GHC 816-16: US Employers' Accounting of Postretirement Benefits Other Than Pensions Flashcards
Comments
- Liabilities are simply the present value of the expected payment streams (i.e. how much is owed by the company to the employees in the future)
- Payments are made for retirees from today up until they point that they are no longer part of the plan (due to death or the end of payment eligibility)
- Payments for active employees are projected from the point in which they would occur (after retirement) back to the date of retirement, and then projected back from that date to today. Decrements such as termination from the company, disability, and death must be considered - Expected Postretirement Benefit Obligation (EPBO) is the total liability amount expected to be paid (as a present value)
- Accrued Postretirement Benefit Obligation (APBO) is the portion of the total liability amount expected to be paid (as a present value) that has been earned/accrued as of today
- Service Cost is the portion of the EPBO that is earned/accrued during one single year
- Net Periodic Postretirement Benefit Cost (NPPBC) is simply a one year cost/expense based on the overall liability
- It accounts for the increase in APBO during the year, the interest on the liability amount, interest on any assets and a delayed recognition (amortization) of certain plan changes and adjustments
Introduction
- Financial Accounting Standard No. 106 (FAS 106) effective for fiscal years beginning after December 1992
a. Provided guidance in US employers’ accounting for postretirement benefits other than pension (i.e. retiree medical and other coverage) - All generally accepted accounting principles were re-codified into Accounting Standards Codification (ASC)
- FAS 106 is now under ASC 715-60
a. i.e. new references should be to ASC 715-60, not FAS 106
Projected Unit Credit Method
- Expected Postretirement Benefit Obligation (EPBO) – present value of expected future benefit payments to be paid to or for an employee (and dependents) under the terms of the postretirement benefit plan
- [Present value of all benefits expected to be paid now and in the future for the plan] - Accrued Postretirement Benefit Obligation (APBO) – present value of the benefits attributed to
employee service rendered as of a given date
a. i.e. portion of the overall EPBO that is attributed to past service and already earned as of that date
b. [Present value of all accrued benefits to be paid for the plan. As of today, this captures the service that employees have completed and the benefit as of now that has been accrued. This captures the value of the future payments that have already been earned through the employee’s service, but it does not capture additional values that will be accrued with future service.]
- Service Cost – present value of expected benefits that is attributed and earned during the current year only
- Projected unit credit method – assumes that present value of all expected future benefit payments (or EPBO) is earned over the benefit’s attribution period
a. Used to determine APBO and Service Costs - Attribution period = service between #1 and #2
#1. Date when employee first starts accruing a benefit
- Could be date of hire or could be when they meet eligibility criteria such as age/service levels
#2. Date when benefit is fully accrued (“Full Eligibility Date”)
- i.e. additional service will not lead to a material amount of additional benefits - In most cases, an equal amount of the EPBO is attributed to each year of service (unless plan provisions dictate a disproportionate share per year of service)
a. For benefits not based on service, date the attribution period ends is typically the first day that employee is eligible to retire and get benefits
b. For benefits based on service or earnings at retirement, date the attribution period ends is typically the same as assumed retirement date
c. Possible for Health and Life benefits to have different attribution periods to determine APBO and Service Cost - Allocate EPBO over employee’s attribution period (benefits accrue and are accounted for during the time in which they are earned)
a. Annual charge to Profit & Loss statement (Service Cost)
b. Accumulation of liability on Balance Sheet (APBO)
c. Goal is to ensure full present value of benefits is expensed by the time employee is eligible - APBO = EPBO that is attributed to service earned as of that date
- Service Cost = EPBO attributed to the current year only
a. Once attribution period ends (employee reaches full eligibility), Service Cost = 0
Illustration of APBO and Service Cost Calculation for Active Member
- Project benefit stream payable from retirement and onwards
- Various actuarial assumptions needed - Determine present value of projected benefits at retirement date
- Discount each year’s payment with interest rate - Discount present value from retirement date back to valuation date to get EPBO
- Various actuarial assumptions needed - Attribute EPBO on pro-rata basis over Past Service and Future Service
a. Attribution Service
- Past Service = time from Date of Hire to Valuation Date
- Future Service = time from Valuation Date to Full Eligibility Date
- Attribution Service = Past Service + Future Service
b. APBO = EPBO x Past Service / Attribution Period
c. Remainder of EPBO is deemed to be earned over Future Service
c. Service Cost = EPBO / Attribution Period
d. If employee is past full eligibility date, Service Cost = 0
Actuarial Assumptions
