Funding the $2 Trillion Retiree Benefit Liability

By Lightfoot, Donald G. | Risk Management, December 1989 | Go to article overview

Funding the $2 Trillion Retiree Benefit Liability


Lightfoot, Donald G., Risk Management


Funding the $2 Trillion Retiree Benefit Liability

The total unfunded liability for retiree benefits may represent the greatest crisis in employee benefits since the unfunded pension liability uproar resulting from the enactment of ERISA. In 1983, the U.S. Department of Labor estimated the accrued liability of private employers for retiree health benefits at $98.1 billion. In 1989, that figure has risen to over $2 trillion.

The funding crisis exists for several reasons. First, the retiree population continues to increase at a staggering rate. In 1985, approximately 28 million Americans were over the age of 65, while it is estimated that by the year 2020, the same age group will total over 49 million people. In addition, the life expectancy of retirees is increasing, resulting in longer benefit payment periods. For example, in 1908, the life expectancy of the average male was 51.6 years, whereas, by the year 2020, the life expectancy of the average male is estimated at 82.7 years.

This funding crisis is also due in part to the fact that, since 1965, the increase in health care costs have been approximately three times greater than the increase in the Consumer Price Index. From 1984 to 1987, per capita medical care costs for individuals over the age of 65 increased 85 percent. Also, most employers discharge their retiree medical liabilities on a pay-as-you-go basis. Recent studies have shown that only 1 percent of employers have prefunded these plans.

According to findings of a survey by the Institute on Aging, Work and Health in Washington, DC, many of the larger employers in the United States plan to redesign their retiree medical benefit plans within the next year. The reason most companies intend to make this change stems from the anticipated accrual accounting requirements of the Financial Accounting Standards Board (FASB).

Eighty-five of the 95 companies responding to the survey have either increased plan deductibles, copayments or premium contributions within the past two years, or plan to make such changes by 1990. In addition, 68 percent of the firms surveyed said their plans to redesign their retiree medical benefits included adding managed care, 50 percent said they would expand their onsite wellness programs, and 33 percent planned to offer employee-paid long-term care insurance. Ninety-eight percent of the companies surveyed were extremely interested in using a tax-favored prefunding vehicle for future retiree health benefits. Of those mechanisms suggested by the respondents, 85 percent said they would use a tax-favored health care trust, or 501(c)9 Trust (VEBA).

The FASB study came about as a result of its concern about the lack of information in financial statements on the cost of and obligation for retiree benefits. Most importantly, FASB is questioning the pay-as-you-go method commonly used by most employers.

In November, 1982, FASB published preliminary views regarding retiree benefits. The board concluded that "The cost of retiree's health care and life insurance benefits would be accrued during the service lives of employees who are expected to receive those benefits, provided the amounts involved are material. Pay-as-you-go (cash basis) and terminal funding (accrue at retirement) methods would not be acceptable for recognizing such costs in accrual-basis financial statements." The board stated that this proposal was based on its belief that post-employment benefits are a form of deferred compensation. Therefore, the cost is incurred and should be recognized during the years in which the employee provides services.

In 1984, FASB published Accounting Standards No. 81 requiring, for years ending after December 15, 1984, that certain disclosures be made in financial statements. All financial statements must include a description of retiree health care and life insurance benefits and the employee group covered, the cost included in the employer's net income for the period, and a description of the firm's current accounting and funding policy. …

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