The Breaking Point Worker health costs will rise a staggering 24% this year. Companies can no longer afford to pick up the bill. The battle is here.
By David Stires

(FORTUNE Magazine) – The death of Kjeston "Michelle" Rodgers was, by all accounts, an accident. The 40-year-old single mother of three daughters was walking in a dimly lit area outside a General Electric plant in Louisville, where she had assembled washing machines for the past eight years. It was 4:59 A.M., so the sun hadn't yet risen, and she was wearing dark clothes. And as one of 17,500 workers striking against her employer on Jan. 14--the first day of a two-day nationwide strike against GE--she was carrying a picket sign. Some think that may have obstructed her view of the police car that hit her at 40 miles an hour as she stepped into the street.

Still, what a number of her co-workers and fellow union members at IUE-CWA Local 761 wonder is, What if the person who ran over Michelle had been a company man? "There's no telling where it would have went," says Bill Blair, a fellow striker.

There's no telling because tensions have been particularly high this year--on both sides of the labor-management divide. This is the first time in more than three decades that GE workers have felt passionate enough about any issue to stage a national strike, one that spread to 48 locations in 23 states, affecting plants that make everything from consumer products to jet engines. The catalyzing issue, in this case, had nothing to do with wages, job cuts, or factory safety. It had to do with fast-rising health costs--and who was going to pay for them.

Tensions were also high because GE had not only increased certain health-care co-payments but also because it did so in January, just five months before the two sides were to begin negotiating the next three-year contract. The January increase will cost each employee an extra $200 to $400 this year, depending on whose estimate you believe. GE officials say its collective-bargaining agreement has allowed it to impose such increases at its discretion since 1994. But union leaders say that such health-benefit issues have always been negotiated in the past, not decided unilaterally by the company. "It was like waving a red flag at a bull," says Morton Bahr, president of the Communications Workers of America, IUE's parent union.

A decade after the collapse of "Hillarycare," soaring health costs are once more in the national spotlight, and tempers are again flaring. The amount of money spent on health care in the U.S. jumped 8.7%, to $1.4 trillion, in 2001, the largest one-year gain since 1991. In labor talks all across the country, health benefits have become a major issue in negotiations. Health care, in fact, has become what hours and wages and job security were in the past--the make-or-break issue upon which unions and employers are increasingly giving no quarter. And that spells "strike."

Just months before the GE incident, workers at Hershey Foods struck for 44 days to stop a plan that would have significantly raised their health-care costs. When it was over, the union members accepted lower pay increases instead of the healthcare increase.

And this year--an unusually heavy bargaining year, as it happens--the flare-ups are sure to increase. In addition to GE, companies negotiating new contracts include the Big Three automakers; telecom firms Verizon, Qwest, and Avaya; and tire makers Goodyear, Bridgestone/Firestone, and Michelin's Uniroyal/Goodrich subsidiary. "Every one of them is expecting hard bargaining in the area of health care," says Gordon Pavy, a collective-bargaining specialist at the AFL-CIO.

Admittedly, labor conflicts are not the only--and not the biggest--problem caused by spiraling medical expenses. A far greater concern is that rising costs cause an increase in the number of uninsured. That more than 41 million Americans lack health insurance is not just a national embarrassment. It's also a serious economic problem, since other payers, primarily government and businesses, get stuck picking up the tab for those without coverage.

Nevertheless, in what is the slowly unfolding drama of rising health costs, labor conflicts are likely to deepen for years to come. That's because when workers and their employers sit down at the bargaining table, they're going to continually run into an obstacle: The forces sending health costs skyward are largely beyond their control. Costs are rocketing because of advances in medical technology, an aging population, and increased use of hospitals and prescription drugs--forces that most health experts believe can only be controlled by changes in public policy. The bottom line?

"Until the public-policy crisis is solved, we're going to have a much more chaotic labor relations process," says Tom Juravich, a professor of labor studies and director of the Labor Relations and Research Center at the University of Massachusetts. "We're going to have a lot more strikes."

Economist Mark Zandi of in West Chester, Pa., agrees: "The battle between employers and employees over health-care costs has only just begun."

Take a quick tour of this country's attempts to rein in health spending, and you'll see why a clash between management and labor is looming. In the 1970s the federal government launched a number of soberly named initiatives, including the Economic Stabilization Program in 1971--74 and National Health Planning in 1975--79, which contained medical costs in large part by setting price limits. Most were dismantled in the early 1980s, and medical inflation returned with a vengeance.

