Employee benefits for retired workers are of particular interest to policy makers because of the large number of retired and retiring baby-boomers. Nevertheless, fewer firms offered health insurance for retired workers, their surviving spouses, and dependents in the recent past than they did 20 years ago, leading to concerns about the health insurance coverage and ultimate health status of retirees. The increasing cost (to firms and workers) of health insurance has undoubtedly had something to do with this decline in benefits offering. Retiree health insurance is fundamentally different from private pensions and other annuities because firms do not have to "prefund" its expenses. The law requires firms to put away funds owed to the employees on retirement for pensions and other annuities. On the other hand, if a firm promises current employees that they will receive health benefits upon future retirement, the firm is not required to have funds available when the employees retire. Typically, ongoing retiree health insurance is paid for using general funds. In other words, there is no requirement for a company to set aside any money for its future retirees' health insurance. In addition, many firms are free to revise their retiree health benefit policy; in times of financial hardship, firms might decide to eliminate these benefits altogether. Voluntary Employees' Beneficiary Associations (VEBAs) are trust funds created to finance many aspects of employee benefits. VEBAs are tax-exempt entities defined under Internal Revenue Code (IRC) Section 501(c)(9). By law, the tax benefits of VEBAs are greater if they were created as part of a collectively bargained agreement between representatives of the firm's union and management. VEBAs can be dedicated to life insurance, accident benefits, child care facilities, disaster loans or grants, supplemental unemployment insurance, education and training, severance benefits, and retiree health benefits. Money in a VEBA may not be used for anything except the stated purpose of the VEBA. In addition, VEBAs may not be used to pay for pensions and annuities at retirement. This report focuses on the effect of VEBAs on funding retiree health insurance. The abbreviation VEBA is used differently by different authors. Some consider a VEBA the association and its members, who go on to open a trust, leading to the phrase "VEBA trust." This report, however, subsumes the trust into the word VEBA, making a single word encompass a group of employees and its associated trust fund. The report shows that, under some circumstances, using VEBAs to fund retiree health insurance may benefit both firms and workers. A unionized firm can use VEBA contributions to reduce or eliminate its retiree health insurance liabilities. The unionized workforce will be able to afford at least some retiree health benefits, because once the firm has contributed funds into the VEBA, the funds can never revert back to the firm. The funds always remain with the workers, even if the firm enters bankruptcy. On the other hand, a VEBA without sufficient funding offers few benefits to the workers. The individual negotiations between General Motors (GM), Ford, and Chrysler (together known as the Detroit 3) and the International Union, United Automobile, Aerospace & Agricultural Implement Workers of America (UAW), together with the retiree health VEBAs that became the source of the UAW's retiree health funding on January 1, 2010, illustrate many aspects of VEBA implementation. The terms governing these VEBAs were agreed upon during the 2007 contract negotiations and were then revised during 2009, when first Chrysler and then GM entered chapter 11 bankruptcy. The next section of this report covers the funding of retiree health insurance from the perspective of the firm, the workers, and the VEBA. The third section discusses the role of VEBAs in chapter 11 bankruptcy reorganization, and the fourth section provides an overview of the benefits and risks associated with VEBAs in unionized firms. The fifth section discusses legislative issues. The Detroit 3 VEBAs serve as examples throughout the report. GM receives a special emphasis in the report because, as a public company, its financial information is more readily available than Chrysler's financial information. Although Ford is not emphasized in the report because it did not enter bankruptcy proceedings, it too renegotiated its 2007 retiree health VEBA with the UAW in 2009. VEBAs historically belonged to a single firm. More recently, however, some VEBAs are structured as a trust independent of the firm. These trusts are sometimes termed independent VEBAs, new VEBAs or stand-alone VEBAs. An independent VEBA must be controlled by its membership, by independent trustees, or by other fiduciaries designated by the membership. Trustees chosen by a collective bargaining agreement are considered designated by the membership. In all cases, the trust acts in the interest of the workers. The Detroit 3 VEBA is an independent VEBA. The automobile