Save Now, Pay Later: Corporations Prepare for the Cost of Retirement Benefits

By Kahn, Sharon | Management Review, April 1992 | Go to article overview

Save Now, Pay Later: Corporations Prepare for the Cost of Retirement Benefits


Kahn, Sharon, Management Review


As corporate America wakes up to promises made to pay its retirees' medical costs, employee benefits executives are focusing most of their near panic on how to cut the enormous liabilities--last estimated at $402 billion by the General Accounting Office.

Yet, even as companies slash medical care benefits and increase retiree copayments and deductibles, a parallel and seemingly opposing trend is taking shape. A handful of corporations are socking away money to pay for future retiree medical costs, just as wise parents create a savings plan to cover future tuition for their college-bound children.

Funding future retiree medical expenses similar to the way pensions are funded could have a profound impact on the way that the country's corporate and investment communities pay for healthcare. Although no one predicts the retiree medical benefits pool will approach anything like the $1.4 trillion that exists in pension assets, "the total could represent a sizable asset pool that could be invested in the future," says John Santaguida, a vice president at Bankers Trust in New York. "It could be significant."

The burden of retiree medical costs has received much attention over the past few months as companies begin complying with Financial Accounting Standards Board Statement No. 106, otherwise known as Employers' Accounting for Postretirement Benefits Other Than Pensions. FASB 106 doesn't require employers to set aside a single penny of funding. But, by January 1993, companies must list the future cost of retiree medical benefits as a liability on their financial statements during the employee's years of service rather than the common past practice of accruing liabilities as they are paid. (For a more complete explanation of FASB 106, see "Managers Get Gray Hairs Over Retiree Benefits," Management Review, January.)

Because the liabilities are hefty indeed for many companies, "FASB 106 provides a definite incentive to prefund," explains Diana Scott, a Chicago-based consultant at Towers Perrin who was the original author of 106 while a project manager at FASB. "Every dollar of prefunding offsets a dollar of liabilities."

While the current focus of most companies is to bring retiree medical costs under control rather than find new ways to pay for them, longer term they realize employers must find the means to pay for these liabilities. In fact, "companies may see prefunding as a bargaining chip as they reduce the size of the benefits they will cover," suggests Peter B. Blanton, a Salomon Bros. vice president. Similarly, unions and employee groups may see prefunding as a way to secure their future as employers cut back on healthcare benefits.

INTEREST MOUNTING

While most observers suggest it will be 1993 before prefunding gains momentum, healthcare consultants say the interest in prefunding is growing daily. Carolina Power & Light began prefunding last year when it recognized that "the magnitude of our retiree medical liability would be substantial--large enough to require careful attention," says J. Henry Oehmann, manager of employee benefits at the Raleigh-based utility. The question became not whether to prefund, but to what degree and by using what method.

Carolina P&L chose two methods: VEBAs and 401(h) accounts (see box on page 31). "We're still exploring whether to partially or completely fund our liability," says Oehmann. "But we've taken the first step by creating vehicles to initiate funding."

Like many companies, Carolina Power & Light also was motivated by the near certainty that healthcare costs will not likely abate by the time current employees reach retirement age.

"If you prefund," says Oehmann, "you can put money into investments that will accrue earnings that can be used to pay for the outlays when the time comes." Those outlays could be vast. Minneapolis-based North-western National Life estimates that, on top of Medicare coverage, a 65-year-old retiree in 1991 spent $1,680 out-of-pocket on medical expenses during his first year of retirement, or 15 percent of his household income. …

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