Changes in Actuarial Assumptions/plan Designs after FASB 106

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Recently, employees' postretirement health care benefits have attracted considerable public attention as more and more companies implement SFAS No. 106, Employers' Accounting for Postretirement Benefits Other Than Pensions. According to SFAS No. 106, employers must accrue the future cost of health care benefits for retirees during the employees' active years of service, instead of using a pay-as-you-go basis. This mandatory accounting change to an accrual basis is significantly changing the financial statements of employers providing such benefits. In fact, about 95% of the companies providing postretirement health care benefrts were using a pay-as-you-go method of accounting before the announced rule. Now, at a time when a majority of large employers are providing these retirement benefits, a combination of several environmental factors--rapid escalation in health care costs, growing retiree populations, and the shifting of Medicare costs to retirees and employers--may cause this new accounting rule to have a greater impact than any previously issued accounting pronouncement.

A true case shows the sensitivity of an employer's expense and liabilities to different actuarial assumptions and various health care plan designs. This sensitivity analysis will give preparers and users of financial statements an idea of the different consequences of SFAS No. 106.

ACCOUNTING FOR NONPENSION BENEFITS

MEASUREMENT ISSUES. The primary measure of the obligation at each balance sheet date is called the expected postretirement benefit obligation (EPBO) which is the actuarial present value of benefits expected to be paid during the retirement period. As with the calculation of pension liabilities, in order to determine a company's EPBO, assumptions are needed regarding mortality, retirement date, employee turnover, discount rate, etc. In addition, the projection of retiree health care costs requires estimates of the medical cost trend rate, the portion of cost to be reimbursed by Medicare, and marital and dependency status during retirement.

RECOGNITION ISSUES. Once the actuarial present value of plan benefits has been determined through the measurement process, each employer must use a specified actuarial method to compute the annual retiree benefits expense and the accumulated postretirement benefit obligation (APBO), the portion of the EPBO attributed to service rendered prior to the measurement date. Attribution is the process of assigning the cost of retiree benefits to periods of employee service. Therefore, the primary question is what is the appropriate attribution period. Under the FASB's Statement No. 106, the cost would generally be recognized from the date of hire to the date the employee attains eligibility for the maximum benefits earned under the plan (full eligibility date).

EMPLOYERS' REACTION: REDUCTION OF THEIR COMMITMENT

Employers' increasing financial obligation associated with their retiree benefits is understandable if statistical data is examined. In 1989, the U.S. General Accounting Office (GAO) estimated employer-sponsored retiree health plans covered about seven million retirees, at a cost to employers of approximately $9 billion. Recent estimated projections for aggregate unfunded obligations for private employers to date have ranged from approximately $227 billion to approximately $250 billion. According to the study by GAO in 1988, companies can anticipate an additional $175 billion in obligations when future service is taken into account.

Many U.S. companies are aggressively attempting to limit their own liability as they confront changes in accounting rules, growing medical costs, an aging workforce, and demanding shareholders. Several reactions have taken place. First, many companies work feverishly to hold down cash outlays in many ways. For example, they sign a contract with a larger insurer or a health-care company that has a network of hospitals and doctors. …