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EBRI Issue Brief Jennifer Davis PDFTextVersion is null EMPLOYEE EBRI BENEFIT RESEARCH INSTITUTE issue brief ahead. MARCH 1991 NUMBER 112 14 22 28 This There has been mixed reaction to this transfer option. Issue Brief addresses a wide range of retiree health 1988. companies are willing to undertake. This method will ment Income Security Act of 1974 (ERISA) provided tion (that is, the actuarial present value of benefits and over work and receive coverage through their Corporate-Owned Life Insurance current level of these benefits (47 percent against, 48 with 20 or more years of service receive the highest pant must be a retiree from the Procter and Gamble coverage though a current employer and 16 percent had received by the employee than on direct funding for Furthermore, the Securities and Exchange Commission Considering the magnitude of these retiree health Curbing the soaring cost of the elderly’s health care The influence of FAS 106 on companies sponsoring malpractice burden). RBRVS is scheduled to be imple- to the employer is strictly prohibited (there is a 100 Georgia State University, 1991. This act states that, in order for an employer to billion, and the liabilities expected to be incurred in increase, though, with the long-anticipated and re- COLI. In a 501(c)(9) trust, as long as the policies are type of portfolio needs frequent rebalancing to maintain beneficiary. According to the U.S. Supreme Court, this are active workers with direct coverage, compared with spouse’s current or former employer (table 3). of service (through the expected retirement date) or In terms of the benefit promise, the Sixth Circuit held by the companies as providing savings for retiree health reduce the pension plan participants’ level of security. years. Third, companies can retain the promise to pay the full Medicare is divided into two parts. Part A is financed There are several vehicles for funding retiree health, 1988. Of companies with a liability for retiree health introduced in both houses of Congress during the first Institute/The Gallup Organization, Inc., 1990). Knowl- Office, 1989. These transfers are limited to only the amount This u Company Changes to Retiree Health u FASB Statement No. 106 on Postretire- u Introduction Table 1 Table 5 4 26 Table 6 Plan sponsors that are more likely to take advantage of issues. It begins by reviewing the provisions and poten- Table 8 modify retiree health benefits after filing for Chapter 11 ________. “Issues and Trends in Retiree Health Insur- retiree health benefits. However, according to an EBRI/ most likely be used by firms with a medical service Profit Sharing Plan or an active participant in the reporting, disclosure, and investment fiduciary require- possible contributions from the company, while those current employer, 23 percent of men aged 40 and over percent for, and 5 percent unsure). Notably, those (SEC) stated in SEC Staff Accounting Bulletin No. 74 this coverage from a past employer. However, among attributed to employee service rendered to a particular mented over five years, beginning January 1, 1992. defines perhaps the chief agenda for all “third par- retiree health plans and the increased funding needs liabilities, putting them on financial statements is percent excise tax). U.S. Department of Labor. Bureau of Labor Statistics. the future by current employees at $175 billion, for a over 20 years, if greater. means proving that the beneficiary of the policy (the held until death, the trust will pay no income tax. cently approved Statement No. 106 (FAS 106) from the yield to maturity and the duration. This investment 1.6 percent of those 65 and over (table 4). Also, 15 in However, if the full-funding limit is not seen as provid- expenses, the money is not legally earmarked for these includes both private and public employers. and second sessions of the 101st Congress. During the cost of medical coverage throughout retirement and, benefits, the use of insurance contracts decreased from edge of these benefits and of the limitations currently each with some tax advantages and limitations. through the mandatory Hospital Insurance (HI) payroll The elderly’s costs for health care have risen much the employer would pay during the year for current Yard-Man that certain “extrinsic evidence” (such as Among Funds Funding Vehicles for Postretirement Medical Benefits Retirees Receiving Health Coverage Benefits—Plan Design and Financing ment Benefits Other Than Pensions Major Activity of Individuals Aged 40 and Over without u u u Retiree Health Plan Integration with Medicare 23 8 this option have older work forces (and, therefore, large tial impact of FAS 106. In response to this newly A company could use corporate-owned life insurance bankruptcy, the change must be (1) necessary to the fall in this category, compared with 10 percent of (SAB 74) in December 1987 that public companies with fewer years of service receive a lesser portion. The earning less than $20,000 were the most likely to be those aged 40 and over with family incomes of $20,000 benefit approach to their retiree health benefits, since Gallup poll conducted in September 1989, 69 percent Profit Sharing Plan who is eligible to retire. Earliest ments for pension and welfare plans. It included date) that exceeds plan assets will be recorded as a unappealing to some companies. Even among compa- ties” that pay: Medicare, Medicaid, and private of the Medicare system are unlikely to encourage Additionally, OBRA ’89 limits the percentage of the ance Benefits.” EBRI Issue Brief no. 84 (Employee total of $402 billion in 1988. strategy can be used with either a defined dollar benefit expenses. These plans include ESOPs and 401(k) plans, employer, in this case) must “expect some benefit or the Financial Accounting Standards Board (FASB), memos, pamphlets, and oral statements) could be percent of those aged 40 and over receive retiree health ing a sufficient cushion for the pension benefits, such a all employees of medium-sized and large private em- taxe and pays for most inpatient hospital care, limited 20 percent to 15 percent during this period. However, therefore, assume the full risk of medical inflation must be segregated and restricted (usually in a trust) to However, there is no leveraging possible with this retiree health expenses and therefore cannot be used being imposed on employer plans and on Medicare first session, Reps. Rod Chandler (R-WA) and Ronnie faster than their incomes. This is a result of health care Employee Benefits in Medium and Large Firms, 1987. (Those Specifically in Tax Law and Examples of Other Arrangements) from Their Employer, by Firm Size and Industry, Retiree Health Coverage, by Age, August 1988 In 1960, 9 percent of the population was aged 65 and 3 adopted standard and health care inflation, many and immediate liabilities), largely overfunded pension (COLI) to set aside money for retiree health liabili- Applies as completion of the reorganization and (2) approved by funding and vesting requirements for pensions but not liability on the company’s balance sheet. remaining cost of retiree health insurance is paid by the to $29,999, 21 percent had this coverage through a women aged 40 and over. Again, almost 12 percent of must disclose the “material” effects that any currently willing to pay such an increased payroll tax (55 per- of those aged 18 and over would rather receive em- point of eligibility for an active employee is at age 55 these firms carry the investment and medical inflation Medicare-allowable rate that nonparticipating physi- insurers—including employer plans that provide nies that advance fund retiree health obligations, very Congress to address issues relating to the funding of Benefit Research Institute, November 1988). which requires companies to recognize benefit costs and considered as part of the agreement (or contract) advantage from the continuance of the life of the benefits through their spouse’s plan, compared with 6 with contributions coming from either the employer or plan or a medical service benefit plan. However, the transfer could reduce the pension plan participants’ ployers who are covered by group health insurance, nursing home care, home health agency visits, and the use of 501(c)(9) trusts increased from 15 percent to to prefund any future benefits. Additionally, the be used as an asset against the FAS 106 liability. These product. associated with retiree health care liabilities. These Increases in postretirement benefits through plan August 1988 costs persistently (and by wide margins) exceeding could influence future public policy proposals. Flippo (D-AL) and Sen. David Pryor (D-AR) cospon- Washington, DC: U.S. Government Printing Office, 401(h) Plans over. By 1990, this proportion had increased to 12 There will be larger expenses for companies sponsoring retiree Age of Respondent Benefits Benefit A recent survey of 1,100 companies that offer retireeTax-Exempt Retiree health benefits were originally offered in the 30 Financial Account- companies are considering whether to continue provid- plans (and, therefore, the assets to transfer), and ties. In this method, the employer purchases life few have fully funded the obligations. Employers private retiree medical benefits in the future. The companies may, however, introduce increased cost vehicles include 501(c)(9) trusts, or voluntary em- the court. Any change must be agreed to by retiree Employee Benefit Research Institute. known changes, including accounting changes, may risk. with 20 years of service. This plan allows for assets to current employer, compared to 13 percent from a past cent). all those aged 40 and over work and receive coverage retiree. The cap is reviewed annually. ployer-paid health insurance benefits after retirement for welfare plans. As a result, employers have generally health insurance coverage to retirees. cians can balance bill. The new law, effective in 1991, Measuring and Both demo- employee, or both, depending on the plan’s provisions. security. assured” (Integrated Administrative Services, 1990). percent of those aged 65 and over. between workers and employers where a collective liabilities as they are incurred. latter would be more difficult due to the uncertainty of 41 percent have employer-sponsored retiree health hospice care for terminally ill patients. increases in major components of the elderly’s income: sored the Retiree Health Benefits Preservation Act 18 percent, and the use of 401(h) plans increased pension plan must maintain assets equal to a minimum amendments or plan initiation are considered retroac- 1990. It requires cost A study by Hewitt Associates of 463 medium-sized and Integration Technique Percentage of Firms Deductible Limited Excludable from Security for ing Standards Earnings for percent, and it is expected to increase to nearly 24 Firm Size Covered by Own health benefits showed that nearly one-half had late 1940s and 1950s, when business was booming as a health plans under FAS 106 than under the current pay-as-you- ing a full retiree health insurance benefit or to make a positive net income (and, therefore, a