- Assumptions should reflect best estimate of future events that affect the APBO
2. Factors Influencing Choice of Best Estimate Assumptions for Postretirement Benefits
a. Plan provisions
b. Characteristics of current and past employees
c. Collective bargaining agreements
d. Past experience in plan
e. Expectations of benefit changes over time
f. Future plan experience expectations
g. Financial market expectations
h. Government legislative change expectations
i. Current assumptions used for other plans sponsored by the entity (e.g. pension plans)
3. Additional unknowns that will affect future payment streams and require assumptions:
a. When members retire
b. How long members will live
c. Probability of claims and when they will occur
d. Whether members have covered dependents or not
- Assumptions generally split into two groups
a. Healthcare Assumptions (mostly short-term, though a few long-term)
b. Long-Term Assumptions
Long-Term Assumptions
- Discount Rate
- Salary Escalation
- Mortality Decrements
- Other Decrements
1. Discount Rate
a. Interest rate to discount cash flows
b. Should reference market yields at the valuation date of high quality corporate bonds
- If no deep market exists, can use government bonds as a reference
c. Reflects timing of estimated benefit payments
- Typically calculate a single weighted average discount rate based on spot rates that reflect the expected timing and amounts of future benefit payments
* Single rate should produce same expected value as the spot rates
d. Sensitivity of changes to discount rate can be measured with Modified Duration
- Modified duration is approximate percentage change in APBO for 1% change in discount rate
* Represents average time of payment of benefits, weighted by the present value of expected benefits
e. Entity has little control over the discount rate
- Governed by market conditions
f. Single weighted-average discount rate approach is used to measure APBO, Service Cost and Interest Cost for the period
g. Alternative approaches to using single weighted-average rate
- Separate single weighted-average rates for Service Cost earned during the year and Interest Cost (interest earned on aggregate benefit obligation)
- Separate single weighted-average rates for Service Cost earned during the year and separate single weighted-average rates for active and retired members for the
Interest Cost
- Separate single weighted-average rates for Service Cost earned during the year and separate single weighted-average rates for each individual member for the Interest Cost
- Separate discount rates for each future projected benefit payment. Discount rates could be the spot rates associated with each payments’ individual PV for APBO or Service Cost
h. Plans should confirm the method of determining the rate with the auditors
2. Salary Escalation
a. Assumption to project current salary to expected salary at retirement
- Some benefits (such as life insurance) may be based on salary at retirement
b. Based on expected adjustments for inflation and merit increases
c. Negotiated collective bargaining agreements should be reflected
d. Assumption should be consistent with pension valuation (if definition of earnings is similar)
3. Mortality Decrement
a. Probability that member dies
b. Typically based on age and gender
c. Use standard population tables
- May be adjusted based on actual plan experience
- Standard tables often make adjustments for future improvements in mortality
d. Current/most up-to-date table is RP-2014
e. Usually consistent with pension valuation
4. Other Decrements
a. Retirement
- Based on age and sometimes service
- Plan provisions and health status of employees could affect this
b. Termination
- Leaving the company other than death or retirement
- Based on age, service and may be split by gender
- Based on actual plan experience or industry tables
- Plan provisions, geography and nature of work can affect this
c. Disability
- Becoming disabled or terminating from that disability
- Similar considerations to termination above
d. All three should be consistent with pension assumptions
Healthcare Assumptions
- Per-capita Claims Costs
- Healthplan Inflation / Trend Rates
- Administative Expenses
- Medicare Considerations
- Medical Costs Aging
- Participation
- Percentage of EEs with covered Dependents
1. Per-Capita Claims Costs
a. One of the key assumptions
b. Average amount an individual is expected to claim in a particular year
c. Usually the average expected amount of claims in that year by a retired individual and then used to project average claims for future years
d. References actual plan experience, type of benefit, age group, credibility of data and expected future plan changes
e. E.g. could analyze claim costs over a set multi-year period and determine average claims cost per individual (retirees with family coverage would typically be counted twice to
account for dependent coverage), and then average cost would be indexed with a trend rate
f. Setting retiree medical cost assumptions is different than setting budget or premium rates
- Certain plan experience can be combined for one claims cost
- Population that will incur the costs is different than the population today
g. Considerations in Setting Retiree Medical Cost Assumptions
(1) How many different claims costs are needed for the population and different benefit types
(2) What data is available
- Do you have sufficient data and is the population going to stay the same?
