An Interview with J. Peter Kelly, Director of the MBA Program
October 2003
Legacy costs consist of the long-term financial liabilities associated with funding pension plans and providing life and health care insurance benefits to retirees. The problem is multi-faceted. First is the financial burden associated with these liabilities, both in terms of the cash needed to fund pension plans and pay insurance premiums and/or claims. Second is the effect these liabilities have on a company’s balance sheet and its ability to borrow money or sell stock to the public. Third, legacy costs make it difficult (if not impossible) for U.S. companies to compete successfully against foreign and domestic firms which may not have similar liabilities. Finally, there is the too often devastating impact on hundreds of thousands of individuals and communities of broken promises,lost benefits and even bankruptcies.
The Legacy Issue
Not all companies in the United States have the problem of legacy costs. The problem is centered in older basic industries such as metals, mining, manufacturing, and transportation which are bound by collective bargaining labor agreements. Labor agreements in these traditionally unionized industries have included defined benefit pension plans and health care benefits for retired workers and dependents not eligible for Medicare due to early retirement age. In addition, most of these agreements provided supplemental insurance which included prescription drug benefits for Medicare-eligible retirees and surviving spouses. Ironically, many of these benefit promises were made in the 1950s and 60s with full federal government support. They were seen as a way to give more to workers without creating immediate inflationary pressure which would have resulted from higher direct wages.
When the companies entered into the labor agreements which provided post-employment benefits, 30 to 40 years ago, no one anticipated the changes that have occurred in the American economy. Neither the companies nor the unions foresaw the wave of foreign competition, bankruptcies, consolidations and liquidations that forced thousands of workers into early retirement. These factors resulted in pension plans running out of funds as workers began drawing pension payments years earlier than expected. Similarly, this wave of early retirements resulted in a surge of health care expenditures against which few companies were financially prepared. The results are well known: pension funds collapsed and were taken over by the Pension Benefit Guaranty Corporation. Companies in bankruptcy or liquidation terminated retiree health care benefits. Recently the Pension Benefit Guaranty Corporation estimated that defined benefit pension plan obligations exceed plan assets by $80 billion in companies they deem to be “financially troubled.”
The human and societal impact is severe Retirees have lost health care benefits and cannot afford to replace them due to prohibitive prices for private insurance policies. The social safety nets are being strained as thousands of people turn to the public sector for assistance.
The Effect on Competition
Foreign employers do not face the legacy cost problem. “Most of the industrialized countries that trade with the United States have implemented national retirement and health
care systems. Consequently, foreign companies have dramatically lower costs which translate into a powerful advantage in the marketplace. Therefore, U.S. companies that compete internationally or face foreign competition in their home markets are at a severe disadvantage,” said Peter Kelly, director of B-W’s MBA and Executive MBA programs. He said that health care costs represent about $1200.00 per U.S. nameplate autos and over $20.00 per ton for domestically produced steel. It has been reported that General Motors, the nation’s largest manufacturer of cars and trucks, has a total health care liability of $57 billion.
Possible Solutions
Prof. Kelly said that in the absence of a national policy that addresses the effects of industrial restructuring, the future is bleak for retirees whose employers become bankrupt and terminate health care and pension programs. He said that until this issue is addressed effectively, many U.S. companies will not achieve globally competitive costs and could face financial collapse from the legacy cost burden.
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Peter Kelly, former chairman and CEO of LTV Corporation, The Harvard educated Kelly earned a law degree at Duquesne University and also is a graduate of the Harvard Business School’s Advanced Management Program. Kelly retired from LTV Steel in December, 2000. |
took over the reins of the MBA program at B-W in 2001.
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