In today’s fiscally prudent economic environment, companies would generally not be looking to reward short- or long-service employees with retirement gifts in excess of $50,000 just because they worked for a number of years and achieved age 55 while employed.
They would be even less inclined to do so when they realized this retirement gift came with another six per cent to 16 per cent load of tax and administration expenses, and a need to maintain lifetime contact.
However, such gifts are still bestowed on new employees at almost 48 per cent of companies in the form of post-retirement benefits, according to the Aon Hewitt benefit database.
In many cases, the promise of non-pension retirement benefit coverage was introduced when the most expensive drug therapies were under $100 per year and provincial medicare programs provided extensive coverage without income tests or user contribution requirements.
For many employers, the promise of retirement benefits is an important part of the total compensation strategy. But for those looking to extricate themselves from legacy financial promises, it is significantly more difficult to exit these promises. For plan sponsors with sufficient cash resources, there are two options available that can result in a reduction of non-pension, post-retirement benefit liability: insurance settlement and employee buyouts.
Typically, non-pension, post-retirement benefit programs are defined benefit in nature, with a fairly open-ended list of eligible medical and dental expenses. Generally, new therapies are automatically included as eligible expenses. It is this open-ended promise that makes it difficult for a plan sponsor to “buy” its way out of these programs.
There are a number of unfavourable factors a plan sponsor faces when assessing the financial considerations of a program.
• a low discount rate environment for the foreseeable future
• longer than expected lifetimes
• a probable return to persistently high medical inflation
• accounting changes that increased the burden of these plans on the corporate profit- and-loss statement and their balance sheet
• increasing year-over-year cash commitments
• changing provincial medicare programs
• the evolution of new and costly medical therapies.
The concept is straightforward. The solution is to sell the entire obligation (or part thereof) to an insurance carrier in exchange for a single premium payment. The advantages are:
• The complete transfer of risk means the liability can be “settled” from an accounting perspective. This eliminates the obligation from the plan sponsor’s balance sheet and the ongoing expense from the profit-and-loss statement.
• Through the single premium deposit, the benefit commitment to retirees will be fulfilled by the insurance company. By transferring the risk to a third party, the plan sponsor absolves itself of the financial and administrative responsibilities of operating this plan. Should the insurance company fail to meet its obligations, there may be negative fallout for the original plan sponsor. However, assuming best practices and good governance were employed during the initial stages, this fallout can be expected to be minimal.
The reason it is often difficult to find an insurance company ready to accept the risk associated with a retiree benefit program is because the risk is both long-term and complex. There are different types of expenses that are part of the retiree benefit program: physiotherapy and other paramedical expenses; prescription drug expenses; medical equipment and medical service, emergency and non-emergency; and all the different types of dental expenses.
Also making it more complex and long-term is this coverage is for the remaining lifetime of the group of retirees and usually their dependants. The duration of the promise is until the last eligible member of the group passes away — depending on the group, this could be 50 years or longer.
These types of projects are rarely transitioned to an insurance company successfully. Single premiums are often greater than 100 per cent of the obligation recorded on a plan sponsor’s balance sheet, and can sometimes be double this amount because the insurance carrier’s assumptions are more conservative than the assumptions used by the plan sponsor.
This is rightly so, since the insurer is assessing the risk in a very different manner than when the plan sponsor is developing “best estimate” assumptions for the annual balance sheet disclosure exercise. The insurers will also shy away from or request changes to plan design elements that are unlimited (meaning unlimited lifetime maximums on drug or health expenses).
Thus, to successfully execute a single-premium insurance settlement, significant cash reserves are required to purchase insurance coverage. The plan sponsor must determine whether the single premium is worth the transfer of risk.
For a look at the second option — employee buyouts — to reduce non-pension, post-retirement benefit liability, see article #17918 on www.hrreporter.com.
Greg Durant and Nabil Merali are both at Aon Hewitt in Toronto. Durant is chief actuary in the health and benefits practice and Merali is a health-care consultant in the Canadian health management practice. For more information, visit www.aonhewitt.ca.