We believe that these proposals respond to the stated Sense of Congress regarding the use of the "savings". Each of these proposals balance the need to meet our obligation to fund health care benefits for prospective, current and retired employees against the interests of current and future customers in avoiding large and disruptive rate changes.

Pending Legislation

Legislation addressing the use of "savings" after 2005 was introduced in the House of Representatives and the Senate in the 108^th Congress and is expected to be reintroduced in the 109^th Congress. Either piece of legislation would profoundly change the Postal Service's regulatory processes as well as the funding of the CSRS and retiree health benefit obligations. Both legislative proposals require continuation of universal service and greatly strengthen the role of the regulator, granting it authority to create a new system of rate and service regulation. Each bill would also return responsibility for funding CSRS obligations arising from military service to the U.S. Treasury. Both pieces of legislation contain a number of other complex provisions to provide for adequate funding of retirement health care benefits.

If there is no legislative change, beginning in 2006 we will be required to escrow the CSRS postal reform "savings" and recognize their full amount as an operating expense for the purpose of determining postage rates and fees. Based on OPM's most recent estimate, we would have to place $3.1 billion in escrow and include that amount in the determination of postage rates and fees in 2006. We estimate a double digit rate increase would then be required to fund these "savings."

Health Benefits

We participate in the Federal Employees Health Benefits Program (FEHBP). Eligible postal employees with at least five consecutive years participation in the FEHBP immediately preceding retirement are entitled to continue FEHBP coverage into retirement. We account for employee and retiree health benefit costs as an expense in the period our contribution is due and payable to the FEHBP. This expense is included in compensation and benefits.

The major drivers of our active employee health care costs are the number of employees electing coverage and the premium costs of the plans they select. Premiums for each plan participating in FEHBP are determined annually by OPM. In 2004 health benefits expenses for active employees were $4,845 million, an increase of $319 million over 2003. This was 7.3% of our total expenses. The 2003 expense of $4,526 million was 7.0% of our total expenses and increased by $325 million over 2002 when employee health benefits were only 6.2% of our expenses.

Retiree health benefits costs of $1,313 million in 2004 represent 2.0% of our total expenses, up from $1,133 million (1.7%) in 2003 and $987 million (1.5%) in 2002. This cost has risen steadily over the last three years, driven by double digit increases in FEHBP premium costs, an increasing number of annuitants enrolled in the plan, and the declining number of annuitants for whom a portion of the premium cost is allocable to Post Office Department service. The combined effect of these drivers increased retiree health benefit costs by 15.9% ($180 million) in 2004, 14.8% ($146 million) in 2003 and 15.0% ($129 million) in 2002.

OPM recently announced a 7.9% average increase in average health benefit premiums, to take effect in January 2005. Compared to the double digit increases in average premiums over the last several years, this is an encouraging development. However, the pool of covered annuitants will continue to grow rapidly into the future. As of the end of 2004, there were approximately 438,000 Postal Service annuitants and survivors compared to 430,000 in 2003. We estimate that over 250,000 of our current employees will be eligible for retirement by 2008. As a result of the growing pool of retirees, we project that retiree health benefits costs will continue to grow at a 10% or greater annual rate over the next several years.

If we were not considered a participant of a multi-employer plan, we would be required to record and disclose our obligation for future costs under the program. Because there are several areas of judgment involved in calculating this obligation, estimates can vary widely based on the assumptions used. Based on September 30, 2004, data, we estimated the 2004 present value of future premium payments to be between $48 billion and $59 billion. Based on September 30, 2003, data, we estimated the 2003 value of future payments to be between $47 billion and $57 billion. In both cases, the range in the estimate exists only because long-term medical inflation assumptions differed by 1%.

In December 2003, President Bush signed into law the Medicare Prescription Drug Modernization Act of 2003. The Act will add a voluntary prescription drug benefit to the Medicare program. The provisions of the Medicare legislation could have a significant impact on future Postal Service health care costs.

As the Postal Service is a participant in the Federal Employees Health Benefits Program, the availability of the rebate provision of this Act may be affected by how it is implemented by OPM.