NEW YORK—Thousands of retirees from auto parts manufacturers that abandoned their pension plans will be able to get health care coverage through a groundbreaking arrangement that will use a special trust to tap federal premium subsidies.

U.S. Bankruptcy Court Judge Martin Glenn in New York last week approved formation of the Auto Retiree VEBA Trust, which experts say is the first of its kind.

Judge Glenn's order, in a case involving the 2009 bankruptcy reorganization of Plymouth, Mich.-based auto parts manufacturer Metaldyne Corp., will make medical, prescription drug, dental and vision care available to Metaldyne retirees and their dependents. Such coverage also will be available to retirees who worked at other financially distressed or failed auto parts companies based in Michigan, Ohio and Wisconsin whose pension plans were taken over by the Pension Benefit Guaranty Corp.

The coverage will be provided through Auto Retiree VEBA Trust, a voluntary employees' beneficiary association.

Retirees and their dependents of well-known auto parts companies that include Delphi Corp. and Collins & Aikman Corp. and dozens of others will be able to obtain coverage at a fraction of the cost—due to a little-known provision in a 2009 economic stimulus law that expanded eligibility for a federal health insurance premium subsidy.

That subsidy, the Health Coverage Tax Credit, is available to individuals who have lost their jobs due to foreign competition or to pre-Medicare eligible retirees whose pension plans have been taken over by the PBGC.

The subsidy can be used to offset the cost of health insurance programs, such as COBRA continuation coverage.

The 2009 American Recovery and Reinvestment Act provision expanded the situations in which the tax credit would be available to include those in which coverage would be offered through a VEBA whose formation was authorized by a bankruptcy court.

The 2009 law also temporarily boosted the amount of the tax credit to 80% from 65%. This year, that hike in the tax credit expired with the credit falling back to 65%. But President Barack Obama last week signed into law a trade bill that increases the credit to 72.5% of the premium through 2013.

With the change in 2009 law, “We saw an opportunity to form an industrywide VEBA for auto part retirees” whose pension plans had been taken over by the PBGC, said Dean Gloster, a partner with Farella Braun + Martel L.L.P., a San Francisco law firm representing trustees of the auto parts industry VEBA.

With the tax credit effectively paying the majority of the premium, the cost savings for affected retirees will be enormous. The cost of family coverage for pre-Medicare eligible retirees trying to get coverage in the personal lines market, for example, can easily exceed $20,000, benefit experts say, while group coverage premiums typically top $15,000 for family coverage.

“For individuals to get coverage on their own, the cost is just prohibitive,” said Derek Guyton, a partner at Mercer L.L.C. in Chicago.

The auto parts VEBA, though, will provide access to coverage for individuals who either could not afford it or could not get it on their own.

“This is a very elegant approach,” said Jon Clement, a director with Buck Consultants L.L.C. in Southfield, Mich.

“Retirees who are 55 to 64 are one of the hardest groups to insure, because they have high medical needs, no employer and they aren't eligible yet for Medicare. We're thrilled to be part of offering them an affordable, subsidized solution,” Mr. Gloster said.

Quotes have been received from several insurers, and Mr. Gloster said he expects coverage to be available beginning Jan. 1, 2012.

The auto parts industry VEBA is not the first to offer retiree health care coverage.

In 2008, for example, major U.S. automakers reached an agreement with the United Auto Workers union and Chrysler L.L.C., Ford Motor Co. and General Motors Co. put in billions of dollars into a VEBA in exchange for ending their obligation to provide health care coverage to UAW-represented retirees and their families.

In addition, a handful of VEBAs have been established since 2009 to provide coverage for Medicare-eligible retirees of individual companies whose pension plans were taken over by the PBGC. Those retirees have been able to use the tax credit to partially offset premiums they pay for coverage offered through the VEBAs.

But no other industrywide VEBA that utilizes the tax credits has been set up until now, Mr. Gloster said.

Combining the tax credits with an industrywide VEBA makes the auto parts VEBA unique, Buck Consultants' Mr. Clement said.

“This is the first of its kind,” Mr. Gloster said.

And, there could be more on the way.

“It is an amazing amount of difficult work to set one of these up, but the good news is that it can be a model on how to provide subsidized health care for some of those who are the most in need of it, and otherwise hardest to insure,” Mr. Gloster said.

The program was limited to retirees who worked for auto parts companies based in the three Midwestern states due to Internal Revenue Service requirements and court rulings.

Back in the early 1980s, the IRS, through a safe harbor, gave its blessing to VEBAs covering employees of different employers so long as the employers were in the same line of business and were in three contiguous states.

“There may be geographic restrictions on the ability of a multi-employer trust to qualify as a tax-exempt VEBA under Internal Revenue Code section 501(c)(9), and we are taking a conservative position. But a large number of auto parts companies were headquartered in the tri-state area of Michigan, Ohio, and Wisconsin, and their retirees are eligible, regardless of what state those retirees live in now,” Mr. Gloster said.