The Auto Industry - It's Simple Risk and Return Regarding Health Care Issues

Implications: US auto manufacturers face a huge dilemma.  To be competitive with Toyota and other non-US auto manufacturers, they must lower health care costs and unfunded liabilities.  (This is well documented in the referenced article.)  What is interesting is the impact on value from both the the firms' perspective and the UAW's perspective.

Analysis: The issue facing US auto manufacturers and the UAW is a trade off of risk and return.  The actual form of agreement is still being debated and negotiated.  However the implications are visible.

Most financial analysis addresses the cost of health care.  (The estimates of how much health care costs, per US automobile, varies.  However it is significant and puts US auto manufacturers at a competitive disadvantage.) 

In addition to cost reduction, US auto manufacturers must also eliminate the inherent risk with such programs.  It is the risk that is too often neglected in financial analysis.  If GM, Ford, and Chrysler are able to successfully fund and transfer the OPEB liability to the UAW, the over risk premium the market assess these firms should go down.  (Note: How these firms fund this liability is another matter.  Example: firm stock.)  Basically the firms will have transferred a lot of the OPEB risk to the UAW.

However this is not a win-lose situation.  The OPEB liabilities of GM and Ford are greater than the equity value on their balance sheets.  (Note: Chrysler is now private.)  As the rating agencies have noted, default risk dominates the value of US auto manufacturers.  If the UAW accepts the OPEB funds and thus risks, it also lowers the default risk that it currently absorbs.  (Note: OPEB liabilities have little priority of claims in bankruptcy.)  Financial analysts must realize that the unfunded OPEB liability on the balance sheet of US auto manufacturers is also the receivable on the employees'/retiree's (or their agent's) balance sheet.

The bottom line is such a program would reduce the "total" risk of US auto manufacturers without significantly increasing the "total" risk currently being absorbed by the firm's employees and retirees.  What the proposal does is shift the employee/retiree risk away from employer default  risk to fund operating risk.  This fund operating risk deals with the recognition, measurement, and ultimately management of funds assets, payments to employees/retirees (liabilities), and matching of assets and liabilities (e.g., duration).

In summary, financial analysts must look at the risk implications in this proposal, not just the cost implications.  The risk could be a win-win if properly executed.