By the mid-1980s, costs had risen to the point where companies became aggressive about negotiating concessions from their employees over health care. Strikes flared up all over the country, with everyone from miners to communications workers staging long walkouts. In 1989 the U.S. suffered 51 major work stoppages (involving 1,000 or more workers), idling more than 450,000 workers, according to the Bureau of Labor Statistics. That year the number of man-hours lost because of the work stoppages quadrupled.

The strikes abated in the early 1990s as managed care replaced the old fee-for-service insurance, clamping down on spending by capping payments to health-care providers and limiting patients' access to costly specialists and tests. Annual growth in national health spending between 1993 and 2000 fell to 5.7%, down from the heady 9.7% growth seen between 1988 and 1993. What happened then is a familiar story: Everybody--consumers, employers, and physicians--rebelled against the HMOs' aggressive cost-containment measures. And by 1997, medical inflation was rearing its ugly head once more.

Now, that same Everybody is looking for a miracle cure. Again.

The big new ideas on the health-care fronts, though, aren't winning raves with at least one major constituency: workers.

Employers, for instance, are boosting worker payroll contributions, co-pays, and deductibles for doctor and hospital visits. Many are adopting "tiered" drug-benefit plans, where patients pay the least for generic drugs, more for "preferred" brand-name prescriptions, and most for non-preferred brand-name drugs. And some are switching to "consumer-driven" health plans, which combine a high-deductible insurance policy with a health-care spending account that's funded by the employer. The idea is to turn patients into more prudent shoppers when it comes to medical care. It's also an attempt to curtail their use of pricey doctors, tests, and procedures.

The upshot in each case, however, is that workers are paying more. After rising a relatively modest 7.4% in 2001, the amount each employee paid in premiums and out-of-pocket costs last year grew 10.8%, according to Hewitt Associates, a Lincolnshire, Ill., consulting firm that conducts large national surveys of company benefit practices (see chart). This year the hit to workers' wallets is expected to jump an incredible 24.2%. Wage increases, meanwhile, have been creeping along at a 3% to 4% clip. The health-care cost rise in just the past five years is even more startling: Employees can each expect to pay $1,753 on average for health insurance and out-of-pocket costs this year, up more than 70% from the $1,014 spent in 1998.

With no end in sight to rising medical costs (and with no significant cost-cutting or burden-shifting plan in the offing from the Bush administration), workers will have to accept an even bigger bite out of their paychecks, or companies will have to take it out of profits. You don't need a crystal ball to see that that is a fight waiting to happen.

In addition to the private sector, labor and health experts anticipate a sharp rise in tensions in the public sector, an area that's traditionally a big union stronghold. State governments are facing their biggest financial crisis since World War II and are taking a knife to health expenses, which account for 30% of spending. Already, strikes over medical benefits by public employees, from teachers to garbage haulers, aren't uncommon.

What we can expect, say labor experts, is a jump in the number of strikes by as much as 20% over the next few years, as management and labor duke it out over how much each side will pay.

It's precisely what this already fragile economy doesn't need. As last year's West Coast dock strike showed, work stoppages have a way of rippling through the economy and eating into the profits of companies far removed from the conflicts. Economists say the dock strike was the single biggest influence on the fourth quarter's sharp drop in national output, when real gross domestic product grew at an annual rate of just 0.7%, down sharply from growth of 4.0% in the third quarter. By one estimate, the dock strike cost the economy $2 billion a day.

What's going to make the skirmish particularly nasty is that workers aren't the only ones getting whacked by rising health costs. Companies say years of soaring health costs are hurting their bottom lines and competitiveness. If they don't pass on more of their medical expenses to workers, they say, they'll have to eliminate jobs.

And they, too, have the stats to back it up. The amount companies paid for their employees' health-insurance premiums rose 14.8% last year, to $4,564 per employee, according to Hewitt Associates. The firm estimates that the figure will again climb in the double digits this year, bringing the amount that employers pay for each worker's health insurance to $5,134. That's nearly 70% more than the $3,062 they spent in 1998. (Sound familiar?)

"It hits across the board," says Ken Sperling, a health-care practice leader for Hewitt. Particularly vulnerable to medical inflation are the steel, telecom, and auto industries, which have a disproportionate number of older workers and huge retiree forces they still support. But it's really a problem all across corporate America. "We're hearing it from financial services companies, manufacturing companies, technology companies--you name it. The cost pressures are everywhere."

Consider SBC Communications, the second-largest local telephone company. It paid $2.5 billion in medical, dental, and vision claims for 343,000 employees and retirees last year. That's $7,289 per person. The total is almost 50% more than what it paid in 1999, making it one of SBC's fastest-growing expenses.

