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Accounting for Post Retiree Healthcare
White Paper
By Lawrence L. Bell, JD, LTM, CLU, ChFC, CFP, AEP
Elizabeth J. Weber, JD
January 2011

2. ACCOUNTING FOR POST RETIREE HEALTHCARE
The regulatory frenzy surrounding healthcare and accounting have created a perfect storm. But
this is nothing new. We are besieged with commentary that Medicare is nearly bankrupt and the
new accounting standards require transparency - mark to market and present value calculations of
long term liabilitiesi which creates havoc for tax planning and compliance. In light of the most
recent announcements there is a ―silver lining.‖ From a planning standpoint, state and local
governments (―SLGs‖), for profit and non-profit employers and unions can use a tool which will:
CREATE an immediate cost savings to the Plan Sponsor;
ROLL BACK any charge to earnings that would otherwise be booked before year end;
and
Provide ONGOING benefit savings over the long run reducing the Plan Sponsor’s
administration costs and human resources drain.
The Problem
Employers who provide post retiree medical and/or drug coverage are faced with increasing costs
and at the same time they must report the present value of the expected liability to comply with
generally accepted accounting principles. This is true whether using Financial Accounting
Standards Board (―FASB‖), International Accounting Standards Board (―IASB‖) or Government
Accounting Standards Board (―GASB‖) standards.
The Pieces of the Puzzle
Earlier this decade, in order to reduce the health care costs for retirees, legislation was passed to
provide a savings to the employer. The Retiree Drug Subsidy (―RDS‖) was established by the
Medicare Prescription Drug, Improvement, and Modernization Act of 2003 (―RSS03‖) for
employers that sponsored group health plans providing prescription drug benefits to retirees.
RDS03 created the Medicare Part D Program to provide prescription drug coverage to Medicare
participants. The purpose was to encourage employers to continue offering prescription drug
benefits to their retirees as opposed to terminating their retiree prescription drug benefit plans. If
the employer dropped former employees they would then be forced to seek benefits through
Medicare. Additionally many of these benefits were guaranteed through the collective bargaining
process or local law and therefore largely non modifiable.
Under RDS03, employers were qualified to receive a subsidy equal to 28% of covered
prescription drug costs for their retirees. Employers were entitled to an income tax deduction
upon receipt of the subsidy and were permitted to take this deduction into account when
accounting for their retiree prescription drug expenses.
The Patient Protection and Affordable Care Act (―PPACA‖) retained the Retiree Drug Subsidy,
but eliminated the employer’s ability to deduct the amount of the subsidy. This change obviously
increased the employer’s tax liability, which increased the employer’s cost of providing
prescription drug coverage to retirees. The amount by which an employer’s tax liability was
increased is dependent on the total amount of the subsidy and the employer’s applicable corporate
tax rate.
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3. While employers do not incur the higher tax liability until 2013, under financial accounting rules,
(ASC 715 formerly FAS 106, Employers’ Accounting for Postretirement Benefits Other Than
Pensions), employers must now include the present value of the future taxes as a current liability
charged against earnings.
Because of the increased cost of providing retiree prescription drug coverage, employers may
consider eliminating their retiree prescription drug benefits altogether. If an employer decides to
eliminate these benefits, retirees who were previously covered by the employer’s prescription
drug plan would be eligible to enroll for prescription drug coverage under Medicare Part D.
Although Medicare Part D has historically had a gap in coverage (referred to as ―the donut hole‖)
that made the program a much more expensive option for retirees compared to coverage under an
employer’s prescription drug plan, PPACA established a system to eliminate this gap or ―donut
hole.‖
Essentially, before PPACA, the program provided expansive benefits for the initial $2,830 in
prescription drug costs and for prescription drug costs above $6,440, but required enrollees to
bear the full cost of prescription drugs within the donut hole (between $2,830 and $6,440).
However, PPACA provides for enhanced Medicare Part D coverage, which progressively
narrows this gap between 2011 and 2020, thus making Medicare Part D a more financially viable
alternative to employer-provided prescription drug coverage. This enhanced Medicare Part D
coverage provides many employers with an additional reason to consider eliminating retiree drug
benefits.
