The Tax Management Transfer Pricing Report ™ provides news and analysis on U.S. and international governments’ tax policies regarding intercompany transfer pricing.
By Andrew W. Stumpff
Stevenson Keppelman Associates, Ann Arbor, MI. The author would like to express his thanks to Richard L. Sanderson and Robert B. Stevenson for reviewing and commenting on an earlier version of this article.
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 Big Three automakers, in fact, had maintained VEBAs for this purpose for some time.
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 effectively 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 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.8) Conversely, nearly all other VEBAs, and there are tens of thousands of them,9 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”10 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.11
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.12 A stand-alone trust, inadequate as its funding might be, provides some ongoing source of payment that is protected from the employer's creditors.
The employer also realizes an accounting benefit, whereby the canceled corporate liabilities no longer appear on the employer's balance sheet. Obtaining this treatment requires a complete separation between the employer and the stand-alone trust: Representatives of the employer may not, for example, serve on the trust's board of trustees.13
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 14 (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.15 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.
1 For good summaries of these arrangements, see Borzi, “Retiree Health VEBAs: A New Twist on an Old Paradigm: Implications for Retirees, Unions and Employers” (Kaiser Family Found. 2009), available at http://www.kff.org/medicare/upload/7865.pdf; and FitzGerald, “Revisiting VEBAs,” from PLI Course Handbook, Pension Plan Investments: Current Perspectives, 802 PLI/Tax 573 (2008), available at http://www.pli.edu/emktg/Pocket_MBA/Revisiting_VEBAs8.DOC. Other companies outside the Big Three had previously established similar trusts. See note 7, below.For good summaries of these arrangements, see Borzi, “Retiree Health VEBAs: A New Twist on an Old Paradigm: Implications for Retirees, Unions and Employers” (Kaiser Family Found. 2009), available at ; and FitzGerald, “Revisiting VEBAs,” from PLI Course Handbook, , 802 573 (2008), available at . Other companies outside the Big Three had previously established similar trusts. See note 7, below.
2 Smerd, “Are VEBAs the Future of Employee Health Care?” Workforce Management Online (Oct. 2007), available at http://www.workforce.com/archive/feature/25/16/34/index.php.
4 The funding requirements of Title I of ERISA apply only to “employee pension benefit plans,” not to “employee welfare benefit plans,” which include health insurance plans. An employer might wish to pre-fund welfare benefits for accounting reasons, to improve its balance sheet; or to accelerate the year in which it may claim a tax deduction. (This latter stratagem is limited by §§419 and 419A.)
5 For a thorough description of the legal requirements that apply to VEBAs, see Utz, “Voluntary Employees' Beneficiary Associations (“VEBAs”): Part I,” Vol. 14, No. 2 J. of Def. Comp. 1 (Winter 2009), and Utz, “Voluntary Employees' Beneficiary Associations (“VEBAs”): Part II,” Vol. 14, No. 3 J. Def. Comp. 1 (Spring 2009).
6 The way this happens is described in more detail below. In general, in the Big Three context the takeover occurs because of uncertainty concerning the employer's solvency, and is subject both to agreement with the United Auto Workers union and court approval. Note that there is formally no actual assumption of liability. Instead, the automaker ceases to provide post-retirement medical benefits, and the VEBA simultaneously agrees to provide them.
7 The Big Three are not the first companies to establish trusts of this sort. A similar arrangement was established as far back as the early 1990s, at the former International Harvester Company (now Navistar Corporation). More recently, trusts like those established at the Big Three were put in place as a result of negotiations between the United Steelworkers union and steelmakers like International Steel Group (successor to LTV Corporation and Bethlehem Steel), as well as between the United Auto Workers and Dana Corporation and Tower Automotive. See Bernstein, “Can VEBAs Alleviate Retiree Health Problems?” No. 1 Capital Matters (April 2008) 8, available at http://www.law.harvard.edu/programs/lwp/pensions/publications/occpapers/occasionalpapers_Ap9_fin2.pdf; Greenhouse and Rosenbloom, “A Likely Auto Adviser is Strong in Union Ways,” NY Times (Feb. 17, 2009); “News From USW: Union Announces Lowered Costs for Republic VEBA Participants,” RedOrbit News, available at http://www.redorbit.com/news/business/1190728/news_from_usw_union_announces_lowered_costs_for_republic_veba/index.html; Borzi, note 1, above, at 4.
8See Stumpff, “The Unimportance of Being a VEBA: Tax Attributes of Non-Exempt Welfare Benefit Trusts,” 47 Tax Lawyer 113 (1993).
9 In 2007 alone, tax-exemption applications for over 12,000 VEBAs were filed with the IRS. Borzi, note 1, above, at fn. 5.
10See Borzi, above, note 1, at 1.
11 Bernstein, note 7, above, at 1.
12See Gilson, Creating Value Through Corporate Restructuring: Case Studies in Bankruptcies, Buyouts and Breakups (Wiley 2001), at 335.
13See Borzi, note 1, above, at 10
14 This is the default case under ERISA. The vesting and anti-cutback rules that apply to pension plans under ERISA Title I do not apply to welfare plans such as those providing health insurance benefits.
15 FitzGerald, note 1, above, at 9.
All Bloomberg BNA treatises are available on standing order, which ensures you will always receive the most current edition of the book or supplement of the title you have ordered from Bloomberg BNA’s book division. As soon as a new supplement or edition is published (usually annually) for a title you’ve previously purchased and requested to be placed on standing order, we’ll ship it to you to review for 30 days without any obligation. During this period, you can either (a) honor the invoice and receive a 5% discount (in addition to any other discounts you may qualify for) off the then-current price of the update, plus shipping and handling or (b) return the book(s), in which case, your invoice will be cancelled upon receipt of the book(s). Call us for a prepaid UPS label for your return. It’s as simple and easy as that. Most importantly, standing orders mean you will never have to worry about the timeliness of the information you’re relying on. And, you may discontinue standing orders at any time by contacting us at 1.800.960.1220 or by sending an email to email@example.com.
Put me on standing order at a 5% discount off list price of all future updates, in addition to any other discounts I may quality for. (Returnable within 30 days.)
Notify me when updates are available (No standing order will be created).
This Bloomberg BNA report is available on standing order, which ensures you will all receive the latest edition. This report is updated annually and we will send you the latest edition once it has been published. By signing up for standing order you will never have to worry about the timeliness of the information you need. And, you may discontinue standing orders at any time by contacting us at 1.800.372.1033, option 5, or by sending us an email to firstname.lastname@example.org.
Put me on standing order
Notify me when new releases are available (no standing order will be created)