The company could also tell the employees and retirees that the pension plan was in bad shape, creating another burden on the company, Pittman suggested. He thought retirees would see through the maneuver, since it was widely known in the company that the pension plan was healthy, and even if Varity were to go under, he wrote, “the demise of Varity would not necessarily mean the loss of a pension.”
In short, he didn’t feel the company had much bargaining power with its retirees, but he was hoping it could fool the United Auto Workers, the main representative for Varity’s wage earners. “We could convince the union that unless we can reduce our retiree and employees costs we will be unable to continue to operate… thus creating significant hardship for their members,” he wrote in the memo.
If the union didn’t agree, it would be tough to cut their benefits, because they were backed up by negotiated contracts that companies couldn’t unilaterally change. So Pittman suggested a strategy he called “Creeping Take Aways.” Using this approach, Varity “would progressively introduce minor reductions and usage controls rules into the medical benefits plan.” These were “designed to be insufficient to warrant retirees incurring the legal cost and trouble to have the benefits reinstated.” A few years later, Varity could take an ax to the benefits, provoking the union to sue. In court, the company would say that because the union hadn’t objected to the earlier cuts, it tacitly agreed that the company had the right to cut their medical coverage unilaterally.
If that argument didn’t sway the judge, no problem. “There have been a number of companies that have [reduced benefits] knowing that they would lose in court if challenged,” he wrote. The company could simply drag out the case for years.
“The strategy works as follows: the employer implements a major reduction to employee benefits… retirees come together, pool resources or approach their union to fund their case and take the company to court. Financial pressure is applied to retirees during the potentially extended period leading up to the court hearing by forcing them to incur their own medical expenses, in addition to funding the legal proceedings. The next step is for the company, at a carefully chosen moment, to suggest to retirees that they agree to reinstatement of the plan, but at a much reduced level.” The longer Varity could drag out the case, Pittman noted, the better the odds that cash-strapped employees would settle for much less than they were due. Fundamentally, the company had nothing to lose.
PROJECT SUNSHINE
The human resources managers then came up with a surefire way to cut most or all of a unit’s retiree health benefits. “Organized liquidation,” Pittman dubbed it. “This action involves the transferring of all retiree medical liability into a separate or subsidiary company that is then put into receivership,” Pittman wrote. The retirees would sue, of course, but “if made to look realistic, the collapse of [the unit] could be part of a strategy leading to a negotiated reduction” of benefits. When the “financial pressure on retirees is greatest but before we appear to be losing [the] case,” the company could “agree to reinstatement at a reduced level.”
Rice and his executive team thought that was a great idea. Later that year, they organized a new corporate subsidiary, which they named Massey Combines. The bottom had fallen out of the agriculture industry, and demand for the tractors and combines had dried up. So the Varity executives loaded up this subsidiary with its money-losing farm equipment lines, plus millions of dollars in corporate debt, including benefit liabilities for four thousand retirees.
Varity executives then set about convincing active employees to transfer to the new entity, labeling the internal sales program “Project Sunshine.” With meetings, videos, and brochures, executives sought to persuade employees that the spin-off had a “bright future” and that, if they switched over to the new unit, their benefits would remain unchanged. Ultimately, fifteen hundred workers took the bait.
The new firm had a negative net worth of $46 million on its first day of business, and two years later it collapsed. The retirees’ medical coverage disappeared overnight. To celebrate, Victor Rice invited his business managers to his hotel suite in Chicago and boasted, over cognac and cigars, that he had “loaded all his losers in one wagon.”
Even as it pursued Project Sunshine, Varity had begun implementing the less dramatic suggestions presented by its human resource managers, including a series of creeping take-aways. In 1987, Varity stopped reimbursing retirees for Medicare Part B premiums; in 1989, it moved retirees into a managed-care health plan and raised their health care co-payments and deductibles.
The “pleading” strategy had also met with some success. A union bargaining unit at a facility in Racine, Wisconsin, had agreed to accept reduced benefits.
But Rice wanted more. A big motive now was FAS 106, the new accounting rule that required employers to put the liability for its retiree health benefits on its books. Varity wanted to reduce its liability by 40 percent and turned to Towers Perrin for advice. The consulting firm said it would hook them up with one of their experts who had “successfully negotiated rather dramatic decreases in postretirement welfare benefits.” The consultant projected he could cut 63 percent from the company’s estimated $344 million retiree liability by using his benefits-reduction model, which he called “Strawman.”
Accounting smoke and mirrors could take care of some of the cost reductions. The company could change some of the key assumptions it used to estimate its obligations. For one, it could assume that fewer employees and retirees were married, so the liability for spousal and survivor benefits would be lower. Towers Perrin also suggested the company could use “liberalized” turnover assumptions. For example, they could assume that job turnover would be higher, so employees wouldn’t build up significant benefits.
At the same time, it could lower mortality assumptions and assume that the people who remained would work until age seventy, which would make it look as if the company had fewer years of retirement to pay for. The consultant must have known that this latter point, for one, wasn’t true. His research showed that virtually no one at Varity worked past sixty-five.