- If data isn’t available, may need to rely on active data with aging and behavior adjustments
(3) Employer Caps on the Subsidy
- Employers may limit the amount they subsidize up to a fixed dollar “cap”
- Cap can be applied in many ways, so there are additional complications:
A. Gross vs. Net Cap – retiree contributions for amount above the cap may be in addition to what they already pay based on some formula of years and service, so cap can be either on gross costs or net costs
B. Blended Active/Retiree Costs – projection of blended active/retiree cost is needed to apply the cap, but also a projection of retiree only costs is needed to capture the portion of liability due to difference in these two amounts
C. Cap Increases – if employer periodically increases the cap, there is effectively no real cap, and thus the valuation should not value a cap
(4) Retiree claims experience is different than active experience
- Retiree populations aren’t as stable as active
* Lots of movement in and out of the group
- Amount of retiree claims data is limited
* Often use 3-5 year averages to smooth out data
- Small groups can use manual rates or rates adjusted from the active population
* Claims data must be clear on “mixed” or “split” contracts
- Claims vary pre and post-Medicare eligibility, so must be aware of data such as pre-Medicare retiree with Medicare eligible spouses, or vice versa
(5) Using premium rates
- Retiree premium rates and retiree medical claims costs for accounting serve different purposes
* Premium rates are for given year
* Claims costs are used to project up to 30 years into the future
* Premiums often swing year to year, and that would cause big swings in the retiree medical liability
* Fully insured premiums are often provided to employee on a combined active/retiree basis, so retiree portion would have to be split out
* If premiums weren’t developed internally, assumptions built into those premiums are not known and may not reflect the population and expectations
* If premiums were developed internally, must determine if they are appropriate for use as liability and then age-adjust the premiums
(6) Future changes in benefits
- Changes in benefits must be reflected at earlier of: when change become known or when it’s communicated
- If employer knows they will have a new vendor or plan design, this should be reflected in the valuation
* Can be accounted for in the claims costs or in the trend
* Special accounting may be triggered (i.e. creation of a prior service cost)
- When regulatory changes are known, they must be reflected in valuations
* Even if the change will not occur until the future
E.g. Retiree Drug Subsidy of 2006 and ACA Excise
Tax on “Cadillac” plans in 2018 both accounted for when they were first announced
2. Health Plan Inflation / Trend Rates
a. Rate of change in annual health costs
b. Often benefit specific because benefits react differently to different factors
c. Factors that Affect Health Care Trend Rates
- General Inflation and Real Health Care Inflation interaction (health usually is general inflation plus a positive margin)
- Changes in Utilization
- Behavioral Patterns of Population
- GDP (government financing may be affected by growth in GDP or proportion spend on health costs)
- Type of Benefits (e.g. prescription vs. medical)
- Geographical Location of Services
- Integration with Government Programs
- Plan Provisions (maximums, deductible and copays)
d. Trend assumptions usually consist of:
- Short-term rate reflecting recent experience
- Long-term (ultimate) rate reflecting long-term horizon
- Transitional rates to move from short-term to long-term
* E.g. 8% per year, reducing for a period of 15 years down to 4% ultimate rate
e. Health care trends rates have been greater than GDP growth rate, so short-term rates have been high
- High growth can’t be sustained over the long term, as it would erode the economy, so trends rates are expected to grade down to the GDP growth rate (plus appropriate margin)
- Rates usually grade down with simple straight-line approach
f. Must consider type of benefit, overall impact on valuation results and plan provisions
g. Trend rates may experience leveraging effect if there is a fixed dollar deductible
3. Administration Expenses
a. Fully-insured premiums have retention load built in as pct. of claims costs
b. Self-insured plays pay insurance companies a fee to administer the benefits
c. Admin expenses must be built into valuation, and these may have a lower trend rate than medical costs
4. Medicare Considerations
a. Medicare has a fee schedule for procedures which helps keep overall trend low
b. Per capita claims and trend should be different for Medicare eligible and pre-Medicare population
c. Prescription drugs have higher trend rate and may use different assumptions, so the mix of medical and prescription costs should be considered
5. Medical Costs Aging
a. Need for certain benefits can change as a person ages
b. Assumption usually set based on industry studies (plan experience typically not credible)
6. Participation
a. Some eligible employees may elect not to get coverage (e.g. if the plan requires contributions)
7. Pct. Of Employees with Covered Dependents (and their age)
a. Dependents may be covered in some plans
- May be covered for their lifetime, the lifetime of the retiree or some other period
b. Determine probability that member may have a spouse during retirement
- Usually based on current marital status
c. For age of dependent, when not available, usually assume a margin above/below the age of the retiree (e.g. spouse assumed to be +3 or -3 years older or younger, based on gender of employee)
Accounting Items
