(FORTUNE Magazine) – IMAGINE A RECENT FORTUNE 500 retiree named Fred, a prince of an employee over the years, but right now a corporate horror. Fred, 60, is covered by his company's health plan and has a life expectancy of 78; that's 18 years of health benefits. Young at heart, Fred has a new, 30-year-old wife who can expect to live to 80. She also comes under the company's health plan. So, gulp, does Fred Jr., 1 year old, whose coverage extends through the year he reaches 21. Add it up: 88 years of health benefits to be bestowed on a family that will be performing no work whatever for the company. The example is obviously extreme. But when the subject is the promises that companies have made about health benefits, words of moderation mislead. All elements of this problem are enormous -- the commitments, the expectations of employees, and potentially even their disappointments. Excruciatingly aware of what they have let themselves in for, companies are searching for roads of retreat. Some exist; most are tortuous. Business is caught up, of course, in a national drama: The $550 billion the U.S. spent on health care last year amounted to nearly 11.5% of GNP, far more than in other industrialized countries. Costs are out of control, having risen since 1980 at a 10.5% annual rate. Many companies would kill to be so lucky. In 1987, General Motors' U.S. health care costs rose by 32%, to nearly $3 billion. Last year, says a consultant, the rise was again ''horrendo.'' The nation meanwhile equivocates about health costs, clamoring that they be contained yet demanding the easy availability of quality care. But no one wants to write the checks -- neither the government, nor business, nor the patients. The corporate obsession of the moment is retiree benefits, which around 70% of all large companies provide. In one way, these costs are no more than the tip of the iceberg: Typically, a corporation's health expenditures for active employees exceed those for retirees. But the actives produce and the retirees do not. Many, like Fred, are under 65 and prodigiously expensive to cover, since they do not yet qualify for Medicare. All those active employees, furthermore, are themselves marching toward retirement in cadence with a rapidly aging population. By the year 2020 or so the demographic profile of the entire nation is expected to match Florida's today: 18% of the population will be over 65. These facts spell dollars, tons of them, and that reality should long ago have made managers fixated about their retiree costs. But in truth, most slumbered until shocked awake by accounting. Up to now, nearly all corporations have reported their retiree payments as the cash went out the door. But in the offing are new rules that would require companies to estimate * all they will pay in the future, charge these obligations to their income statements, and recognize them as a liability on their balance sheets. The obligations will be huge. One conservative estimate, by the Employee Benefit Research Institute, a nonpartisan, nonprofit organization in Washington, puts the present value of this liability, for all private employers, at $169 billion. Other estimates run as high as $2 trillion, not far below all the liabilities that nonfinancial corporations carry on their books. This vast discrepancy suggests the difficulty of pulling the problem into focus. But even the $169 billion figure implies that retiree health care costs will mangle many companies. This problem also has a long tail, threatening to wrap itself around just about everybody in the country. Companies that provide retiree benefits feel compelled to attack this cost. But the moral and legal difficulties of cutting benefits for existing retirees have caused many companies to concentrate instead on reducing the benefits of their future retirees, a.k.a. their current employees. Many managements appear to detest this job -- and all the other complexities of administering and policing health programs. A growing number yearn for some form of national health insurance to take over the task (see the FORTUNE 500/CNN Moneyline poll that follows). MANY corporations edged into this bog during World War II, when wages were frozen and labor exacted health plans and other fringe benefits instead. Later, managements blithely extended like coverage to their non-unionized forces, retirees -- and themselves. Health benefits have customarily been supremely egalitarian, linked to neither length of service nor salary. That's one difference from pensions, among many. Most important, managements refused to index pensions to inflation. ''Are you crazy?'' they asked. ''We can't afford that risk.'' But their health plans embraced indexing without ever using the word. Companies did not state their promises in terms of dollars -- ''We will give you X amounts to help defray your health costs'' -- but instead obligated themselves to cover their troops' medical bills, whatever these turned out to be. They slipped into this awesome error partly because they viewed their health programs as short-term commitments subject to change, not long-term commitments like pensions. That thinking affected the financing of both. Wanting pension commitments to be