companies have had no say in its operation since it became the active source of retiree health funding for the three firms on January 1, 2010. Like many independent VEBAs, the specific details of the Detroit 3 VEBA were negotiated between the firms and the union. Beginning with GM, UAW and management representatives bargained over the amount of funding needed to pay for health insurance for all (eligible) present and future retirees, their spouses, and their dependents for the remainder of their lifetimes. The parties also bargained over the sources of the funding. As mentioned above, the firm does not have to prefund retiree health insurance in the same way it must prefund pensions. Indeed, the firm may not want to tie up large amounts of money for many years. Perhaps as a consequence, the recent unfunded liabilities for post-retirement health care have been quite large. A commonly cited Credit Suisse/First Boston study estimated that the total unfunded post-retirement benefits liability (excluding pensions) of the Standard & Poor's 500 companies was $336 billion at the end of 2005. VEBAs, as tax-exempt instruments, provide the firm incentives to prefund health benefits. More specifically, contributions to the VEBA are tax deductible, and the investment income grows tax-free. Tax law regulations, however, impose several constraints on funding levels associated with most VEBAs : In calculating expected expenditures over the life of the VEBA, no allowance can be made for medical inflation (i.e., future medical inflation must be assumed equal to zero). The levels to which certain VEBAs may be funded are limited. If these levels are exceeded, the VEBA must pay the Unrelated Business Income Tax (UBIT) on the amount over the limit. Nevertheless, these constraints to tax deductibility do not apply to VEBAs created by a collectively bargained agreement. In this case, VEBA fund managers use the actuarially standard level of medical inflation rather than assume no medical inflation; this distinction is especially important when forecasting the value of future claims to a retiree health VEBA. In addition, the UBIT is never owed, and VEBAs used to fund retiree health insurance do not have deductibility limits. These differences make the tax advantages of retiree health insurance VEBAs in unionized workplaces far greater than the tax advantages of some other types of VEBAs. The remainder of this report is restricted to VEBAs in unionized firms. In addition to these tax advantages, VEBAs can improve a firm's financial position. Firms are required by the Financial Accounting Standards Board (FASB, which establishes financial and reporting standards for private-sector U.S. firms) to use accrual accounting when calculating liabilities for retirement health; in other words, the liability increases as the number of employees eligible for benefits along with the expected amount of these benefits increases. This liability must be reported on the firm's balance sheet, where a particularly large value can depress the firm's market value. Transferring the firm's liability for current and future benefits to a VEBA can sometimes increase the market value of the firm. Historically, employees participating in a VEBA have worked for the same firm. Nevertheless, employees can work for different firms, as long as they share a "common bond," or an employment-related characteristic that unites the group. For example, the automotive industry retiree health VEBA negotiated by the UAW includes workers from each of the Detroit 3. The workers may be active workers or retirees; their spouses and dependents may also have their health insurance funded by the VEBA. A primary advantage of a VEBA to the worker is a reduction in the risk associated with actually receiving promised current and future retiree benefits. If the firm has already deposited funds into a dedicated retiree health VEBA, these funds must go to their intended recipients. They may never revert back to the firm. In many instances without a VEBA, the workers have no recourse if the firm lacks the funds to pay for promised retiree health benefits. If the firm falls short, or simply decides to place its money elsewhere, no law or regulation compels the firm to honor past promises. The presence of a VEBA, however, does not automatically remove the risk associated with the worker, because the VEBA itself must have money. For current and future retirees to receive promised benefits, there must be sufficient money in the VEBA to cover the benefits' costs. A VEBA that contains sufficient funds to cover the expected costs of the retiree benefits is known as a fully funded VEBA. Finally, VEBAs offer tax advantages to the workers. As with conventional employer-sponsored health insurance, the firm's contributions to a retiree health VEBA are not included in the worker's gross income. Generally, benefits from VEBAs are taxed when distributed; health insurance benefits, however, are not taxed provided they are used for tax-qualified medical care.