Changes to Retiree Health Benefits Come With Big Accounting Effects

Several companies are moving retirees off company-provided health insurance and instead providing a subsidy to purchase insurance in the private market, including on the government-run health exchanges that are part of Obamacare. Those that make the switch are finding that the move comes with big accounting effects, both good and bad.

IBM, for example, announced in September 2013 that it would stop providing and administering medical insurance for retirees, instead providing them with a subsidy that would enable them to head out into the open market to purchase insurance of their own, often through the health insurance exchanges such as Healthcare.gov. The company's first-quarter 2014 results shows a 16-percent drop in its first-quarter cost of providing non-pension post-retirement benefits, essentially medical insurance, compared to its first quarter of 2013.

The gain results from a complicated accounting construct that requires companies to set up a reserve for a future benefit that they've promised to retirees. In the case of medical insurance, if a company promises to provide active employees with that benefit in retirement, the company must book a growing liability over a given employee's years of service to reflect that future obligation. “The standard requires companies to recognize the net present value of retiree benefits during the active working lifetime of employees,” says Bruce Richards, a specialist at human resources consulting firm Mercer who focuses on individual insurance exchanges.

In the most extreme case, if a company were to eliminate the retiree medical benefit completely, the liability that has built on the balance sheet is unwound and recognized immediately in earnings, says Ken Stoler, a partner for PwC's HR accounting advisory group. “Some believe if you are shutting down a plan it means no ongoing expense to recognize, but it's more than that,” he says. “It's not just a future reduction in cost. It's a big bang in earnings now.”

A scant few companies are following such a drastic path, says Travis Winkels, senior consultant at Towers Watson. “That has negative public relations issues,” he says. “You cut the benefits and walk away, and you reduce the obligation to zero and see this big gain. Most companies aren't interested in going that far unless they're in pretty dire financial straits.”

Instead, says Winkels, most companies are looking for a way to reduce their insurance costs while continuing to ensure that retirees have some type of coverage. Many are achieving it by canceling the corporate-delivered insurance coverage and giving retirees a subsidy that they can use to purchase their own insurance. It's synonymous, he says, with the movement from defined benefit pension plans to defined contribution plans, where individuals take more ownership and control over their benefits. “They're continuing the subsidy, but changing the delivery structure,” he says.

“Some believe if you are shutting down a plan it means no ongoing expense to recognize, but it's more than that. It's not just a future reduction in cost. It's a big bang in earnings now.”

—Ken Stoler,

Partner,

PwC

From an accounting standpoint, that's a plan amendment, not a curtailment of a benefit or a lump sum settlement of a benefit, says Stoler. “The company has an ongoing plan, but they've changed how they're defining or describing that benefit,” he says. Under that scenario, the company may reduce its costs, and therefore reduce the liability that it needs to carry on the balance sheet, which will produce a gain, but a much smaller one. In addition, the gain under such a scenario would trickle into earnings over many years rather than hit earnings in one punch, he says.

Exchange Change

When companies cut retirees loose with a subsidy to purchase their own insurance, retirees typically are directed to private exchanges that existed before the Affordable Care Act but have grown since Obamacare began affecting the market, says John Grosso, an actuary at Aon Hewitt who focuses on retiree healthcare. Exchanges offer the promise of larger populations, which better spreads the risk and therefore reduces the cost.

“Because of enhancements to the Medicare Part D program, we have a more competitive and cost-effective individual health insurance market for those who are eligible for Medicare,” he says. Companies looking for ways to reduce their overall health costs are perking up at the potential for retirees in particular to find plans they like at a lower cost than the company itself can provide, he says. “There's more choice than an employer would ever be able to offer,” he says.

Companies also find relief in shedding the administrative burden of providing health insurance to retirees, says Barbara Gniewek, a principal in PwC's HR services group, another significant reason more companies are going that route.

ELIMINATING RETIREE HEALTHCARE COVERAGE

The following information from PwC explains what can happen when an employer eliminates retiree healthcare benefits for employees.

An employer may eliminate retiree healthcare benefits for all current and future retirees without providing any substitute compensation to employees or retirees. In other cases, the employer may amend its plan to provide a reduced level of benefit for some period, say, two years, until ultimate wind-down of the plan. In such a case, the plan would need to be remeasured. As a result of the reduction in benefits, the remeasured plan obligation is reduced, often significantly, since only two additional years of benefits will be provided.

The reduction of the plan's obligation would be accounted for as a negative plan amendment. Under the delayed recognition rules for postretirement benefit plan accounting, this negative amendment would be recognized in other comprehensive income (OCI) and subject to amortization over future periods.

Source: PwC.

Gniewek warns that companies should consider the retirees' points of view and approach the decision carefully. It can leave retirees feeling tossed aside, she says, a scenario she faced even in her own family when a relative's coverage moved to an exchange. “The perception was they were ditched,” she says. “So I had to explain this means you can pick a plan that better meets your needs. So communication to retirees is critical.”

Another avenue for companies to consider is to purchase an annuity that would pay the subsidy to retirees, says Winkels, which is becoming more common for companies struggling to cope with the obligations associated with defined benefit pension plans. When a company annuitizes a benefit, it pays an insurer to take over the full financial obligation of the plan for a fixed price, and insurers price that future obligation with all its inherent risks accordingly. The accounting benefit is the immediate, one-time gain or loss of removing the benefit obligation from the balance sheet and recognizing it fully in earnings, he says. “The annuity guarantees the benefit, so there's no future reduction in benefits possible at that point,” he says.

Juliette Meunier, a partner in EY's human capital practice, cautions companies to be sure they understand the penalties under the ACA of eliminating coverage for certain groups of employees. If an employer elects not to provide coverage according to the minimum requirements of the law, the excise tax is $2,000 per full-time employee, regardless of whether some employees will continue to receive coverage. In such a case, external auditors will be looking for good internal controls to assure the capture of all the necessary data to reflect the obligation properly in financial statements.

A recent Towers Watson survey suggests some 40 percent of companies will make the move by 2015 to somehow alter or offload retiree medical coverage, but any move to shift health coverage for active employees is more distant on the horizon, Grosso. “We expect the same opportunity to arise, but it may take longer,” he says. “It's somewhat predicated on the development of public marketplaces, like the ACA-sponsored state exchanges, because that's the optimal place for people to get coverage.”