positive tax bill). insurance on the active work force (and sometimes on representatives, either the union (if collectively bar- have on future financial statements. In this bulletin, Even within these guidelines, there are several assump- employer. There are several possible reasons for the than a share in the ownership of the company that not advance funded and have not viewed retiree grow tax free, and funds are immediately available to through a spouse’s plan, although only 5 percent of men graphic trends and the history of health care costs in offering retiree health coverage may begin reviewing blocks nonparticipating physicians from charging more current budget crunch and newly enacted budget Funding Corporate Liabilities for Retiree Health Bene- Major Activity 55–64 65 and over ________. bargaining agreement did not explicitly state such However, each state can stipulate what constitutes an the yield needed to match future medical inflation. coverage before age 65 and 36 percent have such Undoubtedly, such combinations and innovations will Both private and public financing of retiree health of 125 percent of current liability for accrued benefits, Social Security payments, pension distributions, and slightly, from 1 percent to 2 percent. Other companies tive under FAS 106, unless the plan initiation specifi- ployee beneficiary associations (VEBAs), and 401(h) sharing with retirees through copayments, deductibles, (H.R. 1865/S. 812), which would have permitted sharing in the form of deductibles and coinsurance. Part Employee Benefits in State and Local Govern- Contributions Contributions large private employers found that the median annual Retiree Tax Retirees Board Asset Company and Industry Employer Plan Another vehicle is a 401(h) plan, in which contribu- percent in the next 40 years as the baby boom ages. FAS 106 requires companies to record unfunded changed or planned to change their plans as a result result of economic expansion and there were very few Firm Pays Medicare Supplement 13% limited contribution toward this benefit. However, retirees). Later, the company can collect the life 401(k) Plans gained) or a court-appointed committee of retirees. With FAS 106 requirements, employers may not only Alternatively, a company can invest to hedge overall differences in income. Workers have higher incomes medical benefits as a vested right. offset the accounting liability (since the funds are in the SEC states that it wants employers to estimate the Quaker Oats plans to maintain retiree medical benefits tions that employers must use to estimate postretire- aged 40 and over are in this category, compared with 17 could be cashed out at retirement (Employee Benefit than 125 percent of the Medicare-allowable fee in reforms that require policymakers to offset any proposed various retiree health plan designs. the United States suggest that continuing, if slower, fits. Washington, DC: Employee Benefit Research go system. Ralston Purina continues to provide company-paid insurable interest; some states limit this to only key items. However, in Workers and retirees with higher family incomes are coverage at age 65 and over (U.S. Department of continue, especially without a full-funding option from so only amounts over that minimum can be transferred. employer tax deductions for advance funding of retiree are reducing their liabilities to zero by creating a benefits are likely to be limited in the future as health cally associates increased benefits with service rendered investment income. Between 1977 and 1988, the plans. Alternatively, some plans are used to help etc. The company also retains the investment risk if B is voluntary and is financed with participant premi- ments, 1987. Washington. DC: U.S. Government Moore v. Metropolitan Life Insurance medical cost for retirees is 1.1 percent of active payroll, 1 tions are put into a separate account within a defined Firm Pays Medicare Part B 11 These changing demographics are likely to have serious Total (thousands) 11,426 20,376 retiree health benefit liabilities Total (thousands) on their financial 10,358 of FAS 106. Twenty-eight percent of surveyed compa- retirees in relation to the number of active workers. 31 11 32 The transfer allows both the government and the plan changing the benefit promise can prove difficult for insurance proceeds tax free and/or borrow the maxi- A dedicated bond portfolio can also be used for the while helping to contain actual costs as well as FASB percent of women. Similar patterns are evident 401(h) accounts). The IRS has subsequently sent out a effect of accounting changes such as FAS 106 in their see their current costs increase but also experience inflation, usually through bonds. This is a partial compared with retired persons (assuming generally that ment benefit liabilities. Most important is the assump- Research Institute/The Gallup Organization, Inc., growth in spending for the elderly’s health care is tax cuts with spending cuts in entitlement programs or 1991, 120 percent in 1992, and 115 percent in 1993. Institute, 1987. Company, retiree health benefits to current retirees. For future more likely to have retiree health coverage employees, some to all employees, and others do not Labor, 1990). the federal government. after the plan initiation date. Any resulting increase in defined contribution plan that is presented to employ- there is prefunding. This type of plan design, also called employers and employees set aside monies to help plan ums and general federal revenues through the Supple- in which the benefits were not bargained, (table 4). which is expected to increase to 6.25 percent of payroll care inflation continues to increase. The combination health and long-term care insurance. elderly’s per capita consumer spending for health care Printing Office, 1988. Firm Pays for Medigap Coverage 8 401(h) benefit pension plan. Medical benefits must be subordi- implications for the financing and delivery of health statements, effective for fiscal years beginning after nies had increased employee premium contributions Working 42.6% 7.8% The resulting liabilities were not substantial, and the 6 A third method for setting aside funds for retiree health Firm Offers Carve-Out Plan 52 employers, as legal issues may arise. Several court mum cash surrender value to derive positive cash flow sponsor to benefit, at least in the short term. The u u u defined dollar plan. This bond portfolio also results in a ________. next SEC filings if it is expected to be material. additional costs added, as Medicare covers less of the hedge against medical inflation and tends toward among those who receive coverage from a past em- 1989). tion about health care cost trends. Under FAS 106, OBRA ’89 also provides for limits on aggregate Medi- field directive suspending future determination letters those with benefits from a past employer are retired) liabilities through its Retiree Health Incentive Plan. a tax increase elsewhere make the enactment of propos- inevitable. This prospect is likely to force continued Retiree Health Benefits: What Is the Promise? Such retirees, the company will continue to offer medical specify whether or which employer-employee relation- At family incomes over $20,000, those aged 40 and the Second Circuit ruled that, since Metropolitan Life APBO of retirees and active workers is amortized over for the purchase of retiree health insurance, although a medical service benefit, was most common when ees as an opportunity for them to set aside money to pay The transfer will not violate the requirement that mentary Medical Insurance (SMI) trust fund. Part B Firm Size Williams, Fred. “Health Cost Reporting Speeded.” could leave retirees paying more. This increases the rose an estimated 226 percent, approximately 67 While Congress has passed some legislation, the courts, u Plan Design after FAS 106 is fully adopted (Hewitt Associates, With Job, but No nate to retirement benefits. This means that the care services because, overall, the elderly use more Firm Offers Coordination of Benefits Plan 27 December 15, 1992. According to current accounting within the past two years or expected to do so in 1991, financing of these benefits was not of concern. How- Fewer than 20 3.7% u u u benefits is through a 401(k) plan. However, this rulings have restricted employers’ attempts to change in later years. COLI does not fund postretirement simple example in table 2 shows that the transfer results series of cash flows matched to the time that employees als that would expand the deductibility of funding these these funds are not specifically reserved for this purpose. many of the retiree health plans were started in the The plan, which will be updated annually to reflect employers are required to develop an estimate of the care physician expenditures, referred to as Volume for HSOP arrangements, pending notice from the minimizing the risks (potential volatility and future largely due to the loss of wage and salary income. This elderly’s health care bill. ployer. an estimate is necessary unless the employer adopts reevaluation of how this care is financed and who Washington, DC: Employee Benefit Research Work Previous Week 4.0 0.5 ships are insurable. benefits; however, Ralston is phasing out its contribu- over are more likely to have retiree health coverage had reserved the right to change the benefits in its plan percent faster than their average income (Chollet, The Retiree Health Benefits and Pension Preservation for health benefits in retirement. contributions to 401(h) accounts be “subordinate” to the remaining service period (to full eligibility date) of None of these options provide for funding retiree need for individuals to find ways to finance retiree provides payments for physicians’ services, outpatient Pensions and Investments (29 October 1990): 2, 47. in applying contract law, have provided a general 501(c)(9) 1990). A survey of 97 large employers by Towers, Firm Offers“Medicare Exclusion Plan 14 contributions made to cover medical benefits cannot Among the 50 state employee plans, 22 offer full 20–99 5.8 health care services than others in the population. In standards, companies only record the existence of a 18 percent began to require deductibles, and 14 percent ever, in more recent years, the changing demographics Looking for Work 0.8 0.1 method depends on an employer’s ability to communi- retiree health plans, although they have issued conflict- in higher after-tax income for the plan sponsor and a (Voluntary Employee benefits in either a traditional sense or in accordance are likely to start receiving these benefits. The portfolio expected future annual change in their health care inflationary changes, is composed of two parts: compre- unknowns) associated with funding a postretirement Performance Standard (VPS), effective in 1990. VPS is would make retiree health benefits coincide with lower national office. FAS 106 or does not know and cannot reasonably should pay. benefits even more unlikely. In fact, the recently Institute, 1989. tion to the medical plan, and eventually the retiree through a current employer than through a past em- documents, other