How to deal with retiree needs under OPEB.

How to deal with retiree needs under OPEB 

At the root of the OPEB obligation quandary are the employees these benefits protect. How much should a firm consider the people factor in making its retiree-coverage decision? A lot, says one benefits consultant, and he offers a new plan design that does so. Most large companies provide medical benefits for retirees. Nearly all recognize the cost on a pay-as-you-go basis. Soon, however, there will be new accounting standards for postretirement welfare benefits that will require employers to recognize the cost of these benefits during employees' working years.

What will this mean for employers? And how might a company deal with the new rules? It could let earnings decline, thereby allowing shareholders to absorb most of the increase in costs. If profits are relatively high, the actual impact of the increase in expense might not be severe, making this a practical course of action.

It could also reduce benefits to protect earnings, thereby placing the cost burden on employees and retirees. If pay and benefits are competitive, this might be an acceptable step.

Or the company could increase the price of its products, essentially making its customers pay for the added benefit expense. If its products are not extremely price sensitive, this might be a suitable option.

This example highlights two points: First, the change in accounting rules is a serious business problem, not simply an accounting or benefit issue. Second, there is no easy solution to the problem. Ultimately, what this, or indeed any, organization decides to do depends on the magnitued of its liabilities for retiree benefits, its overall compensation and benefit philosophy, its human resource objectives, and its long-term needs and resources. Tough decisions are required no matter what course an employer takes.

The big picture

In reviewing alternatives, companies will have to reexamine and, in many cases, modify their commitment to current and future retirees. This requires careful consideration of a number of critical factors. Among them: Legal status--If an employer has not clearly communicated its right to modify benefit plans and has made no benefit changes in the past, it may have forfeited its legal ability to reduce benefits for current retirees. Even if it has effectively retained its legal right--by virtue of past practices and clear, consistent communication--it may decide not to make any changes to avoid litigation by retirees and the associated publicity. An employer may also feel that it has an obligation to fulfill benefit promises already made implicitly or explicity to current retirees, precluding any major benefit cutback.

On the other hand, if an employer is modifying plan provisions for active employees to counter the effect of inflation, similar modifications in the retiree plan may be both appropriate and necessary. Typically, such modifications do not represent a major shift in commitment. Rather, they take the form of a series of small changes--for example, increasing deductibles or setting up a hospital precertification program. Employee expectations--Current employees who are near retirement have come to expect a certain level of benefit protection after retirement. Young, short-service employees, on the other hand, typically have little interest in or knowledge about postretirement benefits. They also have plenty of time to adapt to a new benefit plan. Some employers, therefore, may decide to maintain current benefit levels and provisions for all employees who will retire over, say, the next five years, but completely redesign the plan for everyone else. This "clean-slate" approach enables an employer to set up a plan based solely on the most appropriate allocation of company benefit dollars over the long term, while providing special transition rules for soon-to-retire employees. Benefit equity--Should a 55-year-old retiree with 10 years of service receive an employer-provided benefit worth two to three times that for a 65-year-old retiree with 30 years of service? Should single and married retirees receive the same level of benefits from their employer?

At present, most retiree welfare plans provide the same benefits to all eligible retirees, regardless of age at retirement or length of service, and greater benefits to those with dependents. Thus, younger retirees receive a richer benefit from the company than do Medicare-eligible retirees (for whom the company is secondary insurer), and short-service retirees receive more valuable benefits--relative to their time with the company--than do career employees. Concern about the inequities inherent in this approach may well prompt employers to rethink the allocation of their benefit dollars. Overall benefit protection--The adequacy and competitiveness of postretirement medical benefits should be assessed in the context of the company's total retirement income program. Retirees' ability to contribute toward their medical coverage and to absorb increased deductibles and coinsurance depends to some extent on the amounts they receive from the pension plan and capital accumulation vehicles (e.g., savings or profit-sharing plans), if any.

The nature and extent of benefit modifications also depend on the level of expense that an employer can accept both currently and over the long term. If a corporation can absorb nearly all of the cost increase, it may be able to make only modest benefit changes. These might include: * increasing the plan deductible and/or out-of-pocket limit. * reducing benefit reimbursement levels. * tightening integration with other employer plans and/or with Medicare. * raising employee contributions. * restricting eligibility. * adopting utilization review and other managed care techniques to reduce health care usage and costs. One practical way to make relatively modest plan changes and simultaneously foster more equitable distribution of benefit dollars is to introduce service-related employee contributions. The figure below shows a typical contribution schedule. Here, career employees receive fully subsidized benefits, while shorter-service employees pay a portion of the cost of their coverage, commensurate with their length of service.

Although employers can achieve some savings from this type of contribution schedule, their portion of the total cost will continue to rise as medical prices themselves rise. Those seeking a significant reduction in costs--say, 40 percent or more--need to consider other design alternatives.

A novel approach to structuring retiree contributions is the defined dollar benefit (DDB) concept. Under a DDB plan, the employer provides a specified amount of money for the purchase of retiree welfare benefits. This amount, which can be linked to the employee's age at retirement, length of service, number of dependents, and so on, is fixed until (and if) the company decides to increase it. Here's a simple example:

Company A currently spends $600 per year per person on medical benefits for Medicare-eligible retirees. It decides to implement a DDB plan, under which it will contribute exactly that amount toward each retiree's coverage. As the cost of coverage rises, retirees who wish to retain coverage must begin paying the difference between the plan cost and the employer's defined dollar benefit of $600.

While retirees pay nothing in the first year, in the second year, inflation raises the cost of coverage by, say, 10 percent, requiring retirees to contribute $60 toward the total cost. If, over time, the company decides that the financial burden on retirees is too great, it could grant an increase in the DDB amount (raising it, for example, to $700 by the fifth year). Until then, however, the employer is not affected by medical inflation.

A chief advantage of DDB is flexibility. An employer can structure the plan to achieve its cost-saving objectives gradually over time. It might, for example, use DDB to move from paying 100 percent of the total plan cost to 50 percent over perhaps a 15-year period. Or it might limit cost-shifting to, say, 65 percent to 35 percent, or any combination it desires. Employers also can vary DDB contributions by length of service. The $600 DDB described above, for instance, might be granted only to retirees with 20 years of service. Retirees with receive proportional amounts. In short, use of a DDB plan can reduce the cost impact of the expected change in accounting rules by 50 percent or more.

A final word

In preparing to deal with new accounting rules for postretirement welfare benefits, employers will certainly have to reexamine both the design and financing arrangements of their existing plans. Many may also find it necessary to redefine their benefit commitment to retired employees. In evaluating their alternatives, they should take into account their overall benefit objectives, employees' needs and the adequacy of the total retirement income provided to them, and the company's own longterm needs and resources.

PHOTO : A patchwork priest's robe, brocaded silk, unknown Japanese, early 19th century. This

PHOTO : textile was created through a process called "Dangawari," in which different designs are

PHOTO : sewn together and then placed on top of another design.

PHOTO : Top: An Ainu robe, cotton applique and embroidery, Japanese, mid-19th century The Ainu

PHOTO : people often design their clothing incorporating abstract animal forms. The abstract

PHOTO : design on this robe probably symbolizes the owl, an animal important to the northern

PHOTO : Japanese Ainu religion.

PHOTO : Bottom: A riding coat, cotton with silk applique, unknown Japanese, c. 1870. A resist-dye

PHOTO : technique was used on this Japanese coat to illustrate two tortoises swimmingin the ocean.

PHOTO : To the Japanese, the tortoise is a symbol of longevity, and thus the coat's wearer would

PHOTO : be protected from evil during his travels.