Stevenson Keppelman Associates, Ann Arbor, MI

The “Big Three” automakers, Ford, General Motors and Chrysler, as well as other companies, have agreed to establish and fund voluntary employees' beneficiary associations, or “VEBAs,” to meet their post-retirement health insurance obligations.¹ The assumption by these trusts of the automakers' retiree obligations was essential to all three companies' efforts to survive the economic downturn, and, in the case of General Motors and Chrysler, to negotiate successful bankruptcies.

The Big Three trusts have received a lot of publicity, but some conceptual confusion appears to surround them, at least among non-benefits specialists. In particular there seems something of a generally held apprehension that VEBAs themselves represent an inherently innovative funding strategy; a novel way to pay for an employer's health insurance promises. In this vein people ask questions in discussing the automakers' arrangements like: “Are VEBAs the Future of Employee Health Care?”;² and “Will VEBAs Sweep the Nation?”³

These questions are, for the most part, not apt. Even the term “Big Three VEBAs” serves to obscure what actually happened at the automakers, and precisely what is and is not important and interesting about the new entities. It may be helpful to take a step back and briefly seek some overall perspective.

VEBAs Are Not New. What Is New Are VEBAs’ Assumption of Employers’ Liability. VEBAs are simply tax-exempt trusts, and have existed since the predecessor of §501(c)(9) was added to the Code as part of the Revenue Act of 1928, over 80 years ago. Originally a mechanism through which associations of employees could provide benefits for members from their own contributions, the traditional role for a VEBA evolved, over time, into the most common means for employers to pre-fund their obligations for benefits such as health insurance. An employer is not required to pre-fund nonpension benefits under the Employee Retirement Income Security Act of 1974 (ERISA), but it may do so if it wants to.⁴ If an employer does pre-fund benefits, ERISA generally requires that the pre-funding be done through a trust. VEBAs are tax-exempt under §501(c)(9), so qualifying as one is a way in which the trust itself can be made not have to pay income tax on its own investment earnings. (In order to be exempt, a trust must meet a number of requirements, including providing only certain kinds of benefits; restricting membership to persons sharing an employment-related bond; meeting nondiscrimination requirements, and others.⁵)

In the traditional case the employer did not relinquish liability for benefits to the VEBA. The VEBA served as a source of assets from which to pay benefits, but the employer remained ultimately liable for them under the relevant employee benefit plan.

The VEBAs established most recently by the automakers, however, are different. They do not serve merely as an advance-funding vehicle by which the employer can pre-pay part of its liability under the plan. Rather, they actually assume the employer's liability for benefits under the plan, and the employer is relieved of that liability.⁶ Thus these trusts serve as a mechanism not merely of pre-funding, but of permanently settling, the employer's obligations under the plan.

The assumption of the employer's liability is the critical distinguishing feature that makes the Big Three trusts, and other recent trusts like them, different from what had gone before.

The Trusts Did Not Have to be VEBAs. It is not necessary that these trusts qualify as VEBAs. In order to take over the employer's liability, it is necessary just that such a fund be an entity separate from the employer. In the case of health insurance ERISA requires that the entity take the form of a trust, but not necessarily that it be a tax-exempt trust. (Moreover, there is reason to believe the trust would likely in practice be effectively free from tax whether or not it qualified as a VEBA.⁷) Conversely, nearly all other VEBAs, and there are tens of thousands of them,⁸ have nothing to do with transferring liability from the employer.

In short, the fact that they qualify as VEBAs is not one of the Big Three trusts' distinguishing features.

Because the trust's status as a VEBA under §501(c)(9) is completely irrelevant to the transaction at issue - a permanent transfer of liability from the employer to a stand-alone entity - it would be preferable to choose a better name by which to refer to these entities. It would, for example, be more meaningful generally to call them, as some have, the “Big Three Stand-Alone Trusts”⁹ rather than the “Big Three VEBAs,” to emphasize what is important (that they are stand-alone vehicles), and to deemphasize what is not important (that they are VEBAs). Another proposed alternative to “stand-alone trust” is “defeasance trust,” which conveys that the employer's liability for benefits is being defeased by its contribution to the trust.¹⁰

Stand-alone Welfare Benefit Trusts Make Sense in Only Limited Contexts. Arrangements like those adopted by the Big Three are not particularly generalizable.