Though these moves would lower the liabilities the company would publicly disclose, “the real reduction,” Towers Perrin concluded, “can come only if the benefits are reduced.” To facilitate Varity’s decisionmaking process, the consulting firm’s actuaries prepared charts showing which units had the highest potential retiree costs.
Rice wanted quick results, and laid down the law in a memo to managers. “The reported FAS 106 liability will be closely reviewed by analysts and it will affect the stock price and debt ratings.” Cutting benefits to reduce the costs that “will result from FAS 106 ABSOLUTE TOP PRIORITY.”
In December, Rice gathered the president, the CFO, the vice president for HR, and the company’s benefits chief and reiterated his goals: “We must reduce the liabilities, and take aggressive actions that would be reviewed favorably within the financial community.” His statement of objectives was accompanied by a checklist.
• 40% MAY be all we can get now…
• Continue to aggressively push legal counsel on risk analysis.
• I don’t believe in “show stoppers,” and won’t accept them. Give me a course of action. Keep on schedule.
• I am concerned we will run out of time. If you or the business units need more resources, get them. Let’s not be penny wise and pound-foolish.
Not long after, the company’s legal advisers prepared a “Litigation Risk assessment” listing dozens of manufacturing plants and facilities operated by the company, with estimates for retiree medical liabilities at each. Each was assigned a litigation risk number, with five having the highest risk (“virtually unavoidable commitments” with “almost certain loss” in litigation) and 1 having the lowest. Varity would go after the weakest units first. Varity sent managers a memo summing it up: “We are not averse to assuming acceptable levels of risk [of lawsuits].… No approach is too aggressive to consider.”
A few months later, in April 1993, Varity announced it would make steep cuts to the health benefits, effective January 1, 1994. Under the new accounting rules, the move allowed Varity to report reduced expense—as good as income from selling tractors.
As the company predicted, retirees sued. Hourly and salaried workers brought five suits altogether. A federal judge in one of the cases in Michigan cited “a veritable mountain of evidence” that Varity had promised lifetime medical coverage to the 3,300 retirees of Varity’s Kelsey-Hayes unit and ordered the company to restore the benefits, which it did in 2000. Cases at two other units were settled in 1997 and 1998.
But, as Varity human resources managers had predicted, the process dragged out for years, and though most of the retirees prevailed, it was too late for the many retirees who had died in the interim.
The Massey Combines employees, who had been loaded into the unit that went bankrupt, sued Varity, and the court heard the testimony about how Rice had boasted, over cognac and cigars, that he’d dumped all his losers into the doomed unit. This didn’t go over well with the Des Moines jury. They handed a victory to the Massey Combines employees and awarded them $38 million in punitive damages.
But no punitive damages are allowed under federal benefits law, so the judge threw out the award but ordered Varity to reinstate the retirees into Varity’s health care plan. (The only thing a plaintiff can win in a federal benefits case is the benefit he should have been paid. If he’s dead, there’s nothing to award, even out-of-pocket costs the retirees had incurred.) Varity appealed, and the former employees fought their case all the way to the U.S. Supreme Court. In 1996—a full decade after Pittman and Wellman had begun sketching out Varity’s plan—the Court, in Varity Corp. v. Howe, found that Varity had deceived the employees and thus violated its fiduciary duty. It ordered that the benefits be reinstated. But this victory was Pyrrhic; the employees were still out of a job, and some had died in the meantime.
Victor Rice, meanwhile, turned from breaking up retiree benefits to breaking up the company. In 1996, he sold Massey Ferguson’s farm machinery business assets to AGCO and merged its auto-parts businesses with a British auto-parts maker, renaming it LucasVarity. The combination languished, and Rice started shopping the company almost as soon as he assumed the corner office. TRW bought the firm in 1999, and Rice collected $50 million in severance. TRW, an aerospace and automotive company, enrolled the portfolios of Varity retirees in its existing retiree medical plans. Things were fine—until 2006.
CREEPING REDUX
John Galloway, the retired foundry worker, had so far survived all these benefit shenanigans with his coverage largely intact. That was thanks in large part to the dogged efforts of Roger McClow, a lawyer in Detroit who had represented groups of retirees from different units of the company since 1993. At the same time the Varity employees were taking their case to the Supreme Court, McClow was juggling a handful of cases, representing both salaried and union retirees from the other units, including Massey Ferguson and Kelsey-Hayes.
It was during the tedious discovery phase for two of those suits that McClow unearthed the trove of Varity memos quoted above. When he requested records pertinent to the case, attorneys for the company responded with a “documents dump,” the passive-aggressive move in which an opposing party responds to an adversary’s information request by trying to bury it in paperwork. McClow and an assistant spent days shoveling through decades-old payroll records, benefits booklets, and the other detritus of the human resources departments from various units, some defunct.
Against great odds, the colorful documents had survived the company shredders. When the company had shuttered an operation in Buffalo, a former Massey Combines officer who was transferred to Kelsey-Hayes brought his Massey Ferguson documents with him to Romulus, Michigan, where they gathered dust in the orphaned files of a long-gone human resources manager until they were rounded up to add bulk to the documents dump.
