Objective 7 - Retiree Benefits

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 employees
4. Providing ongoing health care coverage is a social responsibility of the employer
5. Retiree health care benefits help provide a competitive package of total compensation
6. The 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 employer’s benefit provisions

1. Standard coordination of benefits: plan payment = the lesser of (C * %) or (C - M). The plan pays the lesser of regular plan benefits) or (covered expense - Medicare). Aka COB.
2. Exclusion: plan payment - (C - M) * %. Exclude the Medicare payment, then apply the benefit formula of the secondary plan.
3. Carveout: plan payment = (C * %) - M. Apply the benefit formula first, then subtract the Medicare payments.
4. Supplemental plans (Medigap)

Question 3

Recent plan design changes to control retiree medical plan costs

Answer 3

1. Making eligibility requirements more stringent (eg. age 60 with 15 years of service)
2. Introducing service-related benefits (i.e., varying the employer cost share based on length of service)
3. Adjusting retiree contributions based on the employee;s age at retirement (i.e., early retirement reductions)
4. Setting the employer subsidy as a fixed dollar amount rather than as a percentage of plan costs
5. Providing an account-based employer subsidy (e.g., the employee earns a set amount for his account for each year of service)

Question 4

Characteristics of the ideal vehicle for prefunding retiree benefits

Answer 4

1. Company tax deduction - for contributions that adequately fund retiree health benefits
2. Tax-free or tax-deferred savings mechanism for employees
3. Tax-sheltered investment earnings
4. Tax-free benefits for retirees
5. There is no impact on plan design provisions
6. Funds are 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 - such as VEBAs or continuance funds held by an insurance company
2. 401(h) funding in a qualified pension trust
3. Incidental account in a profit sharing plan
4. Employe-purchased group annuities
5. Employee Stock Ownership Plans with a money purchase plan account
6. Qualified retirement trust funds - pension plan or 401(k) profit sharing plan

Question 6

FAS 106 attribution of costs

Answer 6

1. Expected future benefit payments must be accrued while each employee is working (pay-as-you-go accounting is no longer allowed)
2. The period when benefits are accrued is called the attribution period, and usually begins at hire and ends at full eligibility (which is normally shorter than the full working lifetime)
3. The net periodic postretirement benefit cost (aka “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 expected 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 service
5. APBO = Accumulated postretirement benefit obligation
   a) Expected APBO = (Current APBO + Service Cost) * (1 + d) - (Benefit payments) * (1 + 0.5d)

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 - the cost of benefits accruing in the current period
2. Interest cost - interest on the APBO, the service cost (if not at end of year), 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 = Assetsi - BP(i/2)
4. Amortization of net transition obligation or asset
   a) The net transition obligation is the difference between the APBO and plan asset 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 employees. If most participants are inactive or eligible for retirement, use life expectancy instead.

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 exceed the cumulative amount expensed
3. Accrued expense = prior period accrued expense + net periodic postretirement benefit cost - contributions (plan funding and benefit payments)

Question 9

Assumptions needed for the valuation of pension plans

Answer 9

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 10

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

Answer 10

(In addition to the pension assumptions that were listed separately)

1. Economic assumptions
   a) Current retiree plan costs - the starting point for projecting future benefit costs
   b) Current retiree contributions - the starting point for projecting future contributions
   c) Health care cost trend - should represent expected long-term trends. Trend rates should grade down over time to a lower level an today’s trends (such as GDP plus one percentage point).
   d) Medicare Part B premium rate increase - employers who pay this premium for the retiree need an assumption for future increases
   e) Retiree contribution rate increase - should reflect the current and expected future policies regarding retiree contributions to the plan
2. Demographic assumptions
   a) Plan participation - needed if a retiree contribution is required (watch for antiselection)
   b) Souse plan continuation after death of retiree - needed if a contribution is required
   c) Dependent children plan termination - since dependents’ ages are normally not recorded, an assumption is needed for when the limiting age is reached
   d) Plan design change - a valuation may account for future plan design change is changes are expected

Question 11

Common problems in setting assumptions for retiree group benefit plan valuations

Answer 11

1. Under age 65 premium - determining the costs for under age 65 participants is difficult because their experience is blended with active employees
2. Composite premiums - current rate may be on a per employee basis, rather than having separate rates for retirees, spouses, and children
3. Spouse / dependent premium - data for dependents may be based on the age of the retiree, rather than the age of the dependent
4. Old premium structure - the current premium differences between actives and retirees may be based on outdated studies
5. Missing data - some claims data may be missing
6. Different plans - costs developed for current retirees may not be applicable for future retirees due to different plan provisions
7. Costs by age - few plan sponsors will have enough retirees to develop the needed costs by age