By terminating its retiree drug benefits, an employer would avoid the increased tax liability and
current accounting hit to earnings. However, this course of action could potentially open the
employer up to legal and reputational liability.
Employers should consider the probability of litigation and reputational risk when terminating a
retiree drug plan. Relying on provisions of the Employee Retirement Income and Security Act of
1974, as amended (―ERISA‖), lawsuits can be filed by affected unions, retirees and plan
participants. While challenges to retiree benefit changes may not be successful in instances
where the company has been careful to reserve the right to amend or terminate health benefits it
will no doubt have an impact on employee morale. Termination of retiree prescription drug
coverage generally would result in negative media coverage, reputational risk and employee
dissatisfaction for the employer.
Usual Responses
Employers that provide retiree prescription drug coverage (RDS) will analyze the increased future
tax liability and the current accounting charges necessary to retain retiree prescription drug
coverage, and evaluate the practical and legal risks of eliminating this benefit. Employers that
decide to retain retiree prescription drug benefits must include the future tax liability of these
benefits into their current and projected earnings. Employers that eliminate retiree drug benefits
will incur negative employee reaction, negative, community and press coverage and potential
litigation in response to that decision.
The Rules
The accounting guidance for postretirement benefits under ASC Codification Topic 715,
Compensation - Retirement Benefits (formerly FAS 106) requires that measurements of benefit
obligations be based on facts and circumstances that exist on the measurement date. The
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4. measurement of the Accumulated Post Retirement Benefit Obligation (―APBO‖) for accounting
purposes after March 23, 2010 (the effective date of PPACA) must be included for financial
statements. This requirement caused substantial confusion for employers shortly after passage of
the new law. Additional regulatory guidance was required to clarify this matter. In ASC 715-60-
35-142 through 35-143, FASB stated that employers must disclose the impact of the law on their
benefit obligations, including any significant changes to their measurement assumptions.
When a significant event occurs impacting financial liability, disclosure is required under ASC
715. If the effect of the changes in the APBO is significant, it should be measured in the period
in which the legislation was signed into law (e.g., the first quarter of 2010 for a calendar year-end
company). This would affect benefit expense for the remainder of the year and future years as
well.
If the effect of the changes in the APBO is not significant, it should be reflected in the APBO at
the next measurement date (e.g., December 31 for a calendar year-end company unless a
significant event occurs before year end, such as a curtailment, that would require an interim
measurement). When reflecting the effect of the changes in either of the above cases, the effects
would be included even if the changes are not yet effective (i.e., 2013 for the retiree health care
change).
The impact on the APBO is initially recognized in a category called ―accumulated other
comprehensive income.‖ Plan changes, once adopted, should be accounted for as plan
amendments with the effect on the APBO accounted for as prior service cost/credit.
Impact on active employee benefits. If the Act impacts the level of active employees’ health care
benefits and the cost to the employer of providing those benefits, the impact should generally be
recognized in the period the related benefit cost is recognized.
Benefit Mandates
The new healthcare law includes benefit mandate provisions that will modify postretirement
benefit obligations and expense. The law effects the elimination of lifetime and annual benefit
maximums, covering dependent children to age 26, and first dollar coverage for preventive
services among other changes. The fact that the new required benefits have a delayed effective
date does not extend time for reporting and measuring postretirement benefit obligations. It must
be prior to the various effective dates. This is because the determination of obligations involves
long-term projections of employer provided benefits.
For example the new law imposes an excise tax on the aggregate value of employer-sponsored
health insurance coverage for a plan participant if it exceeds a threshold amount (the so-called
―Cadillac Plans‖). The excise tax is equal to 40% of the excess over the threshold. In most
circumstances, the tax will be levied on insurers or third-party administrators (―TPAs‖), not
directly on employers. However, these additional costs will undoubtedly be passed-through to
employers, thus increasing the net cost of providing benefits by the amount of the expected excise
tax. Under the accounting rules, the additional costs employers expect to incur as a result of the
excise tax will be included in current period’s measurement of the benefit obligation, even though
the excise tax does not become effective until 2018 and is not levied directly on the employers,
but rather reflected as an increased premium.