information from the company that health liabilities to the extent that companies can fund Such plans are 401(k) plans, corporate-owned life 1950s and 1960s. These plans present the company 1991). Estimated out-of-pocket spending as a percent- Act (H.R. 1866), introduced by Chandler and Flippo, the pension retirement benefits. The transfer is made active employees not yet eligible but expected to health care in the future. The provision of these hospital services, rural health clinic office visits, and framework for resolving retiree entitlement questions. In reaction to FAS 106 and increases in health care Perrin, Forster & Crosby Inc. found that FAS 106 100–249 5.1 exceed 25 percent of aggregate employer contributions retiree health benefits to those aged 65 and over 1988, the elderly accounted for 33 percent of all health Housekeeping 28.2 37.6 plan and the cost for the current period in footnotes to decreased benefits. The survey also found that, while Benefit Associations) of the work force, coupled with increasing lifespans and Litigation on the rights of employees to receive higher tax collected by the government. This is because cate to employees that they should use the money ing rulings. with FAS 106, but it does create a cash flow stream to Retiree Health Benefits: Issues of Structure, Financing, should be chosen so that the yield is greater than the 250–499 4.3 Employee Benefit Research Institute/The Gallup set annually. The ways in which employer plans are integrated with Retiree health coverage differs by age group and family medical benefit liability. hensive medical coverage and the health expense family incomes for those with coverage from a past costs that implicitly considers expected health care estimate what the standard’s impact is expected to be in enacted provisions allowing limited use of excess A company with a defined medical plan will be completely paid for by retirees. ployer. With family incomes of $15,000 to $19,999, 13 seemed to promise lifetime benefits was not binding. benefits and who society feels should finance them will with perhaps the largest obstacles for calculating pension liabilities. There is no option that allows was more comprehensive and, in addition to the As mentioned, some companies will continue to offer age of personal income rose from 9 percent in 1977 to receive a benefit. more stringent in that all current participants in the insurance (COLI), and employee stock ownership plans related physician supplies. costs, some firms have dropped the provision of retiree would reduce their pretax earnings by 10 percent, on Source: Gregory de Lissovoy, Judith D. Kasper, Steven Di School u u u 0.1 0.0 for both medical and retirement contributions after the (Meckin, 1990). This was an increase from 16 state care expenditures (U.S. Congress, 1989). The combina- their financial statements, and rarely include any none of the companies had changed to a defined rising health care costs, have left many employers with 500–999 4.8 the retiree health expenses are no longer coming received from this plan to pay for retiree health bene- Carlo, and Jon Gabel, “Changes in Retiree Health Benefits: meet all or part of the benefit costs. Unable to Work 4.3 4.8 expected inflation. A dedicated bond portfolio would the Medicare program have important implications for There are other examples of companies changing their employer. Another possibility is that those with high income. Among those aged 40 and over, 16.5 percent retiree health benefits has been decided to date inflation, changes in health care utilization and deliv- account. Quaker pays the majority of plan costs, while dollar benefit plan might favor this approach because the year of the change. pension assets to fund retiree health benefits may be the Organization, Inc. Public Attitudes on Employee percent of those aged 40 and over had retiree health Therefore, the totality of the employer’s communica- liabilities and funding due in large part to the substan- (ESOPs). Not all are tax-deductible means of funding companies to fully fund these benefits with all the tax pension plan must be fully vested in all accrued benefits coverage but will gradually introduce cost sharing (or health benefits for future retirees entirely, while others 21 nearly 13 percent in 1988. average, among those who answered. However, there be a growing economic and social issue. provision above, would have eliminated the possibility and Coverage uplan first provides medical benefits. Public Policy Proposals Therefore, some plans in 1988. The number of states that do not provide 1,000 or more 61.8 tion of an aging population and continued rapid health 401(k) specific numbers. The Employee Benefit Research Results of a National Survey,” Inquiry (Fall 1990): 291. contribution type of plan in the past two years, 5 u Funding Options higher retiree-to-active-worker ratios and caused these Retired 20.0 49.3 24 fits. Since the money is not directly earmarked for For companies continuing to provide some or all retiree directly from the employer’s income, and therefore the be more difficult to implement for a medical service Although public spending for the elderly’s health care ery, technological advances, and changes in the health retiree health benefits recently, largely in response to retirees contribute a percentage of costs based on their income are more likely to continue working past age the costs to employers and to retirees. Some forms of the employees carry the medical inflation risk. only relief for employers seeking to fund these costs in Ownership. EBRI Report no. G-4. Washington, DC: Ralston introduced an ESOP in January 1989. This tions to the employees was not the relevant contract. In Several cost components make up the expense recorded tial size of the liabilities and the uncertainties of at the time of the transfer. advantages of pension funding. shifting some costs to the retirees) in order to curb or setting money aside, and each has specific limits. Currently, Medicare Part B reimburses physicians at 80 Finally, the expenses for have no plans to change their existing plans. In be- of pension plan terminations and reversions, though Don’t know/no response 14.5 largely through the adoption of generally appli- were substantial differences among companies. Annual u u u The choice of investment strategy depends on Note: The percentages do not add to 100 percent because plans may not be able to make such a contribution if any money toward the cost of retiree coverage de- care cost inflation means that current and future Table 4Institute (EBRI) estimates that earned liabilities (for percent expected to make such a change by 1991 (A. liabilities to grow. 27 retiree health benefits, the assets in 401(k) plans health benefits, several methods of prefunding are Tax-deferred cash value results from the insurance employer is not taking a tax deduction. Some feel that benefit because the interest rate needed (medical advance on a tax-favored basis. medical inflation. The following summary and table 1 outline these some firms offered multiple plans. Based on a survey of 204 service. The longer an employee has worked for the status of plan participants. In making their best esti- FAS 106, medical inflation, and changing demograph- 65. has grown during the past decade, it has decreased as integration involve more cost sharing by the beneficiary Employee Benefit Research Institute, 1989. plan provides employees with an opportunity to set this case, the relevant contract was the official plan surplus assets would have been allowed to fund retiree in companies’ income statements: service cost, interest future expenses. A poll conducted in January 1990 found that the year of the transfer and for each of the four years percent of the Medicare approved “reasonable” charge. Some examples follow. A subsequent tween, some employers may place limits on their Source: Employee Benefit Research Institute tabulations net income of some companies may decrease between u In December 1990, the Financial Accounting Standards Board approved Industry the pension plan has been restricted by the full-funding cable contract principles. creased from 24 to 16 during these two years. In 1987, a firm’s plan design, employee and retiree Employer-Provided Retiree Health Status of Persons Aged 40 and Over, by Age and Family Income, August 1988 uretirees face growing health care expenses. The Costs of FAS 106 to Employers current private-sector employees and retirees) were Foster Higgins, 1990). Retiree health benefits were discussed in the 101st firms. cannot be used to count against the FAS 106 liability currently allowed, although they are limited. This the long-term effects may vary widely and future Corporate-Owned Issue This Private Issue Brief was written by Jennifer Davis 54.1 Companies maintaining retiree health benefits may premiums that are not needed to pay current death inflation) is difficult to estimate with sufficient preci- ________. than others. For all methods, however, Medicare is firm, the lower the retiree contribution, and the higher ics. mate of health care cost trends, employers would a proportion of the total costs. Public Attitudes on Medicare. Between 1984 and EBRI Report aside money for retirement. The company increased its documents and summary plan descriptions. grouping has examples of companies with employee- differences. 64 percent of those aged 18 and over who are not cost, return on plan assets, the amortization of prior health plans or ESOPs. The bill would have also following the last transfer must be at least as high as The patient is required to pay the remaining 20 percent postretirement medical benefit promises, tie the prom- of the August 1988 Current Population Survey. This Employee stock ownership plans (ESOPs) have 30 percent and 60 percent, by one estimate (Integrated Statement No. 106, requiring many companies to record a liability for u Investment Strategies limits. Investment earnings of a 401(h) plan are not 48 percent of full-time participants in medical plans of demographics, and the firm’s financial status, $241 billion in 1988. For some companies, the retiree Congress and several bills were introduced. Discussions Life Insurance FASB Statement No. 106, “Employers’ Accounting for Government universe consists of all persons aged 40 and over in the Coverage also varies by firm size and industry. Among government revenues may be lowered because of for balance sheet purposes. Brief claims and policy expenses. This money is kept by the have a number of concerns, including reducing costs includes specific examples of how some companies sion. of EBRI with assistance from the Institute’s 1988, Medicare financing decreased from 46 percent treated as the primary payer and the employer plan is probably use different estimates for various types of the health expense account. no. G-8. Washington, DC: Employee Benefit Workers match from $0.50 on the dollar to a dollar-for-dollar pay-all programs. eligible for Medicare benefits do not anticipate receiv- service cost, gains and losses, and the transition obliga- eliminated the 150 percent full-funding limitation