, and IBM’s message was our salaries aren’t the highest, but we will take care of you when you stop working,” he says. Now he feels the company is reneging. “I feel I’ve misled a lot of people, that I’ve lied to people,” says Anderson. “It does not sit well with me at all.” IBM says its opt-out levels are low and that it often sees retirees return to the plan after opting out for a period of time. The company also argues that it has not changed its approach to retiree medical benefits for more than a decade and that the rising cost of health care is the real issue.
1. Is it ethical for a company to promise benefits and then years later walk away from the
2. Should the government pay for all pension guarantees?
3. Why is retiree health care coverage easier to eliminate than pension benefits?
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