The new law also changes the tax treatment of federal subsidies paid to sponsors of retiree health
care plans that provide a benefit that is at least actuarially equivalent to the benefits under
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5. Medicare Part D. As a result of the new law, these subsidy payments are taxable in tax years
beginning after December 31, 2012. Accounting rules under ASC 740, Income Taxes, require the
change in tax law to be immediately recognized in continuing operations in the income statement
in the period that includes the enactment date, the date the change is signed into law, not when the
rules are changed. That amount will reduce the deferred tax asset on the balance sheet with an
offsetting charge to the income statement in the period that includes the enactment date (e.g., a
calendar year-end public company would record the charge in the quarter ended March 31, 2010).
Different accounting for the change in tax treatment is required under IFRS, however with the
convergence of FASB and IASB there may no longer be a difference. By way of example, under
Medicare Part D, retirees pay 100% of prescription drug costs once their total drug claims in the
plan year reach the Initial Coverage Limit (―ICL‖, which is $2,830 in 2010), until an out-of
pocket cost limit ($4,550 in 2010) has been paid, at that point Part D provides catastrophic
coverage. The new law provides for a phased-in closing of this Part D ―donut hole‖ starting in
2011, so that by 2020 the effective retiree coinsurance payment will be 25% for all covered drugs.
The loss of the deduction by closing the Part D donut hole is ignored for purposes of determining
whether an employer’s retiree prescription drug benefit is ―actuarially equivalent‖ to Part D for
purposes of determining eligibility to receive the RDS. Therefore, employers’ eligibility for the
RDS is not directly affected by the closing of the donut hole.
The decision to accept the requirements of recent legislation and amend the plan will have an
economic effect on the employer. There are differences in how the deferred amounts are
reflected for accounting purposes and subsequently amortized and reported on the income
statement. Future income will differ depending on the treatment of the impact on the APBO.
If the employer intends to amend its’ plan in the near future to mitigate the impact of the new law
by reducing benefits, the effects of the intended amendment should not be reflected currently.
The amendment should be accounted for when it is formally adopted and communicated to plan
participants in a reasonable period of time, in line with ASC 715-60-35-21.
When the law change impacts the level of active employees’ health care benefits and the cost to
the employer of providing those benefits, the impact will be recognized in the period the related
benefit cost is recognized. The fact that these new benefit mandates have a delayed effective date
does not modify the requirement to report the measurement of postretirement benefit obligations
currently. This is because the determination of obligations requires projections of employer
provided benefits over the working life expectancies of the participants. The costs and the
financial reporting impact of these new requirements will vary from employer to employer based
on each employer’s plan provisions.
These benefit changes will apply to each separate retiree medical plan. If the retiree medical plan
is part of the active employee plan, the new requirements will apply to it, also. If the employer is
providing a separate independent retiree plan it may avoid having the benefit mandates apply to
their retiree medical benefits by restructuring their plans so that retiree medical benefits are
provided under a stand-alone plan. In order to maintain the separateness of the plan it would
require that employers obtain a separate plan number and file a separate IRS Form 5500.
Another Answer
The closing of the Part D ―donut hole‖ may provide additional incentives for exploring alternative
arrangements. Such arrangements include restructuring the employer-sponsored benefit plan to
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6. ―wrap-around‖ a Part D plan, and providing coverage through a customized Part D plan offered
exclusively to retirees (such a plan is also known as an Employer Group Waiver Plan or
―EGWP‖). The effect of any amendments to a plan on the APBO should be treated as prior
service cost.
Employers with prescription drug benefits that are currently provided through a Part D plan or an
alternate arrangement similar to those described above should consider the effects of closing the
Part D donut hole in measurements of postretirement benefit obligations and utilize this tool for a
substantial saving. Under the options presented by Medicare Part D, employers have several
alternatives to RDS:
―wrapping‖ their current prescription program with a Part D drug plan;
developing, implementing and operating their own PDP under Medicare’s EGWP;
outsourcing these activities to one of the government’s certified Medicare Part D PDP
sponsors under Medicare’s EGWP, or
eliminating coverage for their retirees due to rising plan costs – an obviously draconian
move.