and those for the highest of the two years preceding the year as coinsurance, although this may be covered through Retirees ise to length of employment, or comprehensively Administrative Services, 1990). u u u retiree health benefits on their balance sheet in order to comply with u Conclusions recently become another vehicle for funding taxable to the employer. If the pension plan or the u u u state and local governments had health care coverage federal 16.4 Since the cost of health care during the later years of U.S. civilian noninstitutionalized population living in health care liabilities required to be listed on the have raised concerns over equity, benefit security, and Postretirement Benefits Other Than Pensions” (FAS 33 among other factors. The projected impact of FAS 106 has been widely increased pension contributions in the future. those receiving health coverage from a past employer, have changed their overall retiree health liabilities and/ insurer and credited annually with earnings, which are and cost volatility and managing the effects of the research and education staffs. of the elderly’s total health care costs to 44 percent health care services (for example, medical, dental, and the secondary payer. Research Institute, 1990. The method of integration with match on employee contributions up to 6 percent of tion. The service cost is the cost of the benefit earned 501(c)(9) Trusts or VEBAs of transfer. This was designed to discourage employers an employer plan. Medicare pays physicians either on restructure the plan design. Overall, most companies any lump-sum distributions. ing the same level of benefits the Medicare program state and local 19.4 generally accepted accounting standards, beginning with fiscal years after No Retiree Covered byAn additional factor to be considered in determining Covered by Spouse’s Covered by Covered by Spouse’s households. u u u medical benefit plan is discriminatory, neither plan will after retirement at least partially paid for by their The choice of investment strategy depends on a firm’s retiree health benefits. types of plans largely because of high costs (A. life may well exceed many individuals’ household u Retiree Health Care Coverage Employee Stock balance sheet in accordance with FAS 106 will far 106)—approved in December 1990—requires liabilities revenue implications. studied. There will be higher expenses for sponsoring u u u These plans can include both elective and nonelective 62 percent had worked in firms with more than 1,000 A study by the Salomon Brothers Asset Allocation Self-employed 1.3 or used some form of prefunding. not taxable income for the sponsoring company. This funding on corporate and retiree taxes. As a result, Age and Income Total Health Coverage Employer’s Plan Employer Plan Employer’s Plan Employer Plan Hewitt Associates. (Chollet, 1991). Since private insured spending for American Airlines pays its retiree medical benefits on a prescription drugs) and different rates during various Medicare determines the beneficiary contribution Survey of Retiree Medical Benefits, pay. International Business Machines (IBM) will cap its for employees’ service during the year. The interest cost from attempting to accumulate medical expenses in an “assigned” or “unassigned” basis. Physicians who are or will be evaluating their retiree health liabilities offers today when they become eligible in the future A bond portfolio, either immunized or dedi- the parties’ intent in the framework of contract law is Some analysts believe that the market has already Ownership Plan December 15, 1992. be tax qualified. employer (U.S. Department of Labor, 1988). The Retiree health insurance benefits are a common provi- plan design, employee and retiree demographics, and Foster Higgins, 1990). income, financing health care for the elderly is an Unemployed a exceed the costs that currently appear in financial for retiree health benefits to be recognized explicitly on companies under the new standard than under the contributions. While they can be financed wholly employees, and 76 percent had worked in firms with u u u Group argued that bonds are not a good investment decisions on how to fund these obligations are con- There is some debate about the extent to which such Litigation on the rights of employees to receive retiree accumulated cash value is an asset of the company 501(c)(9) trusts, also called voluntary employee benefi- health care remained stable at about 12 percent of periods of time. pay-as-you-go basis, but in the light of the new FASB necessary to make up for the lower Medicare payments 1990. Lincolnshire, IL: Hewitt Associates, 1990. retiree health liabilities: the company pays the full Chandler and Sen. Bob Packwood (R-OR) introduced is the expected increase in the APBO due to the (Employee Benefit Research Institute/The Gallup order to have a larger transfer into the 401(h) account agree to accept assignment for a particular service agree and deciding whether or not changes to the current (thousands) what the taken these liabilities into account, and their disclosure (percentage) Yard-Man court interpreted as a lifetime Employees and/or retirees whose benefits were Don’t know/no response 8.7 cated, may prove to be a viable alternative for Government Accounting Standards Board (GASB) is sion of large employers’ benefit packages, both private • Under Medicare exclusion, Medicare payment is important issue. Currently, some level of health insur- the firm’s financial status, among other factors. One u u u statement footnotes. companies’ balance sheets. FAS 106 applies many of Some companies will continue to offer coverage current pay-as-you-go system, due to the need to through elective deferral, employers may use nonelec- The House Ways and Means Committee held hear- 100 or more employees (table 5). By comparison, 63 strategy for a company providing a medical service transfers affect pension plans’ financial soundness. If health benefits has been decided to date largely through (although it cannot be used to directly decrease the size cerned with both tax-advantaged vehicles and invest- In 1988, 43 percent of those aged 40 and over had Total Integrated Administrative Services, Inc. the elderly’s total health care costs between 1977 and requirements the company redesigned its plan effective under RBRVS. There are six major ways that employer u Employers can provide full retiree health benefits in retirement, make a Postretirement The creation of the ESOP and the change to the retiree premium up to $7,000 for those under age 65 and up to the Health and Long-Term Care Security Act of 1990 ciary associations (VEBAs), were originally established passage of time. The return on plan assets (only for Organization, 1990). Respondents were divided on during the allowed years. The federal government, plan to accept the Medicare approved rate as payment in plan design are necessary. benefit “inference.” The court stated that, if employees on the financial statements will not significantly affect Younger respondents and those with higher incomes Applies Partially Applies Does Not Apply a not currently working on a statement such as FAS 106 and public. FAS 106 has brought the full financial ance is provided to all elderly persons through a combi- funding retiree health obligations. changed (due to FAS 106 or other factors) may investment method is to try to hedge the liability by first subtracted from the bill, deductibles and Within this separate account, individual accounts, 40 and over 84,180 57.1% 16.5% the same principles that were used in accounting for 11.8% 11.4% 3.2% amortize the transition obligation and to expense u u u tive deferrals in order to ensure money is set aside for the adoption of generally applicable contract principles. ings in mid-1989 on possible options for government one feels that the full-funding limits are higher than percent of all nonfarm wage and salary workers are benefit (Bader and Rodgers, 1989). The study found u Bibliography retiree health coverage through their own or their of any FAS 106 liability). ment strategies. but will gradually introduce cost sharing (or Generally, the choice of vehicle may Source: Employee Benefit Research Institute tabulations of the 1988, virtually all of the relative increase in private January 1, 1990, to include employee contributions. To The rates at which the benefits’ expected future cost is plans can be integrated with Medicare: Medigap Medical Issues and Responses contribution toward these benefits, or provide a contribution during . Atlanta, GA: Actuarial medical program were two separate actions. Ralston $3,000 for those aged 65 and over. The caps will apply for use by multiemployer plans through the Internal whether they would be willing to pay an increased (H.R. 4134, S. 2199), which would have provided funded plans) is the actual earnings on those assets. participants, and employee representatives (if collec- full. In most states, physicians can balance bill up to Retiree health benefits are provided to the majority of forgo wages in return for retiree benefits, there may be stock market prices. were most likely to expect to receive these benefits. Source: Employee Benefit Research Institute. 65 and over 26,524 71.5 1.6 for retiree health insurance liabilities of public 1.8 20.5 4.5 nation of benefits from employers and the govern- impact of these benefits to the forefront, causing many matching inflation, either medical or overall inflation. coinsurance of the employer plan are then applied, known as individual medical benefit accounts feel that these changes were illegal and want to pensions (FAS 87 and FAS 88) to other postretirement An added advantage of ESOPs is that the fund could be August 1988 Current Population Survey. This universe consists benefits as earned rather than as paid. Analysts expect retiree medical payments for all their employees. action in the area of employer-sponsored retiree Participants and beneficiaries can bring suit to (1) necessary, such a transfer to a 401(h) account may not employed in firms with 100 or more employees that the liabilities of retiree health benefits are sensitive Companies can design retiree health benefits as either be largely based on tax ramifications. The investment spending for health care by the elderly has been borne retire with medical benefits, there is a minimum discounted (to their present value) must also be as- coverage, a coordination-of-benefits plan, a Medicare Sciences Associates, Inc., 1990. communicates that funds accumulated in the ESOP can to IBM employees retiring after December 31, 1991. Revenue Code (IRC) and the Labor Management Amortization of prior service cost is to phase in the cost tively bargained) must be given notice of the transfer at 125 percent of the Medicare approved rate (140 per- shifting some costs to the retirees) in order to Under $5,000 employment that can be used by employees to pay for the retiree benefits. those aged 65 and over through the Medicare program. payroll tax during working years to insure receiving the limited favorable tax treatment to employers who set an inference that the benefits will continue as long as employers. of all persons aged 40 and over in the U.S. civilian noninstitu- private employers to reevaluate their plans and to Alternatively, a company can simply attempt to maxi- and the employer plan pays the remainder of the (IMBAs), must be kept for each employee who is (or ment—employer-provided retiree health benefits and u u u The disadvantages of COLI are that the first few years’ benefits (for example, health coverage, life insurance, FASB Statement No. 106, “Employers’ Ac- employers with these benefits to record significant leveraged to provide more tax benefits to the employer. health programs. (Piacentini, 1989). recover benefits due them under the terms of their 40 and over At the hearing on June 14, 1989, Fifty-four percent of persons 5,563 90.7 1.8 to changes in both interest rates (or general inflation) pursue the issue in court. 