Health care costs pinch profits

NEW YORK — Wake-up calls usually are loud and jarring, which explains why so much attention is being paid to General Motors Corp.’s warning that soaring health care costs are hurting its bottom line.

It’s not that other companies aren’t seeing their profits getting pinched from the additional expenses they must incur to offer health care and prescription drug coverage to employees and often retirees, too.

But GM’s recent disclosure illustrates that there is no quick fix for the stinging effect of such hefty costs.

The big increases in health care costs come just as companies are trying to fend off other pressures to the bottom line that are slowing earnings growth. That includes such things as the weak dollar, higher commodity prices and increases in financial outlays required to cover new regulatory requirements.

Employer-sponsored health care premiums for a family of four rose 11.2 percent to $9,950 from the spring of 2003 to the spring of 2004, the fourth consecutive year that companies and their employees have seen a double-digit increase in such costs. That’s according to a survey released in September of about 3,000 employers by Kaiser Family Foundation and the Health Research and Educational Trust.

With the quarterly earnings season under way, this issue is often being talked about by executives at companies both big and small. The list includes restaurateurs like Max & Ermas Restaurants Inc. and retail chains such as Big Lots Inc.

Yet none have yet had the same kind of hit to earnings as GM, which offers benefits to more than a million employees, retirees and dependents.

When announcing earlier this month a 37 percent drop in fourth-quarter earnings, GM cited its big jump in health care costs as one of the primary reasons for the decline. Top executives also said continued rising expenses will be a headwind to earnings going forward. Among the most costly: prescription drugs.

Under current accounting rules, companies must estimate the future total cost of the health benefits, based on such factors as the expected life span of retirees and the growth rates in costs, and record that as an expense on their income statements. For 2004, that pretax expense is expected to total $4.3 billion, and the automaker estimates that will rise by $1 billion in 2005.

From purely a cash standpoint, GM projects it will spend about $5.6 billion on health care in 2005, up from $5.2 billion in 2004 and $4.8 billion in 2003. That reflects the amount of money that the company is paying to cover claims from current and retired workers.

“Health care costs … are not in our control,” chief financial officer John Devine said during a conference call with analysts after GM’s earnings were announced Jan. 19. “We work with providers. We work with our own people. We work with the union. We work with people in Washington on this issue. But it has been very frustrating that these issues are out of our control. We have to find a way of getting them back to what we think is a reasonable level of sustainability going forward.”

For many companies, the problem is that the costs of providing these benefits are growing faster than their underlying businesses, and that will only become a more serious issue as the baby boomer generation heads into retirement.

Standard & Poor’s analyst Scott Sprinzen says the “most effective way for companies to reduce these costs is to roll back the benefits.” And some companies are already cutting back. In 2004, 61 percent of employers offered health benefits to workers, down from 65 percent in 2001, the Kaiser study found.

But doing that is easier said than done, especially at unionized companies such as GM. Just look at all the fighting that has gone on in the airline industry to win concessions from workers.

For investors, this issue could turn out to be a double-edged sword.

Sure, mounting expenses eat away at corporate profits, which is bad for shareholder returns. Yet should companies keep trying to shift more of the burden onto the work force, the average employee will ultimately have to pay more for health coverage — which could ultimately pinch every working person’s pocketbook.

So clearly this isn’t an issue that can be remedied fast. And chances are that more companies will follow in GM’s wake.