- Funded Status and Net Periodic Postretirement Benefit Cost (NPPBC)
a. Funded Status = APBO - Fair Value of Plan Assets (if any)
- If plan is unfunded, Funded Status = APBO
b. NPPBC is the “cost” or “expense” of the plan in a period
c. NPPBC = Service Cost + Interest Cost - Return on Assets + Amortization of Unrecognized Amounts (Transition Obligation, Prior Service Cost, Net Gain/Loss)
- Change in APBO over a Year
a. APBO (EOY) = APBO (EOY) + Service Cost - Benefit Payments + Interest Cost + Prior Service Cost - Settlements + Curtailments (Gains)/Losses + Actuarial (Gains)/Losses
b. Service Cost
- Increase in APBO due to service in current year
- Zero for retired employees and actives that are past full eligibility date
c. Benefit Payments
- Annual cash flow expected to be paid in the year or released from the APBO
d. Interest Cost
- Increase in APBO due to interest over time
- Interest Cost = i x [APBO (BOY) + Service Cost - Benefit Payment/2]
- In some instances, Service Cost is measured at beginning of year, so Interest Cost will include interest on the APBO and the Service Cost
* In other instances, Service Cost is an end of year value that includes the interest earned on it
* Both approaches are acceptable, so it must be clear which approach is used
* [For exam purposes, typically assume Service Cost does not include interest already unless otherwise stated]
- Benefit payments are assumed to be paid uniformly during the year, so on average, interest is earned mid-year
e. Prior Service Costs
- Change in APBO due to plan amendments (e.g. introducing, removing or changing benefits)
* Can increase or decrease APBO
- If they decrease the APBO, they are “negative prior service costs”
- Measured at earlier of: when event occurs and when company recognizes related restructuring costs
- ASC allows these amendments to be recognized during the future service periods of when the employees expect to receive benefits under the plan (i.e. not recognized all at once)
- Prior service costs amortized as equal amount over each future period of service an active employee is expected to receive benefits under the plan
* If mostly retired population, amortize over a period based on remaining life expectancy
- Amortization of Prior Service Cost
* In general, amortized over average remaining service of employees to meet full eligibility for benefits
f. Actuarial (Gains)/Losses
- Change in APBO from changes in assumptions or difference between actual experience and expected experience
- Actuarial gain – reduces APBO (i.e. there is less liability, so you have a positive or a gain)
- Actuarial loss – increases APBO (i.e. more liability, so you have a negative or a loss)
- Gains and losses may offset each other in the future, so they can be amortized and not recognized all at once
- Amortization of Unrecognized Net Gain or Loss
* Amount of Net Gain/Loss above 10% corridor divided by average remaining service period of active members expected to receive benefits - Can use expected reamining lifetime if population is mostly retirees
* If gain/loss is below 10% corridor, no amortization is required - 10% corridor is 10% of APBO (or plan asseets, if higher)
* Amortization of Gain/Loss = (Gain/Loss above 10% Corridor) / Avg Remaining Service - 10% corridor = 10% x max(APBO, Assets)
g. Settlements
- Transactions that eliminate all future obligations of a plan (other than through normal terms of a plan)
- i.e. Company may pay a lump sum to members to buy-out the benefits owed
- Settlements reduce APBO
- Measured at the date the event occurs
- Impact to NPPBC could be a gain or a loss
- Maximum gain or loss to recognize is unrecognized gain or loss plus any remaining unrecognized transitional assets
- Maximum amount shall be recognized in earning if entire APBO is settled
- If only part of APBO is settled, company shall recognize a pro rata portion of the maximum amount
- If all settlements during the year are less than or equal to sum of Interest Cost plus Service Cost, then recognition is permitted but not required
h. Curtailments
- Events that significantly reduce the years of future service for active plan members or eliminate the benefit accrual for some or all future service
- e.g. Company may lay off significant portion of active workers, reducing the future expected service of active plan participants
- Impact of curtailment is accelerated recognition of any prior service cost and recognition of change in APBO
- Curtailment = Sum of:
i. Unrecognized prior service cost associated with years of service no longer expected to be rendered (this is a loss)
* E.g. if curtailment eliminates half of estimated future remaining service for those who were active at time of amendment, then the loss is half of the remaining unrecognized prior service cost related to that amendment
ii. Change in APBO (may be decreased (gain) or increased (loss))
* If gain exceeds any unrecognized net loss, it is a curtailment gain
* If losses exceed any unrecognized net gain, it is a curtailment loss
- Unrecognized transitional obligations, if any, are treated as unrecognized net gains for curtailment purposes
- Recognition Timing
* Net Curtailment Loss – recognized when it is probable that curtailment will occur and effects can be estimated
* Net Curtailment Gain – recognized when related employees terminate or plan amendment is adopted
i. Transition Obligations and Assets
- Arises when organization first applies ASC 715 for financial reporting
* Difference between APBO as of date of initial application and amount previously recognized
- Amortized over average remaining service (or life expectancy if population is mostly retired)
Sample Calculation