Stand-alone funding vehicles have been created in two situations. One, the situation of the Big Three, involves a company/sponsor in or on the verge of bankruptcy that is obligated by collective bargaining agreements to provide retiree medical coverage. The employer creates a stand-alone trust and contributes assets to the trust; and then, as noted above, the trust fully assumes the employer's liability for the retiree benefits, thereby relieving the employer of that liability.

The amount contributed to the trust in these situations is a result of negotiation by employer and union and court approval, and reflects a balance of factors including the employer's solvency. The amount may be less than the full, likely present value of the employer's obligation, and/or may comprise assets such as employer stock that are of uncertain value. What motivates the union to agree to the transfer of liability is the prospect of employer insolvency. In the event of the employer's bankruptcy, retirees' claims for unfunded medical benefits would generally have no greater status than that of an unsecured creditor.¹¹ A stand-alone trust, inadequate as its funding might be, provides some ongoing source of payment that is protected from the employer's creditors.

In another context, stand-alone trusts have been established to settle litigation over an employer's right under plan documents to terminate retiree benefits. Again, the employer establishes a trust, contributes assets, and then disclaims all further liability. What motivates plaintiffs in this situation is the possibility that they will lose their court case. Also, some ongoing vehicle is needed in any event to administer benefits, as the full class of claimants and the amounts of their claims cannot be known on the date of settlement, which prevents the employer from simply writing a check to each plaintiff to settle the case.

The defining feature that differentiates stand-alone welfare benefit trusts - a shift in liability from the employer to the trust - can in practice happen only in those limited situations, such as the two described above, where the following conditions are present: (1) the employer is constrained by plan documents or a collective bargaining agreement from simply unilaterally terminating the benefit ¹² (otherwise the employer would have no incentive to pre-fund a trust), and (2) an organized group representing participants - either a union or a class of plaintiffs - exists and is motivated to agree to relieve the employer of liability in exchange for a trust contribution. In most employers' situations at least one of these circumstances will not be present, and the possibility of a stand-alone trust will have no application. Indeed, in most cases where an employer finds that its postretirement medical promise has become too expensive, it can and will simply cancel that promise.

The Fact that They Stand Alone Makes the Big Three and Other New Welfare Benefit Trusts an Interesting New Type of Institution. As noted above, that the Big Three's welfare benefit stand-alone trusts are intended to qualify as VEBAs under §501(c)(9) is not noteworthy. Moreover, trusts of this kind are not destined to become a large-scale, permanent trend - to “sweep the nation.”

That the trusts will stand alone is, however, noteworthy. With the employer out of the picture, the stand-alone welfare benefit trust will assume an independent existence as a free-standing entity whose justification for existence is its obligation to conserve assets and distribute them to a closed set of beneficiaries. The trust will remain in existence, presumably, until the last retiree or beneficiary dies or until all the trust's assets are gone. Standing alone, without any structural tie to the original employer, such a trust will be similar in nature to an eleemosynary institution; it might be expected to behave something like a private foundation.

And the Big Three stand-alone trusts are massive. In total, they hold or are promised assets in excess of $90 billion.¹³ This represents a significant health care institution by global standards, which will in at least some markets have substantial leverage over health care providers, and which will not be constrained by a profit motive. Thus the stand-alone welfare benefit trusts are an interesting new type of player on the American health care stage, which will bear observation in coming years.

For more information, in the Tax Management Portfolios, see Dunkle, 395 T.M., VEBAs and Other Self-Insured Arrangements, and in Tax Practice Series, see ¶5950, VEBAs.