1.0 5.2 1.2 defined contribution plans, defined dollar benefit plans, strategy used within that vehicle, discussed in the next COLI can be nonleveraged; that is, no loans are taken Meckin, John. by the beneficiaries as an increase in out-of-pocket employment period of 10 years and an age minimum of sumed and should be based on current rates of return on exclusion plan, Medicare Part B, a carve-out plan, and Rise in State Employee Health Plan Costs be used to pay any retiree expenses, including retiree Given current trends in health care costs, the company A. Foster Higgins & Co., Inc. Relations Act of 1947 (Taft-Hartley Act). As a result of plan amendments and/or plan initiation that takes least 60 days prior to its occurrence. cent for evaluation and management services). Under Foster Higgins Health aside funds to pay for retiree health benefits. Medicare is funded through a combination of general tionalized population living in households. 28 the retirement status is maintained, thus a “status curb future expenses. An April 1989 study by Johns Hopkins University and consider limiting or eliminating them. For those mize investment returns. Companies can also use bill. Therefore, the beneficiary has some cost Medicare benefits. Both government and employer- All EBRI tabulations of the August 1988 Current Population premiums offer no tax advantages (unless combined was during the past five years) a 5 percent owner of the 65 and over 2,811 93.1 b a b 5.7 0.8 u Medicare Total contributions to a 401(k) plan, including long-term care insurance, and housing). It applies to liabilities on their balance sheets, thereby increasing In a leveraged ESOP, the plan borrows money to pay receiving health coverage from their employer work Kenneth Gideon, Assistant Secretary for Tax Policy of u Currently, employers have few options for tax-favored prefunding of and medical inflation. Notably, the study found that or defined benefit plans. Defined contribution plans for section, may be chiefly intended to exploit tax benefits counting for Postretirement Benefits Other out on a policy or its cash value. In nonleveraged plans, (2) enforce their rights under the terms of the Less than 0.5 percent of the total. of increasing health care costs and increasing inflation, Care Benefits Survey: Report 4, Retiree Health Care. spending. high-quality, fixed-income investments in amounts and 55 years. All employees are automatically enrolled to Medicare supplement plan (table 8). business income unless invested in tax-exempt instru- Moderates: Survey of State Employee Health Benefit medical contributions. accounting for future inflation in funding VEBAs and estimates that these limits will be reached by the late place after FAS 106 is adopted. Gains and losses arise Medicare’s participating physician program, physicians federal government revenues, payroll taxes, and premi- benefit inference.” Some courts, such as the Sixth Survey are for the civilian noninstitutionalized population of the $5,000–$7,499 the Health Insurance Association of America inter- Table 2 Employer-provided retiree health coverage differs by employers who do continue providing benefits at some sharing under this type of plan, although not the based programs face growing financial strains. with some type of trust) and that COLI is nearly dedicated or immunized bond portfolios (described company. However, separate accounts are only for 15 32 employer and employee contributions, are limited to current and future retirees, their beneficiaries, and the amount of debt on the balance sheet compared to for the company stock, which is then held in a trust. in private industry, while 36 percent work for public the U.S. Department of the Treasury, said that “Ex- retiree health benefits. Some options are 401(h) accounts, 501(c)(9) liabilities are relatively insensitive to simultaneous retiree health are similar to defined contribution plans plans, or (3) clarify their rights to future benefits under Consumer costs for health care are defined as out-of-pocket u u u or to achieve an optimal cash flow. COLI, the assets build up and the policies are held to Princeton, NJ: A. Foster Higgins & Co., Inc., 1990. with maturities that match the amount and timing of Than Pensions,” requires liabilities for retiree prefund their retiree medical benefits unless they sign a ments), although for 501(c)(9) plans established under United States living in households. Plans, 1990; Summary of Findings 40 and over 5,640 . New York: Martin 86.2 1.5 changed the law to subject earnings to federal income 1990s, when they will consider various options. ERISA extended VEBAs to single-employer plans. None of these proposals gained significant support in from experience that differs from the assumptions and The transfer will be treated in pension plan administra- may choose to accept assignment on 1.1 8.3 all services pro- 2.9 Effect of a Transfer to a 401(h) Plan on the ums paid by participants. It has been one of the fastest Circuit in International Union, UAW v. Cadillac Malle- viewed 200 financial officers of companies that offered u u u gender (table 3). While 16 percent of all those aged 40 level, there are few funding vehicles available, all of The third method of investment focuses on investment later) similar to those used for pension obligations. Medicare cost sharing. recordkeeping purposes, and the money investments irreversible due to the tax ramifications of surrendering the lesser of $30,000 (or 25 percent of the defined qualified dependents. The statement generally does not both age groups, while retirement was more prevalent spending, Medicare premiums, and privately insured premium 31 equity, a commonly watched ratio (Coopers and The company makes the necessary contributions to the 65 and over 3,449 87.3 b 19 b 9.4 2.9 While the elderly represented about 12 percent of the employers. the terms of the plan. In general, the courts have ruled panding tax incentives would redound to the benefit of By comparison, 75 percent of all nonfarm trusts, 401(k) options, corporate-owned life insurance, and employee changes in these indices. 12 for pensions—the employer allocates a specified term. Direct corporate ownership of the assets elimi- Plan Sponsor’s Income and on Bacon, Peter W., Judith D. Kasper, Gregory de 9 the expected future benefit payments. program waiver. Among the employees, 99 percent • In 1991, the allowable fee is the reasonable charge; in 1992 and E. Segal, 1990. Medigap coverage essentially is coverage that pays vided to Medicare beneficiaries, in which case they are The Ball Corporation of Muncie, Indiana, has revised VEBAs must be based on voluntary membership, and Congress, and they were not passed, with the exception changes in assumptions and may be recognized either tion as if there had been a net experience loss, and a collectively bargained agreement, the contributions growing programs in the federal budget, and recent tax. DEFRA also imposed a 100 percent excise tax on able Iron, have upheld this type of reasoning. Other health benefits to be recognized explicitly on retiree health coverage. Of those responding, 58 7 spending. Among all people aged 40 and over, 43 percent have which have significant limitations. return, on the assumption that, regardless of what the $7,500–$9,999 Finally, the funds can be placed in “safe” investments. • For a Medicare Part B plan, the employer pays the can be commingled. IMBA contributions are treated as the policies. Therefore, the company is vulnerable to benefit plan dollar limit, if greater) or 25 percent of cover post among the older age group. Four percent of those aged employment benefits such as severance pay or ESOP, which the ESOP then uses to pay down the 5 Lybrand, 1989). thereafter, it will be based on RBRVS. Federal Government Receipts EBRI estimates that the present value wage and salary workers are in private industry, and 15 that an employer has a right to terminate or amend population in the late 1980s, they accounted for nearly those employers, and their employees, that have already stock ownership plans. Each of these involves significant limitations. amount to each employee’s account and usually relin- nates trust expenses, nondiscrimination requirements, Lissovoy, Steven DiCarlo, and Jon Gabel. “The Piacentini, Joseph S. “Pension Coverage and Benefit Figuring a retiree medical health liability is not as chose to participate. The company will use two the deductibles and coinsurance rates for Medicare; not permitted to balance bill Medicare patients. its employer-paid retiree health benefit programs to American Telephone and Telegraph (AT&T) has immediately or on a delayed basis. qualifications for membership eligibility must be employers will have 10 years to amortize this amount The final compo- are unlimited and earnings accumulate tax free. Ex- budgets have attempted to slow its rate of growth. In his of the pension asset transfer proposal discussed earlier, employers whose welfare benefit fund provides any type 40 and over 5,092 78.0 2.8 courts have disagreed; the Eighth Circuit in 2.2 12.8 4.3 Anderson v. percent believed that FAS 106 would lower profits, companies’ balance sheets. liability is, the best way to fund the liability is to Companies using this final approach are generally retiree’s share of the Part B premium, and the an annual addition to a defined contribution plan for retiree health coverage through an employer (either Any change in plan design alters an employer’s obliga- future tax law changes. It is estimated that, after seven wage continuation for disabled or terminated employ- compensation. 55–64 without retiree health insurance and 5 percent of Earnings on contributions accumulate of private employers’ liabilities for current retiree health loan. The stock is then allocated to the employees’ percent work for public employers (Piacentini, 1989), retiree welfare benefits, although the employer must 36 percent of every personal health care dollar spent in promised to provide retiree health benefits, but would If it can be assumed that interest rates and medical 13 quishes the investment decisions to the employees the limitations on funding, and the irrevocable dedica- 65 and over 2,864 78.5 b 0.6 16.1 4.5 As of the date a company adopts FAS 106, there is 501(c)(9) trusts (one for union employees and one for simple as calculating the present value of known costs. Entitlement: New Findings from 1988.” in this plan there is no cost sharing by the bene- Issue Brief launch an employee-pay-all program to fund retiree nent is the amortization of the transition obligation maintained the entire retiree health benefit cost for defined by objective standards of an employment- (this is different from the five years for other types of Employer Response to the FASB Proposal for penses for disability, medical benefits, and group-term as part of OBRA ’90. This lack of action was in part due of disqualified benefit. 