"Obviously any multibillion-dollar expense has a significant impact on our earnings," says Larry Solomon, SBC's vice president of communications. Rising costs not only hurt the stock price but also mean that SBC has less money to maintain and upgrade its network. "Rising health-care costs make it more difficult to accomplish that," says Solomon.

Like other companies, SBC has shifted some of its cost increases to employees. This year it raised medical-insurance premium contributions from active and retired managers, as well as prescription drug co-payments. Even with this increased cost sharing, Solomon says, SBC still carries the brunt of its employee medical expenses.

Surging health costs are particularly wrenching because companies have so little pricing power. The government's most widely followed measure of inflation, the consumer price index, shows that an important split is widening between the two dominant sectors in the economy, services and goods. Prices for services rose 3.2% in December from a year earlier, pushed up primarily by rising medical-care costs, as well as by increases in tuition, homeowner's insurance, and other services.

But prices for manufactured goods, excluding the volatile food and energy sectors, were down 1.5% in December from a year earlier--the second-largest drop since 1958. The 2002 decline was led by lower price tags on everything from cars to computers to clothing.

That sharp divergence helps explain the labor conflict at GE. The company's health-care costs have jumped 45% since 1999, to $1.4 billion in 2002. At the same time, GE is competing in many industries, from aircraft to household appliances, where prices are tumbling. The result is that GE reported a 7% gain in net income for 2002, its worst performance in a decade.

Executives at GE declined to say whether the company will seek to pass more health costs on to workers at the contract talks starting in May. Regarding its move to boost employee co-payments in January, GE officials say it's difficult for the company to stay competitive while sustaining the double-digit percentage increases that it has experienced in recent years. "We're asking our workers to share less than 10% of the increases experienced by the company," says Bill Conaty, GE's senior vice president of human resources. "Our changes are moderate, and GE's health-care benefits remain among the best offered in the nation."

To fully understand how large an impact the costs can have on U.S. businesses, however, head to Detroit. The automakers spent $8.8 billion on health care last year for 2.2 million workers, retirees, and dependents, according to the Center for Automotive Research (CAR) in Ann Arbor, Mich. That's up from approximately $7.2 billion in 2000. The Big Three spend roughly $1,200 per vehicle on health care.

Stiff competition from foreign auto-makers prevents U.S. car companies from passing on the cost to their customers. So the growing expense cuts into the bottom line and prevents crucial investment in research and development.

"The alarming rate of increase of employee health-care costs is one of the largest hurdles that the domestic automakers face," says Prudential Securities analyst Michael Bruynesteyn. He points out that the costs for U.S. automakers are particularly high in part because their benefits packages are exceptionally generous. The companies generally don't impose deductibles or require co-payments for patient visits or prescription drugs. "It's Cadillac health care," quips Sean McAlinden, director of CAR's economics and business group.

To put Detroit's health-care crisis into perspective, the Big Three's health liabilities are estimated to be $92 billion, according to Goldman Sachs analyst Gary Lapidus. That's about 50% greater than their combined market capitalizations of $66 billion. It's also three times Lapidus's estimate of their pension obligations--a separate cost that has many investors panicked.

Representatives at GM, Ford, and DaimlerChrysler declined to say whether they plan to increase the amount workers pay for health benefits at the upcoming negotiations starting this summer. Publicly, they say they're proud of the health benefits they provide. But they can't offer "Cadillac health care" forever.

One thing both sides often agree on is that the system is broken and badly needs to be fixed. "We've got to get our head out of the sand and fundamentally restructure our system," says Henry Simmons, president of the National Coalition on Health Care, an alliance of big companies and unions campaigning for more affordable health care. The coalition, which favors universal coverage, counts as members employers such as AT&T and DaimlerChrysler, and all the unions of the AFL-CIO. Of its 100 members, 25 joined in the last six months, including Pfizer, Verizon, and Alcoa. Says Simmons: "There's just a groundswell of people saying the system has to change."

In Washington, health-care reform is again on the agenda. But most observers believe a serious push for reform won't happen anytime soon. With politicians focused on war and the economy, they say, the sense of urgency just isn't there. Besides, any fundamental reform will almost certainly begin with overhauling Medicare. And we're still debating that one.

For now, employers and workers will be left to fight over how much each side will pay.

Standing in his Washington, D.C., office overlooking Gucci Gulch, the Capitol corridors where well-heeled lobbyists ply their trade, Edward Fire, president of IUE-CWA, is calm yet clearly focused on his union's upcoming contract talks with GE in May. If the company has the "arrogance" to wring more out of his members for their medical benefits, he says, the union will strike again. Says Fire: "We'll fight to the bitter end."