Objective 7

Question 1

Reasons for offering a retiree group benefit plan

Answer 1

1. Retiree group benefits are a tax-effective means of providing retirement financial security
2. Retiree benefits are a valuable benefit for those currently receiving the coverage or who are soon to retire
3. The benefits can support workforce planning and growth opportunities for EEs
4. Providing ongoing health care coverage is a social responsibility of the ER
5. Retiree health care benefits help provide a competitive package of total compensation
6. Current cash costs are nominal relative to the total spending on benefits
7. Retiree benefits are often at the top of the list of union demands

Question 2

Methods for coordinating benefits with Medicare

Answer 2

C = covered expenses
M = the Medicare payment
% represents the application of the ER’s benefit provisions
1. Standard COB: plan payment = the lesser of (C * %) or (C - M)
2. Exclusion: plan payment = (C - M) * %
3. Carveout: plan payment = (C * %) - M
4. Supplemental plans (Medigap)

Question 3

Recent plan design changes to control retiree medical plan costs

Answer 3

1. Making eligibility requirements more stringent
2. Introducing service-related benefits
3. Adjusting retiree contributions based on the EE’s age at retirement
4. Setting the ER subsidy as a fixed dollar amount rather than as a percentage of plan costs
5. Providing an account-based ER subsidy

Question 4

Characteristics of the ideal vehicle for prefunding retiree benefits

Answer 4

1. Company tax deduction
2. Tax-free or tax-deferred savings mechanism for EEs
3. Tax-sheltered investment earnings
4. Tax-free benefits for retirees
5. There is no impact on plan design provisions
6. Funds are not counted as an asset under FAS 106
7. Assets are revocable if the obligation to the plan changes

Question 5

Vehicles used to prefund retiree benefits

Answer 5

1. Welfare benefit funds
2. 401(h) funding in a qualified pension trust
3. Incidental account in a profit sharing plan
4. EE-purchased group annuiteies
5. EE Stock Ownership Plans with a money purchase plan account
6. Qualified retirement trust funds

Question 6

FAS 106 attribution of costs

Answer 6

1. Expected future payments must be accrue while each EE is working
2. The period when benefits are accrued is called the attribution period and usu. begins with hire and ends with full eligibility
3. The net periodic postretirement benefit cost is the amount attributed to a specific financial accounting period
4. The expected postretirement benefit obligation (EPBO) is the actuarial present value of all future postretirement benefit payments for the individual
   a. The EPBO is allocated among the amounts attributable to service before the measurement date (APBO), service in the current year (service cost), and future cost
5. APBO = Accumulated postretirement benefit obligation
   a. Expected APBO = (Current APBO + Service Cost) * (1 + d) - (Benefit payments) * (1 + 1/2d)

Question 7

Components of the FAS 106 net periodic postretirement benefit cost

Answer 7

Cost = service cost + interest cost - expected return on assets + amortizations

1. Service cost - cost of benefits accruing in the current period
2. Interest cost - interest on the APBO, the service cost (if not EOY), and minus the interest on benefit payments (assumed to be paid uniformly throughout the year) all at the discount rate. = (APBO + SC) * d - BP * (d / 2)
3. Expected return on plan assets = Assets * i - BP * (i / 2)
4. Amortization of net transition obligation or asset
   a. The net transition obligation is the difference between APBO and plan assets when FAS 106 was first adopted
   b. Amortization is straight line to expected retirement date (can use 20 years if the calculated amortization period was less than 20 years)
5. Net amortization and deferral
   a. Amortization of gains and losses - a gain or loss is the change in APBO resulting from a change in assumptions, or experience that is different than assumed. Can defer recognition until the amount exceeds 10% of the greater of the APBO or the plan assets. Amortize to expected retirement, or use another method with faster amortization.
   b. Prior service cost (plan amendment) - the change in the APBO due to a plan amendment. Amortize over the expected future service to full eligibility date of active EEs.

Question 8

Formula for accrued or prepaid expense for postretirement benefits

Answer 8

1. An accrued expense for postretirement benefits results when the cumulative amount expensed exceeds the cumulative cash outlay
2. A prepaid expense for postretirement benefit results when the cumulative cash outlay exceeds the cumulative amount expensed
3. Accrued expense = prior period accrued expense + net periodic postretirement benefit cost - contributions (plan funding and benefit payments)

Question 9

Footnote disclosures for FAS 106

Answer 9

Includes an explanation of many key assumptions and financials, including:
1. Reconciliation of assets and APBO balances
2. Breakdown by component of annual cost
3. Discount rate
4. Assumed health care trend rate
5. A description of any alternative methods used
Certain disclosures are not required for nonpublic entities

Question 10

Plans covered by FAS 106

Answer 10

1. Single employer plan
2. Multiemployer plan
3. Multiple employer plan
4. Individual contracts
5. Non-US plans

Question 11

Accounting for FAS 106 settlements and curtailments

Answer 11

1. A settlement is an irrevocable transaction which relieves the ER of the benefit obligation:
   a. The max recognized gain/loss is the unrecognized gain or loss, plus any remaining net transition asset
   b. The max gain/loss is prorated, depending on the fraction of the APBO settled
   c. Gains are first used to reduce any unrecognized transition obligation, then any remaining gain is taken into earnings. Losses are taken into earnings.
2. A curtailment is an event which significantly reduces the expected service of plan participants or eliminates defined benefit accruals for a significant number of active participants:
   a. The gain/loss equals the sum of:
   i. Change in the APBO netted against any previously unrecognized net gains/losses
   ii. Special loss equal to the portion of prior service cost and unrecognized transition obligation that is attributable to future years of service that are eliminated
   b. Gains are taken when EEs are terminated or the amendment is adopted. Losses are taken when the curtailment is probably and can be reasonably estimated.