solid, Washington required corporations to set aside funds to cover them at least partially, made contributions to these accounts tax deductible, and exempted their earnings from income tax. But the government did not prod employers to fund their health promises, nor did it shower them with tax incentives. As a result, only a few companies have done any funding at all. The rest pay as they go. The pension vs. health differences -- Arnold Schwarzenegger vs. Danny DeVito -- extend to financial reporting. Corporations have long treated pensions as a form of deferred compensation. They thus account for these on an accrual basis, actuarially recognizing the cost of an employee's pension over his working life. But they did not bite this bullet with their retiree health plans. Instead, they reported their cash costs and let it go at that. Into this haphazard world has now come the Financial Accounting Standards Board, saying, ''These benefits, too, are a form of deferred compensation and thou shalt account for them in precisely that way.'' For retiree health benefits, then, it's out with pay-as-you-go reporting, in with accruals -- which in virtually all cases will be higher. THE NEW RULES will probably not apply until 1992 and may be modified as FASB exposes them to public and undoubtedly heated debate. But their shape can be anticipated. Corporations will first have to estimate future spending on health benefits for current and future retirees and all covered dependents. They must then discount these obligations to present value and begin charging them gradually to earnings. These bookkeeping charges, while not affecting the cash companies pay for medical bills, will inflict big damage on that telltale report card, the income statement. The toll will be especially heavy for perhaps 15 years, as companies recognize liabilities built up in the past. After that, the charges will continue to hurt as they are accrued year after year. Meanwhile, each company's balance sheet will display the ''debt'' owed to retirees, present and future. Estimating these obligations will be only slightly easier than making the sun rise in the West and set in the East. Take the example of Mrs. Fred. The company responsible for her must, in effect, estimate what her medical costs will be over 50 years, taking into account price inflation (What will a hip replacement cost in 2030?), the frequency with which she may use medical services (One hip or two?), and the impact of technology (Will they be using + gold by then for hips?). And what to make of Medicare, the primary provider for those over 65, with business picking up the extras? Lately Medicare, by extending catastrophic coverage to citizens over 65, has assumed billions in costs formerly borne by business. But will this munificence last -- through next year, much less for 49 more? All these matters will, of course, be dealt with actuarially, though by what warm bodies is not clear. Right now, says Diana Scott, the FASB's project manager on this case, ''there just aren't enough actuaries to do all the measurements.'' Some managements, in any event, will be seeking almost any excuse to forecast slow growth for health costs. Outside consultants say many of their clients are gravitating toward 6.5% to 8.5%, telling themselves that the current out-of-control rates just can't continue. The numbers, in short, are going to be lousy. Says Timothy Lucas, FASB's staff director: ''We think they will still be better than what you get now, which is zero.'' THERE ARE SOME estimates around and they are ugly. Harold Dankner, a Coopers & Lybrand consultant, has been working with 25 companies that are testing FASB's rules. For many of this crowd, he says, the retiree accrual costs are going to run three to six times the retiree pay-as-you-go costs. The worst dollar blows -- no surprise -- are due to fall on companies that have demographically mature groups of people to support. Consider steelmaker LTV, a company mired in bankruptcy since 1986. Retiree health benefits did not exactly put it there. But they were always a rumbling issue, now erupted. Last fall, anticipating FASB's rules, LTV made a massive accrual for retiree health costs, charging $2.3 billion to earnings. That charge says nothing about LTV's ability to pay these costs, which is probably dubious, nor does it clean the company's accrual slate. LTV was simply stating that at its measurement date, year-end 1987, it was estimating $2.3 billion to be the present value of its obligation to its existing retirees and to its active employees for the years they had worked so far. LTV took this step, says controller William P. Twomey, because the liability is ''real'' and should be out on the table in the bankruptcy proceedings. But he also acknowledges that LTV had a unique opportunity to get this cost behind it, since it was merely turning its negative net worth into a redder shade of red. Healthier companies, he suspects, could not tolerate the hit, since they ^ would fear the impact on their net worth or on loan covenants. The average company will indeed string its accruals out. One of the few talking publicly about their financial effects is Du Pont. Currently the company provides health