* GM, Ford retiree healthcare trusts report 2011 finances
* Spike in costs, change in assumptions hurt VEBAs
* One-fifth drop in GM investments hits GM VEBA
By Deepa Seetharaman
DETROIT, Oct 18 (Reuters) - A fund that covers medical costs for General Motors Co's unionized retirees said its funding shortfall widened last year partly as a result of the declining value of its investments in GM, government documents show.
The trust has a 10.2 percent stake in GM, making it the automaker's second-largest shareholder behind the U.S. Treasury. It was 40 percent underfunded at the end of 2011, up from a 26 percent shortfall in 2010, according a financial filing with the U.S. Department of Labor this month.
A similar trust that oversees benefits for Ford Motor Co unionized retirees reported a 37 percent shortfall, up from about 26 percent last year, as its obligation grew due in part to rising cost projections, the Ford filings show.
The GM fund is the largest of three that make up a trust known as a VEBA, or voluntary employee beneficiary association. The trust manages health-care benefits for United Auto Workers-affiliated retirees from the three U.S. automakers.
The UAW Retiree Medical Benefits Trust was created in 2007 during labor talks with the UAW to take on the retiree health care burden from GM, Ford and Chrysler Group LLC. It managed benefits for 824,000 retirees in 2011.
The landmark deal was designed to protect UAW retiree benefits if the companies' finances deteriorated and to remove an ever-increasing liability that the automakers said added as much as $2,000 to the cost of a vehicle.
The overall VEBA was underfunded by roughly $20 billion in 2010, during its first full year of operations.
A detailed 2011 report for Chrysler's fund was not yet available. The VEBA has a 41.5 percent stake in Chrysler, the smallest U.S. automaker, which is majority-owned by Italy's Fiat SpA.
The GM VEBA trust said if the rate of health care cost increases moves up by 1 percent, its benefit obligation would increase by $6.4 billion. For the Ford trust, a 1 percent swing would increase the obligation by $3.8 billion.
In 2009, when GM and Chrysler underwent government-funded bankruptcy restructurings, the VEBA took stakes in the companies in lieu of cash payments. The GM fund nearly halved its 17 percent stake during GM's initial public offering in 2010.
Last year, the value of the GM fund's assets fell 14 percent to $28.5 billion and obligations rose 6 percent to $47.4 billion. That led to a nearly $19 billion funding shortfall in 2011, up from an $11.4 billion gap in 2010.
In 2011, its GM investments, including warrants, preferred shares and common stock, fell by more than one-fifth, or about $3 billion, while the broader S&P 500 index was flat.
"There are some risks you cannot escape when you have assets that are north of a billion dollars," said Steve Diamond, a law professor at Santa Clara University School of Law who specializes in corporate finance and securities law. "But you're not allowed to turn yourself into a hedge fund."
The VEBA fared worse than the automaker's pension plan, which was 13 percent underfunded and saw a 4 percent increase in assets in 2011.
"The whole goal here was to ensure that the ups and downs of General Motors did not affect retiree health care and this was the argument the UAW made to membership to sell the deal," said Diamond, who has been publicly critical of the VEBA's structure.
The creation of the VEBA was among the first of many steps GM has taken to cut its legacy costs. GM struck a deal in June to offload one-fourth of its U.S. salaried pension burden to Prudential Financial Inc.
Last year, GM and the UAW agreed to discuss pension buyouts for UAW retirees, which account for more than half of GM's $134 billion global pension liability. Those buyouts have not happened.