1992 budget, President Bush has proposed limiting Some companies have kept their traditional plans but Alpha Portland Industries, Inc. stated that since Con- while only 19 percent thought it would lower stock Table 3 2 Medicare provides a wide range of health benefits to attempt to achieve the highest possible return on waiting until more money accumulates in the fund or in beneficiary continues to pay the deductibles and their own or their spouse’s). Coverage is more likely to tion to employees. While reduced or changed benefits years from beginning a COLI, some plans will have purposes of section 415(c). The plan must allow the $10,000–$14,999u Though there are some legal restrictions on changing a retiree health plan, Previously, without Currently, with tax free to the employer, and qualified lump-sum those aged 65 and over without this benefit were unable ees. insurance obligations was approximately $241 billion in accounts. In this loan, the interest may be tax deduct- implying that public employers are more likely to the United States. These costs have grown rapidly over not necessarily ensure that others receive any benefits, inflation will be strongly linked in the future, compa- through various investment options. This money is tion of funds to benefits. Benefits paid to the employer prove that such a right has been reserved (or stated) in related “common bond.” The employer can make tax- Accruing Postretirement Health Benefits.” Benefits nonunion employees) for investing active employees’ already an obligation for the postretirement benefits The unknowns of medical inflation, medical innova- life insurance purchases are also tax-free to the recipi- no. 94 (Employee Benefit Research Institute, ficiary. Table 7The Omnibus Budget Reconciliation Act of 1989 medical costs for new employees. Ball hopes to encour- explained above. 102,200 retirees, which totaled $319 million in 1989. to the effect that a large, costly new tax incentive net experience losses). Any money transferred that is Employer-Provided Retiree Health Coverage of Persons Aged 40 and Over, by Sex, August 1988 Medicare spending to $114 billion instead of the $117 gress exempted welfare benefits from ERISA’s vesting are capping (or limiting) employer-provided benefits in prices (Bacon, Kasper, and Gabel, 1990). 40 and over 11,205 Transfer into 69.7 Transfer into 4.8 4.0 16.8 4.7 the elderly. However, this program is facing a difficult current assets. This method does not attempt to match u u u other cost sharing in Medicare Part B and Part A. be provided to those with higher family incomes and is may be beneficial from a bottom line standpoint, this sufficient cash inflows from loans and death proceeds anticipation of Congress establishing a tax-advantaged employer to take a reversion of any excess amount some companies have done so. distributions may qualify for special five-year forward to work. Another 4 percent of the younger age group 1988. It is this amount that employers will be required ible for the organization making the loan, so that the 17 provide this benefit. the last decade. Between 1977 and 1987, the total cost thus potentially expanding the inequities between Estimated Total and per Capita Personal Health Care Spending among the Elderly nies would not need to worry about either one sepa- A separate account must be held for key employees, then used by the employee to purchase health insur- specific language and on a widely known basis. are tax free. Quarterly (Fourth Quarter, 1990): 48–50. attributable to current and former employees’ service after-tax contributions for retiree medical benefits. tions, technology, and utilization patterns complicate • September 1989). The coordination-of-benefits plan pays the lesser of (OBRA ’89) includes provisions that will reform the age its employees to save for future medical care costs For employees retiring after March 1, 1990, AT&T would have on the federal budget. deductible contributions; however, these are limited to not used to pay for health benefits is transferred back to ent, although other benefits are taxable upon receipt. Item65 and over 5,509 401(h) Account 69.5 401(h) Account 0.5 billion agreed to in the 1991 budget agreement, al- 0.8 23.2 6.1 requirements, the intent to vest these benefits seems order to reduce costs. This is often done by limiting 25 more likely to be provided directly to men than to financial situation and constraints on cost growth in the liabilities or the future needed cash flows. Some action may lower employee morale and reduce a firm’s method of funding. • Carve-out plans are becoming more common (A. remaining in the separate medical benefit accounts (reduced by loans) to meet the cost of loan interest and and Nonelderly, Selected Years, 1977–1987 averaging on the employee’s tax return. Contrary to the FAS 106 requires that a liability based on the pro- had a job but did not work the particular week in to recognize in their financial statements with the organization can often offer a lower rate on the loan. of health care for the elderly nearly quadrupled, grow- Coverage Total with contributions counting against defined benefit Men Women those individuals whose employers choose to take $15,000–$19,999 rately, since their effect on liabilities would be offset- ance after retirement. By definition (as in defined Bader, Lawrence N., and Helenmarie Rodgers. Retiree Schmidt, Peter K. “Retiree Health Benefits: An Illusory the estimation. In addition, the government may to that date (the accumulated postretirement benefit (1) the plan benefit calculation without regard to way Medicare Part B reimburses physicians. by allowing them the opportunity to contribute after- The effective date for adoption of this statement is the pays for retiree premiums up to a maximum fixed essentially only the cost necessary to pay current the pension plan; while not subject to income tax, it is These though this is still an increase from 1991 spending of “illogical.” dollar contributions toward these costs in retirement, u In 1988, 43 percent of all people aged 40 and over had retiree health women. Sixteen percent of all people aged 40 and over the program are being proposed by President Bush in companies, assuming that the future level of retiree ability to attract and retain employees. Explaining the Foster Higgins, 1990). In these plans, the employer 20 after all liabilities have been satisfied. Income before Taxes and 40 and over 15,310 57.7 13.1 any remaining premiums and enough net cash inflow to 9.1 16.2 3.8 It discusses current coverage of employer retiree health There are several reasons that people may not have rules governing other 401(k) contributions, nonelective question, most likely because they were ill or on vaca- jected unit credit actuarial cost method (which 8 adoption of FAS 106. The General Accounting Office section 415 limits. A reversion of assets from a VEBA Most of the court actions have focused on the issues of ing 265 percent in current dollars, compared with 169 advantage of the tax incentives and those whose ting. In this situation, companies providing a medical contribution plans for pensions), the employer has no The company can receive some of the investment The difference between EBRI and the GAO number for current Medical Benefits in Transition. New York, NY: change aspects of Medicare, thereby affecting employer For Bell Atlantic Corporation, recent collective obligation, or APBO). Promise?” In the Medicare reimbursement amount or (2) the Retiree Health Benefits: What Is the The APBO, less any plan assets provisions, designed to control Medicare Part B expen- tax dollars into a fund. The fund will be invested in fiscal year beginning after December 15, 1992, for most amount, based on the retiree’s age and coverage type welfare benefits plus a contribution to a qualified asset subject to the excise tax on reversions from the pension $105 billion. For 1992, this decrease in projected The EBRI Tax Estimating and Analysis Model Nondiscrimination regulations were added by the capping the increase in the amount contributed, or Total Total (billions) 89,964,438 41,273,463 Per Capita 48,690,975 Retiree Health Expenses 65 and over 5,396 $1,000 62.9 $1,000 1.4 2.4 27.9 5.4 his 1992 budget. benefits is too difficult to estimate and too large to coverage through their own or their spouse’s current or former employer. In an attempt to hedge the liability by matching determines the retiree health plan benefits and receive retiree health benefits directly from their changes to employees may also be costly for the em- meet postretirement health insurance outlays. considers future benefits expected to be earned by the plans as well as which employers are more likely to retiree health coverage. From a public policy perspec- or matching employer contributions can be distributed tion. liabilities is due in part to different assumptions about health care 16 (GAO) estimates these earned liabilities at $217 Combinations percent for similar costs among the nonelderly popula- the specific benefit promise and employer rights to employers do not” (U.S. Congress, 1989). Treasury service benefit would prefer to invest in cash and liability beyond the contributions, even though the proceeds through partial withdrawals or through loans, plans, or it may enact national health care reform. bargaining for nonmanagement employees produced a and previously accrued costs, is called the transition Promise? $20,000–$29,999 cost of covered services minus the Medicare reim- Washington, DC: Employee Benefit ditures, may affect the retiree health care burden of group annuity contracts that yield a fixed rate of employers. However, for certain small, nonpublic (single or joint). Retirees will be responsible for the account. plan. Salomon Brothers, 1989. While the contribution to the asset account (TEAM) estimated the cost of allowing different types Deficit Reduction Act of 1984 (DEFRA) and state that spending will occur through reduced payments to some requiring a long service period before employees Firms that have filed for Chapter 11 bankruptcy and ignore, may decide that this is the most effective Year Coverage is more prevalent among men, those working or having worked Aged 65 and over Under age 65 medical inflation, companies can invest in heath care inflation. EBRI assumes that health care cost inflation will reduces them by Medicare payments. This leaves Aged 65 and over Under age 65 current employers, while 12 percent work but receive ployer. provide