coverage for 100,000 employees, 71,000 retirees or their survivors, and 275,000 dependents, for a total of 446,000 people. Last year, when pretax profits were $3.6 billion, Du Pont's out-of-pocket health costs for this multitude were around $410 million, of which some $180 million went to retirees. But, says A. Herbert Nehrling Jr., director of employee benefits, the company thinks that retiree accruals could be from two to four times the retiree payouts, depending on its assumptions about future health costs. In other words, the retiree expenses hitting Du Pont's 1988 income statement could hypothetically have been $360 million to $720 million, instead of $180 million. A House committee heard a still spookier estimate last fall from an AT&T actuary, Michael Gulotta, who was representing a coalition of large corporations. He said the average company was facing accruals that would be four to five times its retiree pay-as-you-go expense. Say AT&T is this ''average'' company. In 1987 its payouts were $319 million, which means its hypothetical accruals would have been $1.3 billion to $1.6 billion. Those are thunderous figures in relation to the company's 1987 pretax profits of $3.2 billion. Furthermore, comparisons to pretax profits themselves somewhat mislead, since that pair-off implies that these accruals will be costs that can be fully ''tax effected'' -- that is, partially offset on a company's income statement by a reduced provision for taxes. But because of still other accounting rules going into effect for taxes, that will not always be so. Instead, large chunks of the accruals will, in the vernacular, fall straight to the bottom line. The jolt to be delivered to the securities markets is hard to judge. Some of this heavy news has surely been discounted. Certain security analysts may also play down the new rules as mere bookkeeping that has little immediate relevance to cash flow. On the other hand, these charges could heighten the earnings disparities within industries -- between an oldster like Inland Steel, say, and an upstart like Nucor, which does not offer retiree benefits. The strongest reason for expecting jolts is the paucity of information on the retiree issue. Inexplicably, many companies have not focused at all on ) what FASB's rules mean for them. ''I am staggered by this,'' says Donald G. McKinnon of the Mercer Meidinger Hansen benefits consulting firm. Some companies even lack a breakdown of today's costs for employees, retirees, and dependents. If companies are themselves so uninformed, it is hard to believe the market has anticipated all the news to come. MANY MANAGEMENTS are on the prowl for ways to shrink this liability drastically. They carry a legal tool: The fine print in their health-benefit plans customarily notes the right of the employer to change these at will. But the legalities are in the ring with other powerful contenders, including employee relations and humane considerations. Most important, the fine print will not provide managements with an escape from the essential moral dilemma, which concerns what the retiree is truly owed. Lawsuits brought over this issue have shown that most employees who were promised retiree health benefits never dreamed that they could be forced to bear sharply increased portions of the cost. They thought of their benefits as an entitlement. I worked, they say, therefore I earned. There you have what Dallas L. Salisbury, president of the Employee Benefit Research Institute, calls the ''social consciousness issue.'' Those not yet retired, Salisbury says, have time to adjust to changes in coverage: ''They have time to work longer, time to save.'' They also have leverage, including the ability to strike or take another job. But, says Salisbury, ''someone who is 78 and already has bad health problems does not have the option of finding new savings to pay health insurance premiums he never thought he would have to pay.'' With an adjustment for age, he could almost have been talking about Charles Fletcher, 59, a retired distribution manager of American Forest Products, a California company taken private in 1981 by Kohlberg Kravis Roberts and that firm's most notable financial disaster. In 1983, as AFP cut back operations, Fletcher received $22,500 in severance pay and round-tripped $13,000 of it to AFP in exchange, so he thought, for lifetime health insurance for himself and his wife. Then in early 1988 he learned he had leukemia. Three months later KKR sold AFP to Georgia-Pacific. AFP's retirees, including Fletcher, received notice from AFP that their health insurance would be terminated, but that they would each be paid $25,000 as compensation. Says Fletcher: ''Most are older and come under Medicare, so they accepted. But for me, after taxes, that wouldn't cover one stay in the hospital.'' So he bitterly refused the $25,000 and is suing AFP and KKR. A lawyer for those companies says a clause in Fletcher's health plan permits the cancellation. Fletcher joins a swarm of retirees who have sued to try to block their employers from modifying or terminating their health plans. Neither side has scored a legal knockout. ''The law is in flux,'' says Timothy Ryan Jr., of Washington's Pierson Ball & Dowd