The Impact of Liabilities for Retiree Health Benefits on Share Prices

By Mittelstaedt, H. Fred; Warshawsky, Mark J. | Journal of Risk and Insurance, March 1993 | Go to article overview

The Impact of Liabilities for Retiree Health Benefits on Share Prices


Mittelstaedt, H. Fred, Warshawsky, Mark J., Journal of Risk and Insurance


Defined Benefit Pension Plans, in: J. Turner and D. Beller, eds., Trends in Pensions (Washington, D.C.: U.S. Department of Labor).

Warshawsky, M., 1992a, The Uncertain Promise of Retiree Health Benefits: An Evaluation of Corporate Obligations (Washington, D.C.: American Enterprise Institute for Public Policy Research).

Warshawsky, M., 1992b, Financial Accounting and the Funding Status of Pensions, in: J. Turner and D. Beller, eds., Trends in Pensions 1992 (Washington, D.C.: U.S. Department of Labor), Introduction

This study examines the association between liabilities for retiree health benefits and share prices. Health coverage is often provided by large corporations to their retired employees at no premium charge or on highly subsidized terms. In the past few years, however, escalating health care costs, aging workforces, and increasing financial pressures have led some employers to dramatically reduce or even eliminate these unfunded benefits. In this environment, concern has been expressed that corporations may reduce or cancel retiree health benefits en masse before retiree health liabilities are disclosed and income is decreased under the newly adopted Statement of Financial Accounting Standards No. 106: Employers' Accounting for Postretirement Benefits Other Than Pensions (Financial Accounting Standards Board, 1990). Retirees would then become exposed to the unexpected financial risk of uninsured medical care. If liabilities for retiree health benefits, however, have already reduced share prices dollar-for-dollar or at least in a similar manner to other liabilities on the balance sheet, the new accounting disclosures would create much less financial pressure for corporations to cut benefits.

Our evidence indicates that the market reduces stock prices because of retiree health benefit liabilities. Using the framework of Statement No. 106 and the terms of existing contracts, we find that the stock market values retiree health liabilities at about fifty cents on the dollar, significantly less than other liabilities appearing on the balance sheet. The less than dollar-for-dollar relation between stock prices and retiree health liability is consistent with the view that the market expects someone--corporations or the federal government--to do something that would effectively reduce the future burden of corporations for retiree health benefits. Such actions could range from corporations canceling or significantly reducing the level of benefits in retiree plans, thereby placing more of the burden for health care on retired individuals, to further socialization of health care in the form of expanded Medicare coverage or national health insurance. A middle-of-the-road action would be to allow companies some relief in the form of the tax deductibility of contributions to fund retiree health benefits.

Specification error is always a concern for the methodology used in this article. In particular, although our estimate of retiree health liability for each company is calculated using firm-level data, it reflects many assumptions based on aggregate trends. These liabilities may be measured with error relative to the market's estimate or to the true value of the liability. To address this issue, we employ an instrumental variable approach. The results reinforce the finding that the market values retiree health liabilities but calls into question the less than dollar-for-dollar relation between stock prices and retiree health liability. Thus, the less than dollar-for-dollar relation may be attributable to measurement error.

The model used in this study for the valuation of a firm's equity is based on the work of several researchers whose work is based, in turn, on Tobin and Brainard (1977). The valuation of equity shares was examined by Feldstein and Seligman (1981) and Feldstein and Morck (1983) with special consideration for the informativeness of early standards for pension accounting and for the use of various discount rate assumptions in pension liability evaluations, respectively. …

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