For most companies, eliminating coverage is not a viable option because most want to offer their
retirees high-quality prescription drug coverage. Many are doing so by using the EGWP and
outsourcing the administration of their prescription drug benefits to pharmacy benefits
management companies, vendors that have qualified with CMS, which is authorized by Medicare
to administer EGWP plans.
Why is that a good strategy? The waivers were designed to provide the most flexibility. Waivers
simplify plan design, communication, administration and billing. Using a CMS qualifying Third
Party Administrator,(―TPA‖) will not only save time and money by providing the administrative
relief associated with applying for the RDS, it will also provide groups with an advantage in cash
flow management over inconsistent and untimely reimbursements. The TPA will further alleviate
the Employer/Plan Sponsor's HR department as the covered retirees will be serviced by the TPA
and not be a drag on the Employer/Plan Sponsor's resources. This partnership allows entities to
focus more on their core businesses instead of on having to administer a PDP. The bottom line?
Entities will have more staff hours and more cash available to them – becoming a ―profit center‖
if you will instead of a ―cost center.‖
When selecting an outsourcing partner, employer groups should look for a company that can
administer their benefits and process their claims and that can also be a partner in their retirees'
health care. In addition to Prescription Drug Plans, employer groups can, through the EGWP,
provide comprehensive healthcare benefits and prescription drug benefits through Medicare
Advantage Prescription Drug Plans (MA-PDs). Where the TPA can offer PDP or Medicare
Advantage Prescription Drug Plans (a Private Fee-For-Service healthcare plan with integrated
prescription drug coverage) to employer or union groups using the EGWP there are additional
cost savings of up to 20%–30% annually.
One advantage to MA-PD plans is that they offer groups a comprehensive and holistic strategy
regarding a spectrum of healthcare needs. MA-PD plans provide for healthcare services above
and beyond basic Medicare, including durable medical equipment and other services. Working
with a qualified PBM will ensure employer groups find the best plan—whether it is a PDP or an
MAPD—to suit their needs. Another option for coverage, known as ―wrap-around‖ coverage, is
when an employer or plan sponsor contracts with a private Medicare PDP as a way to provide
secondary coverage for individual plans. Wrap plans provide retirees with a specific Medicare
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7. Part D program and cover expenses that would not be covered under Medicare Part D PDPs, such
as coinsurance and deductible costs that are typically the responsibility of the beneficiary and go
toward the retiree's True Out-of-Pocket Maximum (TrOOP). In this scenario, however, plan
sponsors are still involved in the logistics of Medicare Part D administrative functions and are
continuing to work with a prescription benefit manager to administer claims for the ―wrap-
around‖ coverage. A qualifying TPA will then be able to pass on the savings to the
Employer/Plan Sponsor also works with employer groups to provide this coverage. The chart
below is an example of a sample company comparison between the retiree drug subsidy and an
EGWP.
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9. The chart below is a comparison of a RDS with an EGWP, as described in this White Paper
showing the net savings.
Conclusions
The group waiver programs are applicable to all plan sponsors (for profit, not-for-profit, state and
local governments, and Taft Hartley plans). The changes in healthcare rules and the accounting
transparency reporting rules have provided an opportunity for employers and plan sponsors to
obtain better cost controls, more rapid subsidization by CMS, and reduction of human resource
costs through electing to use employer group waiver plans. The decision by CMS to allow the
same approval process for group waivers that is utilized for retiree drug subsidies means there are
over 10,000 employers that are preapproved for the program. Savings are based upon a capitation
approach rather than a percentage of reimbursement, thus it is more easily managed and there is
reduced audit exposure.
i
FASB Initiates Projects to Improve Measurement and Disclosure of Fair Value Estimates, FASB announcement
2.18.09, Proposed FASB Staff Position (FSP) FAS 107-b and APB 28-a
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