law firm, which tends to represent the defense. No case has reached the Supreme Court. In district courts, the retirees have often won. Says Ryan: ''We can eliminate juries, but we can't eliminate the typical 68-year-old judge. He doesn't like these cases at all.'' On appeal, where even 68-year-olds may apply the law strictly, judgments for the retirees have often been reversed, on grounds that the fine print is there and that they have no rights of contract. TWO LAWSUITS, with different verdicts, illuminate the texture of these cases. One action involved NLT Corp., a Nashville insurance company that had been acquired by another insurer, American General, which then sought to conform NLT's medical plan to its own. That meant NLT's retirees, who had been getting cost-free benefits, were hit for a share of the bill and they sued. The lead plaintiff -- the kind you get in these cases -- was a retired assistant secretary of NLT, Robert Musto, now 61, who had worked for the company 29 years. The other action involved Bethlehem Steel and its retired managers, whose Blue Cross/Blue Shield policies had until 1985 been paid for by the company. When it then tried to shift some of the cost to the retirees, they sued. Their chief was a Bethlehem veteran of 31 years, Carroll G. ''Gus'' Heck. Now 63, he had been second-in-command at the company's Buffalo plant. In the courtrooms where these two disputes were aired, the companies leaned on clauses in their plans permitting changes. In each instance, the retirees said they knew nothing of those clauses and had been orally promised cost-free benefits. The witnesses included managers who had done the promising, sometimes in ''exit'' interviews in which people set to retire were reminded of their cost-free coverage. NLT, especially, had trumpeted the virtues of its health plan. A retired vice president told about the spiel he delivered at meetings of district managers: ''I would hit the fact that they were going to have paid-up medical insurance, hospitalization insurance at no cost to them or their wives after retirement.'' In the NLT case, a Nashville district judge, only 54 years old in this instance, came down for the retirees. The promise of benefits, he said indignantly, is not ''a mere gratuity, but rather a legal right derived from a unilateral contract.'' Wrong, said the appeals court, in a decision just handed down. Oral promises, the court said, were outweighed by NLT's written declaration that it could change its plan. Musto and crew are considering an appeal to the Supreme Court.

In the Bethlehem case, a Buffalo district judge, 67, also found for the retirees, 18,000 of them. He dismissed the we-reserve-the-right language in Bethlehem's medical plans as not meaning much, in part because it had been carelessly omitted from two summary documents. To claim the oral representations made at the exit interviews didn't matter, the judge said, would mean that Bethlehem had perpetrated ''an enormous fraud'' upon the plaintiffs. Talking appeal, Bethlehem instead settled. In exchange for certain improvements in other benefits, the retirees accepted cost sharing in their Blue Cross/Blue Shield coverage. ''It was a win-win situation,'' says Heck's lawyer, Richard Moot of Buffalo's Moot & Sprague. Seeming to agree, Bethlehem attorney Kathleen Mills says the company wanted to settle because it disliked being ''in an adversarial position'' with its own people. Says she: ''We didn't see that something we forced down their throats through a court decree was going to make for peace, happiness, and wondrous living.'' By now, many another company, inspecting this trunk of legal and moral problems, has decided its existing retirees must be treated gently. Or perhaps -- you should pardon the expression -- grandfathered while the employer moves on to cut the benefits of the next generation of retirees and the next. JUST TO BEGIN the exercise, a company must analyze its health plans from stem to stern. What has it promised and to what extent can it back away? The answers may drive it to non-egalitarian ''solutions.'' Consultant McKinnon says many companies are thinking of borrowing a years-of-service concept from pensions. That is, the less time an employee has worked, the less he gets in company-paid benefits when he retires. Pillsbury has already adopted such an approach. International Paper took a strikingly different tack in a plan it announced & to its non-unionized employees in mid-1987. In a stair-step arrangement, the benefits of people who had retired before January 1, 1983, were grandfathered -- that is, left untouched. Those who had retired since that date were required to pay increased premiums, while those headed for pasture in the future were told they would then be paying still more. And, last, in a bit of lightning that makes IP a retiree revolutionary, employees hired after October 1, 1987, would not have ''subsidized'' retirement coverage at all. Yes, says William Fuller, an IP spokesman, that means the company won't pay a cent toward coverage -- though it might, for example, help its employees get group rates. Since the company never provided retiree benefits for its hourly paid employees, says Fuller, ''over