Question 12

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

Answer 12

1. Modified projected unit credit (required attribution method under FAS 106) - benefit must be accrued by the full eligibility date (as opposed to the expected retirement date used for pension funding)
2. Delayed funding eligibility (can be used with any actuarial method) - include only participants that are most likely to get benefits (those meeting certain age and service requirements)
3. Modified entry age (used for welfare benefit fund calculations) - uses standard entry age normal method with entry age at later of the hire date and the date the benefit fund was adopted

Question 13

Procedures for measuring retiree group benefit obligations and determining program costs and contributions

Answer 13

1. Identify the purpose of the measurement
2. Identify the measurement date
3. Develop a model that represents the plan provisions, the covered population, and the current benefit costs
4. Evaluate the quality and consistency of data used in the model and make appropriate adjustments
5. Identify administrative inconsistencies and make appropriate adjustments
6. Obtain from the principal other information necessary for measurement
7. Select actuarial assumptions
8. Evaluate retiree group benefit assets
9. Consider how to measure accrued or vested benefits
10. Consider how to measure market-consistent present values
11. Reflect how asset as of the measurement date are reported
12. Select an actuarial cost method
13. Select a cost allocation procedure or contribution allocation procedure
14. Assess the implication of the contribution allocation procedure or plan sponsor’s funding policy
15. Consider the use of approximations and estimates
16. Consider the sources of significant volatility
17. Review and test the results of the calculations for reasonableness
18. Evaluate prescribed assumptions and methods set by another party

Question 14

Considerations in modeling plan provisions for retiree group benefit plans

Answer 14

1. Components of the modeled plan
   a) Covered benefits
   b) Eligiblity conditions
   c) Benefit limitations, exclusions, and cost-sharing provisions
   d) Participant contributions - required contributions may affect participation rates and lead to adverse selection
   e) Payments from other sources
   f) Health care delivery system attributes
   g) Benefit options
   h) Anticipated future changes - for most purposes, only changes that have been communicated to participants may be considered. But in some cases, the actuary may take into account future changes that the sponsor intends to implement.
2. Historical practices of the plan, such as:
   a) Claim payment practices - consider whether there is a significant inconsistency between administrative practice and plan documents
   b) Pattern of regular plan changes - consider any past practices of regular changes in the benefit plans
   c) Governmental programs - if the retiree plan integrates with Medicare or other government programs, consider historical changes in these programs
3. Whether the model continues to reflect actual known plan provisions and practices
4. Whether the results need to be examined by category (eg. medical vs. dental)

Question 15

Considerations in modeling the covered population for retiree group benefit plans

Answer 15

1. Census data - collect sufficient census data to make a reasonable estimate of the obligation
2. Employees currently not accruing benefits - consider whether these employees might begin accruing benefits in the future
3. Contingent participants - examine census data to determine who may become participants in the future
4. Dependents and surviving dependents of participants - include these individuals if they are eligible for coverage and participating
5. Appropriateness of pension plan data - if the plan sponsor maintains pension plan data but not retiree group plan data, the pension plan data may be used with proper adjustments
6. Use of grouping - the actuary may use grouping techniques when grouping is not expected to unreasonably affect the measurement results
7. Hypothetical data - when appropriate, the actuary may prepare measurements based on assumed demographics of current or future plan participants

Question 16

Considerations in modeling initial per capita health care rates for retiree group benefit plans

Answer 16

1. Plan experience (if credible) is the best source of data
2. Multiple rates (such as by gender) may be appropriate to reflect different plan provisions and demographics
3. Exposure data should be obtained for the same time periods and population as the claims experience
4. Multiple claims experience periods may be used, with smoothing
5. When plan data is not available or credible, use relevant databases or active plan experience on the same group (with proper adjustments)
6. May use premiums as the basis for initial per capita health care rates, with appropriate adjustment
7. Develop separate rates for participants eligible for Medicare
8. Age-specific costs should be used for projecting future costs
9. Adjust claim costs to reflect:
   a) Benefit plan design changes
   b) Changes in claim adjudication and enrollment practices
   c) The impact of large individual claims
   d) Trend, with separate rates for major cost components (such as medical and drug)
10. Include administrative and other expenses for the plan sponsor