these benefits. Any reduction in coverage may tive, an insight into this can be gained from the activity No Retiree Health Coverage 57.2% only in the event of death, disability, or separation from employee) be accrued over the period from the first 53.1% 60.6% In the Omnibus Budget Reconciliation Act of 1990 Direct Retiree Health Expenses 40 and over 13,095 $100 48.1 — 21.1 15.2 12.7 3.0 tion (table 7). representatives also testified that long-term revenue inflation-sensitive equities over any type of bond money may not fully cover health insurance costs in change the range of benefits offered or the extent of both with few adverse tax effects. Only if a policy is agreement. VEBA nondiscrimination rules are in section 505 of is intended to fund the liability over the employees’ Burr, Barry B. “Getting the Jump on FASB: Ameritech How, then, can companies plan for and fund their cap on contributions made by the company. Once obligation. This obligation can be recognized on the Research Institute, 1989. bursement amount. In essence, the plan treats all beneficiaries or employer plans. OBRA ’89 provides for employers and non-U.S. plans, the statement is effec- interest, similar to guaranteed investment contracts. remainder. of prefunding on federal government revenues. Allow- each plan benefit is subject to Internal Revenue hospitals (primarily teaching hospitals), higher premi- continue to exceed general inflation but that the difference become eligible to receive these benefits. For the then attempted to curtail retiree health benefits present These constraints will leave more of the costs of retiree investment strategy. intact any cost sharing on the part of the benefici- these benefits through their spouses’ employers. 65 and over for a large employer, and those with higher incomes. 2,914 61.3 3.0 ESOPs businesses and hospitals. As medical prices increase, 2.9 28.0 4.8 increase pressure on public programs to provide these that these persons were involved in during the one service. There are some provisions for hardship with- Employer-provided retiree health benefits are expected date that the plan grants credits toward these benefits the Internal Revenue Code. (OBRA ’90), Congress increased the options for Some companies are creating combinations of these losses from the transfer of excess pension assets to portfolio. retirement. coverage. The issues of which documents legally 1977 $ 43.4 $ 105.7 $1,785 $ 537 surrendered are there tax ramifications. Loans have a between the rates will gradually decline over the next 25 years, Starts Retiree Health Fund.” Pensions and Investment U.S. Congress. House. Committee on Ways and Means. retiree health liabilities? retiree medical costs reach that cap, employees will pay balance sheet in one of two ways: it can be recognized money from any other plan as coming from the a new method of physician payment—the resource- Employees must contribute at least 2 percent of pay in tive for fiscal years beginning after December 15, 1994. working life, neither health inflation nor increased ing firms to prefund retiree medical liability for current Workers ums for the elderly, and an increase in the number of Service (IRS) overview to prohibit discrimination in Income before Taxes $30,000–$49,999 $900 $1,000 19 remaining liability, some plans are funded under certain 22 6 a separate set of issues. As a result of the LTV This does not apply to VEBAs covering groups that are at least 90 health care to be passed on to employer plans or to the these businesses should go up in value, thus increasing ary that the Medicare plan requires, such as deduct- 1984 119.9 221.9 4,202 1,024 benefits. week prior to the survey. For example, if most of those SAB 74 actually goes beyond this and encourages employers to drawals; but these withdrawals, except for those made (generally date of hire) to the date that the employee to continue in the future. Among persons between the Taxable years of the employer beginning after December 31, using a 401(h) account to fund retiree medical previously discussed plans. The most prominent to date converging at 3.5 percent in the year 2013. GAO assumes that Medicare is by far the largest public health care financ- u Court Cases describe the benefits and if they indicate whether these retiree health benefits would be far greater than short- Covered by employer’s plan 18 16.3 23.4 10.4 special attraction since more than the investment value 40 and over 18,081 40.9 28.5 Age (20 February 1989): 1, 47. 19.6 8.7 2.5 the difference. The company uses a bargained all at once as a one-time charge to that year’s earnings Hearing on Employer-Sponsored Retiree Health beneficiary. Therefore, payments from Medicare or based relative value scale (RBRVS)—which values utilization can be taken into account when figuring order to participate, and investment earnings may Data General provides health coverage for retirees and future retirees on a one-time payment basis would state and local employees who pay Medicare payroll both design and operations. DEFRA disallowed percent collectively bargained. Assets held before DEFRA’s tax codes that are specifically for this purpose, such as u Medicare is by far the largest public health care financing program for the 1988 158.2 284.3 5,235 1,283 disclose the potential impact of other significant matters that the Corporation’s attempt to terminate retiree benefit 1990, and before January 1, 1996. There are special transitional Demographics, utilization, and health care costs are beneficiary. Future beneficiaries apparently are aware of A bond portfolio, either immunized or dedicated, may the value of the investments. However, the volatility of health care cost inflation will exceed general inflation by 3.5 ibles and coinsurance. Employee stock ownership plans (ESOPs) have without retiree health coverage were in school, a policy Tax Rate (Estimate) 65 and over Covered by spouse’s employer plan 2,435 0.30% 59.1 0.30% 11.7 4.9 4 for medical expenses, are subject to a 10 percent excise is fully eligible. ages of 18 and 65, 60 percent expect to receive retiree 4.55.0 Under FAS 106, the amount of a 26.9 17.3 4.6 A second plan design is a defined dollar benefit. In this is the “HSOP,” so called because it combines a 401(h) benefits by allowing a transfer of assets from a Similarly, the chief investment officer of Goldman, ing program for the elderly. In 1988, Medicare financed benefits were to continue throughout retirement were term revenue gains and cautioned against this tax However, at any point in time, the cumulative amortization of the can be borrowed and, within limits, interest on policy Coopers & Lybrand. “Employers’ Accounting for enactment are grandfathered. Also, the taxability of earnings 501(c)(9) trust to fund these benefits. All Baby Bells or it can be disclosed in the notes to the financial Insurance. Committee Print, Serial 101-55. Wash- other sources of insurance can be used to meet the Medicare physician payments relative to one another accrue tax free. that contribution. Investment income is not exempt through a defined dollar benefit based on years of taxes. Financing Medicare benefits has caused increas- lead to an estimated loss of $37 billion in that year to employer believes might result from the adoption of FAS 106 or rules for transfers in 1990. 401(h) or 501(c)(9). elderly. However, between 1984 and 1988, Medicare financing decreased percentage points in the years 1988 to 2001, by 2.75 percentage $50,000 and over programs after filing for bankruptcy, Congress enacted this and expect to receive a lower level of Medicare prove to be a viable alternative for funding retiree businesses in the health care field may be more than • A Medicare supplement plan is one in which the increasing the cost to employers of providing this recently become another vehicle for funding retiree 23 company’s accumulated postretirement benefit obliga- transition amount cannot be less than the cumulative amount Medicare, the primary source of publicly financed of requiring schools to provide this coverage would tax. health benefits through their employer, according to a holds only for postretirement medical benefits, as these may not plan, an employer promises a maximum annual dollar defined benefit pension plan (other than a multiem- and an ESOP. This type of plan is still under review by Total Growth Sachs & Co. has stated that the key to linking the an estimated $78 billion of the elderly’s health care, addressed in expenditure (the provision was enacted in 1990). International Union, United Automobile, loans is tax deductible. any other accounting standard. SEC Staff Accounting Bulletins The transfer is also reduced by the amount that the employer has 14 have protected their liability in some way. statements and recognized evenly as a charge to earn- ington, DC: U.S. Government Printing Office, deductibles or coinsurance rates for the employer based on the resources utilized in providing care (that from tax for most plans (it is taxable as unrelated service (that is, there is a cap on the amount that will Employees and/or retirees whose benefits were points from the year 2002 to the year 2015 and then by 2 Postretirement Benefits Other Than Pensions—The Amount of Taxes Retirees the federal government. If the prefunding were amor- 40 and over 10,194 37.6 30.8 ing strain on public funds throughout the 1980s and 22.7 6.0 2.9 These provisions were originally included in the Continuing from 46 percent of the elderly’s total health care costs to 44 percent. the Retiree Benefit Bankruptcy Protection Act of that would have been recognized on a pay-as-you-go basis. If it is benefits than current beneficiaries. However, in a health obligations. An immunized portfolio attempts to be taken into account when figuring reserve limits. Earnings on employer offers only those benefits that are not insurance. Many companies currently use pay-as-you-go 1977–1987 264.5% 169.0% health benefits. Again, the assets of a stand-alone 193.3% 138.9% retiree health benefits, is described and the relationship have wide-ranging effects. Of those aged 55–64 (not are not considered binding but are considered authoritative, and poll conducted in January 1990 (Employee Benefit previously contributed toward these liabilities. Key employees amount after retirement, to be used toward the cost of ployer plan) to a 401(h) plan once a year for five the IRS. Others combine aspects of 501(c)(9) trust and Covered by employer’s plan 11.5 investment policy with liabilities was estimating the percentage points from the year 2016 on. 17.3 6.6 representing 44 percent of their total health care costs Congressional interest in allowing tax favored pre- (to Federal Government) 65 and over 1,145 $270 55.6 $300 9.3 8.0 21.4 5.6 17 Aerospace and Agricultural Implement Workers of America changed (due to FAS 106 or other factors) may feel FASB Exposure Draft.” Actuarial, Benefits and ings over the plan participants’ average remaining years Appropriations for Fiscal Year 1987 for a specified period and 1990. retiree health plan and the beneficiary often pays is, the physician’s time, skill, and intensity of the