time -- a long time -- we will eliminate this expense.'' IP's plan also requires more premiums from retirees under 65 than from those over, which puts the company on the leading edge of a national trend. Early retirees can be a medical disaster. In the first place, some have retired early because they were sick. Second, sick or well, they are ''time rich,'' able to hang out at the doctor's. Third, as they near 65, they may decide that the optional surgery they were considering should be done on their company's bill, before they have to tangle with Medicare's complexities. So a corporate retiree of, say, 58 may run up medical bills about double those of the 58-year-old still working. Says Stephen C. Caulfield, a Mercer Meidinger consultant: ''I tell my clients that if the only issue is health costs, then they don't want to push people into early retirement.'' But that is seldom the only issue. Restructurings and leveraged buyouts and even the old stuff, like 30-and-out retirement programs, keep putting these kids on the street. Happily for IP, it could make its changes without bargaining with its unions. No labor leader has doubts about the value of health benefits and many have leaped to defend them from attack. In 1986, just after LTV went into bankruptcy, it tried to stop paying retiree health costs. The United Steelworkers promptly called a work stoppage -- and LTV began paying again. That same year, the Communications Workers of America struck New York Telephone for nine days over issues that included the company's proposal that retirees and current employees start sharing the cost of their health coverage. That issue flamed the longest. ''At its end, this strike was about * health care, pure and simple,'' says George Kohl, the CWA's director of research. New York Tel did not get cost sharing. This year, as contracts for all of the Bell companies come up once more, Kohl says the issues will be ''one and two, job security and health care.'' At Nynex, parent of New York Tel, management is also brooding about health, partly because it dreads FASB's rules. Vice chairman William Burns says progress just has to be made on the union front: ''All of us in corporate America know it's time for us to get this escalating cost monster under control.'' He touches the heart of the problem. Companies may induce employees to smarten up their purchases of medical services or may even restrict their choice of suppliers. But there will still be a big bill on the plate and somebody -- the company or the employee -- must pay. Most corporations do not enjoy shifting costs to their employees. But in the interests of shareholders, they are naturally going about the job. The employees are just as naturally resisting. This conflict, sharp even now, is apt to turn brutal as FASB's rules bear down. SOME CORPORATIONS have meanwhile been seeking help from Washington, campaigning for tax legislation that would permit employers to fund health benefit plans much as they do pension plans. Congress thinks the objective admirable, but not the means of getting there. Because this program would increase corporate tax deductions, it would cut federal revenues. In a read- my-lips era, cuts are not in the cards. Instead, business may find the tables turned. There is talk of legislation that would cap employers' ability to deduct health costs -- perhaps through a per capita limit. Would corporations fight such a measure? Many clearly would. But some might like to make such a cap an excuse for cutting benefits and escaping their ''indexed,'' open-ended promises. Says consultant Caulfield: ''I wouldn't be surprised to see industry sit on its hands on this one.'' Amazingly, business seems even to be questioning its fundamental beliefs about health. The idea of government-run national health insurance available to all used to be almost universally despised by corporations. But now -- behold the irony! -- they seem to have experienced a certain conversion. Says Willis Goldbeck, head of the Washington Business Group on Health, a nonprofit organization backed primarily by big companies: ''I find more and more businessmen are frustrated with this whole bloody effort. They see ! managing health as a forever deal. And they say, 'I'm not really in that business. Maybe some sort of national health insurance would make sense.' '' Other health experts confirm Goldbeck's findings. There is a shift in the winds and it is not minor. Nonetheless, the hard gusts of the next few years are apt to swirl mostly around retirees and FASB's rules and precisely who is to pay for a bill we can't pin to the mat. Want a useful suggestion? Tell your kid to become an actuary.

CHART: NOT AVAILABLE CREDIT: ILLUSTRATIONS BY VICTOR JUHASZ SOURCE: HEALTH CARE FINANCING ADMINISTRATION; DEPARTMENT OF COMMERCE CAPTION: U.S. health costs are the fastest-rising rocket around, and business is paying for much of the fuel. Out of $532 billion spent last year, not including $18 billion for bricks and mortar, its share was $148 billion. Itemized: $106 billion for employees' bills, $27 billion for Medicare hospital insurance, $12 billion for workers' compensation, and $3 billion for in-house medical facilities. DESCRIPTION: Three charts.