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Postretirement benefits: a growing employment problem.

The Financial Accounting Standards Board (FASB) released in December 1990, Statement of Financial Accounting Standard No. 106 (SFAS # 106), Employers' Accounting for Postretirement Benefits Other than Pensions. It will require the liability for those postretirement benefits be disclosed on the balance sheet and a corresponding expense in the income statement effective for years beginning after December 15, 1992. This Statement is one of the most controversial ever released by the FASB and is causing much uneasiness in corporate board rooms across America. Issuance of the Statement has brought about questions, not only concerning the statement, but about the FASB itself. This article reflects how companies have recognized expenses for these benefits in the past and explores the projections and feelings the anticipation of adopting this Statement has brought about.

Historical and Technical Data

What are other postretirement benefits?

Other postretirement benefits (OPEB) have been defined by Dennis Beresford, FASB Chairman, as any benefits, other than retirement income, provided to an employee or beneficiary on or after the date the employee retires or terminates service to the employer (Journal of Accountancy, 1988). The most significant OPEB are health care and life insurance for retirees, but they can also include some less obvious benefits such as discount merchandise, tuition credit, free legal services or reduced-cost company services or products for retired employees.

Retirement health care, the major cost component of OPEB, is not a new benefit now offered, but the aging of the American work force has given it new prominence. Concern over the long-term funding of the Medicare program and over unfunded liabilities of employers for promised benefits have helped to intensify this attention (Norwood, 1988). Even though health care benefits are traced back to World War II, when these benefits were used as a means to compensate employees for frozen wages (VanRemortel, 1988), prior to the advent of Medicare in the mid-1960s, very few companies promised any retiree medical benefits. However, upon the introduction of Medicare, companies began to augment Medicare with OPEB's because they thought it would be cheaper for them (Randall, 1989). No one anticipated the massive cost increases in medical care the past two decades have brought.

Pay-As-You-Go Approach

Currently, the only expense companies book for retiree health benefits is the cash amount they actually pay for claims and insurance. It is a pay-as-you-go approach. Technically, public companies must single out expense in a footnote in the annual report. Many do not, claiming the amount is not material. The FASB's new rules are projected to increase the amounts currently reflected in the financial statements roughly four-fold by making companies accrue benefit costs as employees earn them, rather than the pay-as-you-go method most companies currently employed.

Many executives look at all the variables and contend future health costs simply cannot be measured. It is ridiculous, they say, to put such "soft" numbers on the financial statements. Other executives argue the rules will prompt companies to seek some way to avoid paying the benefits they have promised (Loomis, 1988).

Expected Impact

This could be one of the most controversial issues the FASB has ever undertaken. Business Week predicts it could knock at least 25% off the annual profits of big industrial companies and it may also wipe out one-third of the net worth of all of corporate America (Norman and Garland, 1988). David Flaum of The Commercial Appeal predicts it may lower sharply the reported profits of companies, push down stock prices and even make it more difficult for a young person to get a job because fewer workers will retire early to open up jobs for younger employees (Flaum, 1988). Business Week also expects if all companies confess to what they are likely to owe, the sum is expected to be more than $1 trillion (Norman and Garland, 1988). Tom Nelson, a consulting actuary with Milliman and Robertson, Inc. of Chicago, predicted in an article in Management Accounting magazine over four years ago a particular firm with a mature workforce could expect costs for an existing plan to more than quadruple in the next 15 years.

He placed the overall present value of future retiree benefits for company at an estimated "several" billion dollars. He further stated a company with a relatively young work force and relatively few present retirees would be expected to begin at around $100,000 per year and, by the year 2000, to increase to almost $1 million per year. (Projections are lower when employees are younger because they are expected to work longer and the liability is spread over more years.)

The big increase toward the year 2000 is because of projected rapidly rising medical costs. (Nelson, 1987). Business Week puts this company's predictions at eight to twelve times current expenses (Norman and Garland, 1988). Diana Scott, project director of the FASB's postretirement benefits policy group, in an interview with Pension World estimated individual companies' liabilities to range from $65 billion to $125 billion (Kutz, 1988). She also estimated in an interview with Business Insurance the obligations for these plans range from $125 billion to $2 trillion. Everyone seems to have a difference of opinion (even Ms. Scott has two of them) on the expected costs to companies, but one thing they all have in common is they feel the sum will be "BIG!"