Question 12

Accounting standards for EE benefit programs

Answer 12

1. FAS 106
2. IAS 19 from the International Accounting Standards Board (IASB)
3. Section 3461 from the Handbook of the Canadian Institute of Chartered Accountants (CICA) - designed to mirror US standards
4. Statements 43 and 45 of the Government Accounting Standards Board (GASB) - for state and local gov’ts in US
5. FASAB 5 from the Federal Accounting Standards Advisory Board (FASAB) - for US federal gov’t plans

Question 13

Tasks of the actuary under IAS 19

Answer 13

1. Allocating expected benefits between past and future years of employment
2. Making assumptions about future experience in areas such as economics and demographics
3. Performing actuarial valuations to calculate the service cost and the defined benefit obligation
4. Preparing all information needed for the IAS 19 footnote disclosures

Question 14

Actuarial assumptions needed for calculating the IAS 19 benefit expense

Answer 14

1. Discount rate - based on market yields on high quality corporate bonds
2. Expected rate of return on assets
3. Salary increases
4. Benefit increases
5. Pre-retirement mortality
6. Termination
7. Disability
8. Retirement age
9. Duration of benefit payments

Question 15

Components of the IAS 19 benefit expense

Answer 15

Benefit expense = service cost + interest cost - expected return on assets + amortizations + other items

1. Service cost - benefit earned by the EE during the plan year minus any EE contributions
2. Interest cost - defined benefit obligation times the discount rate
3. Expected return on assets - expected rate of return times plan assets
4. Amortization of past service costs - must be amortized over average period until these benefits become vested
5. Amortization of gains and losses - recalculated each year by dividing the amount to be amortized by the average future working lives of the population. Can defer recognition until the amount exceeds 10% of the greater of the DBO or the fair value of assets
6. Other items - such as effect of any curtailment or settlement

Question 16

Options for handling the transition obligation resulting from Canadian Section 3461

Answer 16

1. Prospective application - amortized over expected average remaining service lifetime of the EE group
2. Retrospective application - taken as a 1-time charge to opening retained earnings
3. Match US figures

Question 17

Significant differences between Canadian Section 3461 and US accounting standards

Answer 17

1. Canadian standards place a limit on the accrued pension asset that can be recognized on the balance sheet
2. Canadian pension standards do not require poorly funded pension plans to recognize a minimum liability on the balance sheet

Question 18

Types of other posetemployment benefits (OPEB) plans

Answer 18

1. Single-employer plan
2. Agent plan - serves multiple ERs w/ separate actuarial valuations
3. Cost-sharing plan - serves multiple ERs w/ one actuarial valuation

Question 19

GASB standards for ERs sponsoring OPEB plans

Answer 19

1. Standards for ERs in single and agent OPEB plans:
   a. The OPEB cost and the Net OPEB obligation must be calculated and included in the ER’s financial statements
   b. Required disclosures are Notes to the financial statements, Schedule of funding progress, and Schedule of ER contributions
2. Standards for ERs in cost-sharing OPEB plans:
   a. The required contribution to the cost-sharing plan is reported as the OPEB expense
   b. The OPEB liability is calculated as the difference between the required contributions and the contributions actually made
3. Standards for OPEB plans - the same disclosures as listed above for ERs are required here, plus a Statement of net plan assets and Statement of changes in net plan assets

Question 20

Assumptions needed for the valuation of pension plans

Answer 20

1. Economic assumptions:
   a. Inflation
   b. Discount rate
   c. Salary increase
   d. Social Security benefit increase
2. Demographic assumptions:
   a. Termination rate
   b. Mortality rate
   c. Disability rate
   d. Retirement rate

Question 21

Additional assumptions needed for the valuation of retiree life and health plans

Answer 21

In addition to the pension assumptions.

1. Economic assumptions:
   a. Current retiree plan costs
   b. Current retiree contributions
   c. Health care cost trend - should grade down over time to a lower level than today’s trends
   d. Medicare Part B premium rate increase
   e. Retiree contribution rate increase
2. Demographic assumptions:
   a. Plan participation
   b. Spouse plan participation
   c. Dependent children plan termination
   d. Plan design change

Question 22

Common problems in setting assumptions for retiree group benefit plan valuations

Answer 22

1. Under age 65 premium - difficult because experience is blended with active EEs
2. Composite premiums - may not differentiate between retirees, EEs, and dependents
3. Spouse/dependent premium - may be based on age of retiree rather than dependent
4. Old premium structure
5. Missing data
6. Different plans - plan provisions may change
7. Costs by age - few sponsors have enough retiree experience to develop

Question 23

Modified pension methods to use for the valuation of retiree life and health plans

Answer 23

1. Modified projected unit credit (required attribution method under FAS 106)
2. Delayed funding eligibility (can be used with any actuarial method
3. Modified entry age (used for welfare benefit fund calculations)

Question 24

Steps in measuring retiree group benefit obligations

Answer 24

1. Develop a model that represents plan provisions, the covered populations, and the current and projected benefit costs
2. Evaluate the quality and consistency of data used in construction of the model, and make appropriate adjustments
3. Identify administrative inconsistencies and make appropriate adjustments
4. Select projection assumptions
5. Measure the obligations and, when necessary, allocate costs to time periods
6. Review and test the results of the calculations

Question 25

Factors that impact health care trend

Answer 25

1. General economic inflation
2. Medical inflation
3. Definition of covered charges
4. Utilization of services
5. Leveraging caused by plan design features such as fixed-dollar copays
6. Aging of the covered population
7. Participation