McClow obtained another batch of strategy memos when he subpoenaed Towers Perrin. On the final day of shoveling through a roomful of printouts of actuarial projections, he found the suggestions for ways to cut the retiree benefits and “Litigation Risk” analyses. These kinds of unflattering strategy memos come to light so rarely that when Massey Ferguson found out that McClow had obtained them, a lawyer for the company accused him of stealing the documents, then filed a motion for a protective order to get them back. The judge denied the request.
Ironically, the documents never played a role in any court case, even the famous Varity Corp. v. Howe case that went before the Supreme Court, nor did McClow need them for the case he was handling, in which he succeeded in getting the company to restore 80 percent to 100 percent of the retirees’ benefits. He thought the matter was settled.
For several years, nothing happened. Then, in 2006, TRW resurrected the game book of its predecessor and began a series of creeping take-aways. It conducted its first “death audit,” sending letters to retirees, telling them they had to prove they were alive or lose their coverage. Death audits seem to serve a legitimate purpose; after all, companies audit health plans to ensure that ineligible family members aren’t included. With retiree health plans, a cynical person might think death audits exist primarily to generate fees for benefits consulting firms. After all, if a retiree dies, he isn’t running up prescription drug costs, and few eighty-year-olds have dependent children.
Panicked retirees called McClow, who contacted TRW and got the company to back off. After all, the settlement provided for lifetime benefits. It didn’t have any provision about requiring the retirees to prove they were still alive.
Months later, the retirees were notified that they had been dropped from Medicare. Why? Because TRW had automatically enrolled them in a Medicare Advantage plan. These are health plans run by private insurers, who receive a government subsidy to provide the equivalent of Medicare. The benefits differ slightly—Medicare Advantage plans might provide low-cost benefits, such as gym memberships and discounts on hearing aids, but as a trade-off the plans limit the retirees’ choice of hospitals and doctors. TRW called it a “better” plan, and it was—for TRW. The plan saved the company $95,000 a month.
McClow, who looks like a cross between Sean Connery and the Archbishop of Canterbury and has the slightly exasperated air of a middle-school teacher dealing with unruly teens, took the company to court. He pointed out that the settlement didn’t allow the company to change the plan. TRW filed a motion to say it hadn’t changed the plan—it had only changed the administrator. The magistrate agreed.
McClow filed an appeal, and in December 2009, a federal judge vacated the magistrate’s decision because, under federal law, people must be given the choice to remain on Medicare. TRW then filed a motion for reconsideration. This lingered on the judge’s docket for eight months, until McClow filed a motion to get the judge to make a decision.
Finally, in November 2010, the retirees’ prior coverage was restored. Still, TRW and its lawyers came out ahead: The several hundred thousand dollars it paid in legal fees was more than offset by the $1.7 million in savings it enjoyed while the retirees were on the Medicare Advantage Plan.[17]
A few years earlier, in 2008, TRW had initiated a different cost-savings tack when it eliminated coverage for certain categories of drugs. John Galloway learned that TRW was no longer paying for a prescription drug that his wife, Pansy, takes for acid reflux when, instead of a co-pay of $3, he got a bill for $103. According to TRW, the drug wasn’t medically necessary; Tums would do just as well. Maybe for healthy people, but not for someone confined to a bed in a nursing home. McClow filed a motion for an injunction; the settlement hadn’t agreed to allow TRW to establish its own formulary.
In October 2010, TRW began trying another cost-savings tack: It sent the dwindling number of retirees yet another death audit. The “Life Verification Declaration” required the retirees to provide a notarized affidavit, the first page of their federal income tax returns, an
d a marriage license if they had coverage for a spouse. To acquire the needed documentation, the verification form advised retirees to contact the county clerks in the locations of the marriages and births and the local Social Security Administration. And for all those Web-savvy octogenarians, it provided “Helpful Web sites,” such as Michigan.gov.
Retirees were instructed to return all the required documents by November 29. “If you do not, TRW will automatically terminate coverage for you and your dependants as of December 31, 2010.” It also warned them about the “Possible Consequences of Insurance Fraud,” which would include having to reimburse TRW for the cost of services the ineligible person receives. “Research has shown that ineligible members left on a healthcare plan can contribute thousands of dollars to raising healthcare costs that impact everyone,” the letter said.
Audits of regular health plans might save company money by turning up ineligible dependents, such as grown children or ex-spouses. But with retiree health coverage, the only way a person can become ineligible is by dying. If that’s the case, his name turns up within two months on the Social Security death register, which benefits administrators parse monthly to make sure they discontinue sending pension checks and drop the deceased retiree from its plan.
McClow considered the death audit to be a cynical trick to strip retirees of their coverage: “The real savings comes from terminating the retirees who do not respond,” which, in fact, one-third of the retirees failed to do. McClow asked TRW for a list of the one hundred or so Kelsey-Hayes retirees it was prepared to drop because it hadn’t received their affidavits. One by one, McClow looked up each retiree’s name in the Social Security death index. All but one was alive. The trick was to locate the rest and get them to turn in their paperwork.
Retirement Heist Page 16