Some companies are setting up hybrid plans that be provided to retirees for health insurance). Employees tized over 15 years, the first year loss to the federal Disability and medical expenses are tax free to the extent can be expected to continue doing so in the decades greater, additional amortization of the transition obligation must 9 reserves for other benefits are not taxed as long as the reserves for A survey by the Wyatt Company of 312 employers 29 recent poll concerned with public attitudes on Medi- lock in a specified bond yield during a specific period of most companies follow them (Williams, 1990). (legally defined, taking into account compensation, position, and covered by Medicare, such as vision and drug financing (paying for retiree health care benefits out of 10Covered by spouse’s employer plan 3.3 ESOP cannot be used against the FAS 106 liability, and On average, these plans covered 3,772 active employees and 1.2 5.0 In retirement, distributions to the retiree are taxable between Medicare and employer plans is discussed. The Medicare eligible) without retiree health insurance, 43 2 16 Research Institute/The Gallup Organization, 1990). medical coverage. Under this scheme, the employee is liabilities’ duration. He states, “One investment strat- of $176 billion. Total Medicare benefit payments (for funding was not evident during this hearing. then continued with the Retiree Benefit Bankruptcy Protection 7 v. Yard-Man, Inc. provided in sections 104 and 105 of the Internal Revenue Code, be recorded. A company must be able to prove the existence of an Source: Unpublished estimates from the U.S. Department of Health and Human Services, Health Care Financing Administration, and that these changes were illegal and want to pursue the Employees who become disabled with a certain minimum period of The formula is benefits actually paid during any year (direct these benefits do not exceed the new funding limits. Compensation Information Release, 7 March 1989. ________. Select Committee on Aging. Some companies have decided to use a defined contri- nothing. Employers are moving away from these u No congressional action is expected on the retiree health issue. Allowing Health Care service; his or her practice expenses; and his or her combine aspects of several different types of plans. government would be an estimated $9 billion. Any As a result, this change in the debt-equity ratio may affect the ownership of the company) cannot be included in the calculation providing retiree health benefits showed that Income after Taxes Source: Employee Benefit Research Institute tabulations of the August 1988 Current Population Survey. This universe consists $630 $700 nearly 2,000 retirees aged 65 and over. The authors note that the of all 5 26 1 care, 36 percent of those aged 18 to 65 rated the current earnings). This method of financing involves time. The aggregate yield to maturity of the bonds 20 benefits; the beneficiary continues to pay the Act of 1988. and can then be used to pay premiums for medical care. the distributions are taxable to the retiree. Similar to Issue Brief percent were working, compared with 8 percent of which list the nonincludable expenses specifically. concludes with a discussion of congressional FAS 106 relates to all postretirement benefits except pensions. There is a prescribed minimum amortization of gains and losses If set up in a 501(c)(9) trust, none of the investment earnings on responsible for any remaining cost of coverage and thus Deborah J. Chollet, “Health Care Spending among the Elderly,” Working Paper No. 91–2 (Atlanta, GA: Center for Risk Management egy is to invest the funds in a way so the changes in These limits place a cap on the size of the benefit that can be service may be eligible to receive pension benefits and may, costs), plus a reserve for estimated claims incurred in the year but the elderly and disabled) were $21.7 billion in 1977, insurable interest in order to purchase tax-advantaged covenants on current or future debt, resulting in higher interest issue in court. The courts must determine the extent Chollet, Deborah J. “Health Care Spending among the of liabilities or employer cost. 15 bution approach in which a specific amount of money is 25 Costs for America’s Elderly, 1977–88 persons aged 40 and over in the U.S. civilian noninstitutionalized population living in households. firms to prefund retiree medical liability for current and future retirees . Committee Procter and Gamble has used an ESOP and 401(h) plan 11 changes in the tax code relating to retiree health study was done fairly soon after the release of the original 3 18 57 percent of these employers used a pay-as-you-go 856 F.2d. 488 (2d Cir. 1988). An optimal cash flow in this situation would match cash inflows The law sets out certain criteria for those organizations that can It is not required that this liability be recognized in its entirety This holds only for contributions for postretirement medical and and Insurance, Georgia State University, 1991). 24based on amounts in excess of a “corridor” that is 10 percent of However, the most far-reaching and largest of these benefits for the life insurance contracts are subject to the tax normally government’s efforts at informing the public about the 21 no prefunding (that is, setting funds aside to pay for selected equals the specified yield, and the aggregate a therefore, be considered to be employees deemed to be on not yet paid (which must be determined as reasonable by the IRS funded on a tax-advantaged basis. Therefore, contributions to the Medicare plan cost sharing features but gains the The premiums can only be deducted to the extent that the method used for 401(k) plans, this method of proposals designed to change either employer obliga- those aged 65 and over without retiree health insurance carries the full burden of the cost of medical inflation if rates or lower amounts of debt allowed. This secondary effect is Total is less than in table 3 because it excludes those who did not know their family income or did not answer the question. Those who were terminated or left their jobs within a year of the However, this does not include contributions made to the pension inflation and interest rates have the same effect on the 12exposure draft of the statement, so the respondents may not have increasing to $86.3 billion in 1988, increasing to $105 33 insurance on the employees with the company as the However, legislation designed to enhance the security of retiree health benefits that employers are obligated 30 27 Elderly.” Wroking Paper 91-2. Atlanta, GA: Center set aside that may or may not be sufficient to cover all Source: Employee Benefit Research Institute. Print. Washington, DC: U.S. Government Printing (HSOP) to fund its future retiree benefit costs, begin- 29728 F.2d 807 (6th Cir. 1984). with cash outflows. In retiree health funding, this means having use this deduction and limits its use to ESOPs that own 50 would lead to a loss of $37 billion in one year to the federal government, benefits will have a definite effect on federal govern- immediately on the balance sheet due to some phase-in and While this is true for retirees, for current workers older than age death benefits in VEBAs. Also, nondiscrimination rules do not Note: Estimates double count Medicaid payments of Medicare Part B premiums. Source: Employee Benefit Research Institute tabulations of the August 1988 Current Population Survey. This universe Terminally ill is defined as life expectancy of six months or less, the greater of the APBO and the market-related value of plan most companies is that of retiree health. Therefore, this assessed on these trusts, since the inside insurance cash value Issue Brief system in 1986, and 63 percent used this system in b disability retirement. In this case, the long-term disability health Strictly, this question was asked to those aged 18 and over who All of these examples are drawn from telephone conversations and cannot exceed 35 percent of the qualified direct costs), minus 501(c)(9) may lower the amount that can be funded through a Medicare program as poor and 58 percent rated these duration of the bonds equals the time period over difficult to estimate. Less than 0.5 percent of age group total. transfer must also be vested. coverage of the employer plan. 10 retiree health benefits in the future). Prefunding may plan to fund the plan’s past service credits. they, along with other health care costs, exceed 7.5 funding focuses more on the employer’s ability to 13completely investigated its full impact. tions or the public provision of these benefits. (table 6). Housekeeping was another major activity for the employer does not provide increases in the amount 716 F.2d. 1476 (6th Cir. 1983) cert. denied 465 U.S. 1007 (1984). liabilities and assets” (Burr, 1989). 836 F.2d 1512 (8th Cir. 1988). in 1991. investments mature when benefits need to be paid. percent of the company’s stock. of employer-provided retiree health benefits was amortization provisions. apply to plans maintained through a collective bargaining 65, Medicare is the secondary payer. consists of all persons aged 40 and over in the U.S. civilian noninstitutionalized population living in households. assets. will focus only on retiree health benefits. although this coverage has a maximum of 210 days. buildup is tax-deferred and the policies will be held until death. retiree health costs. Although these plans are described ning with fiscal year 1991–1992. To qualify, a partici- to pay on a case-by-case basis. benefits paid to them would fall under the scope of FAS 106. the fund’s after-tax income for the year. with the respective companies. pension plan for these employees. were not eligible to receive Medicare benefits. for Risk Management and Insurance Research The Employee Retire- according to the EBRI Tax Estimating and Analysis Model. ment revenues. efforts as good to fair (Employee Benefit Research which the portfolio locks in that yield. However, this communicate the intended use of the funds when percent of an employee’s adjusted gross income. contributed. A monthly periodical from the EBRI Education and Research Fund devoted to expert evaluations of a single employee benefit issue March 1991 March 1991 March 1991 March 1991 March 1991 March 1991 March 1991 March 1991 March 1991 March 1991 March 1991 March 1991 March 1991 EBRI Issue Brief EBRI Issue Brief EBRI Issue Brief EBRI Issue Brief EBRI Issue Brief EBRI Issue Brief EBRI Issue Brief EBRI Issue Brief EBRI Issue Brief EBRI Issue Brief EBRI Issue Brief EBRI Issue Brief EBRI Issue Brief March 1991 March 1991 March 1991 March 1991 March 1991 March 1991 March 1991 March 1991 March 1991 March 1991 March 1991 March 1991 u u u u u u u u u u u u u 1 5 11 23 9 15 7 3 25 17 13 19 21 10 16 6 18 12 14 2 20 22 4 8 24 uuuu uuuuuuuu EBRI Issue Brief EBRI Issue Brief EBRI Issue Brief EBRI Issue Brief EBRI Issue Brief EBRI Issue Brief EBRI Issue Brief EBRI Issue Brief EBRI Issue Brief EBRI Issue Brief EBRI Issue Brief EBRI Issue Brief |
Are retiree health insurance premiums paid by employer taxable
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