The Retirement Plan Dilemma

Build-up of Current Plans

Retiree medical plans are expected to be a major future business expense for the employers who offer them. Over the last 20 years, unions have won and companies have granted generous plans continuing retirees' health benefits until Medicare kicks in at age 65. They often then pick up what Medicare won't pay. Employer liabilities for these already promised plans will continue to grow as the Federal Medicare program continues to reduce the coverage it provides to retirees age 65 and over. A 2% reduction in Medicare spending means billions of dollars for employers (DiBlase, 1988).

Results of Cost Studies

Many employers don't realize what they've actually promised their employees. In effect, the business community has written a "blank check" to be filled in over the years at whatever prices apply (Loomis, 1988). In 1986, the U.S. Department of Labor released a study in which it estimated benefits already promised to workers over age 40 would have a cost of $98 billion. Shortly thereafter, a report from the House Select Committee on Aging put the liability at closer to $2 trillion (Narod, 1988). (For the Fortune 500 companies, the estimate is 150% of total assets (Nelson, 1987).) For large, old, unionized, industrial companies like the auto and steel giants of the Rust Belt, these expenses are already a sizeable drain on income. In 1987, USX Company spent a whopping 57% of net income on retiree health costs and Bethlehem Steel ran a close second spending 44% of net income (Norman and Garland, 1988).

Getting a Handle on Benefits

Companies cannot see any easy way out of their dilemma, either. Recent court cases have proven to be on the side of the employees by granting them full rights in all promised benefits and forcing companies to pay. However, the stage is most likely being set for head-to-head, union-management confrontation over contract concessions. The American Federation of Labor and the Congress of Industrial Organizations (AFL-CIO) predicts the higher deductibles companies demanded over the last ten years are small compared with what lies ahead. Their health specialists feel companies will use FASB estimates to try to bully labor into many concessions (Norman and Garland, 1988).

To limit their liabilities to future retirees, some firms have already amended their retiree medical plans, defining the dollar amount they will contribute and requiring more cost-sharing by retirees. The pressure on employers to curb rising benefit costs made the 1980's a fertile period for innovative plan design (Norwood, 1988). Flexible benefits plans, where employees choose among a variety of benefits up to a set dollar allowance, is also becoming very popular because of the needs of the changing demographics of the work force.

A 1987 Hewitt Associates Survey of 200 employers (154 offered flex plans) found offering flexible benefit programs reduces the rate of medical cost increases over time. (These medical benefits are reduced over time because employees are careful not to duplicate plans. For instance, if a husband carries less costly medical benefits through his employer, his wife may choose another option through her employer, such as life insurance or child care.)

Companies contend their main objective of flexible programs is to meet the diverse needs of employees, not to contain medical costs (Pension World, 1987). At any rate, companies offering these benefits will have to gather data on their current plans, estimate their future hidden costs and decide from their particular stand-points if they can afford to keep their plans at present levels or begin cutting down where they legally can.

Early retirement is already becoming a thing of the past because companies are finding it too costly to put together employee retirement plans. Since the Age Discrimination in Employment Act effectively eliminated the ceiling on retirement age, companies may demand employees work more years under their future plans before benefits can be received. To keep these older employees, companies will have to make work easier for them and much more attractive so they will want to stay longer (Mackie and Oss, 1989). One source feels we may see medical benefits for retirees paid out of pensions and projects more leased employees and shared employees. They also see a stronger emphasis on these benefits being directly tied to performance with a trend towards a link of pay and benefits, not pay plus benefits (Employee Benefit Plan Review, 1988).

FASB Under Scrutiny

Critics Lobby for More Control

The FASB is starting to feel the heat on this issue as well as others. Corporate chieftains, mainly through the Business Roundtable, are putting pressure on the foundation appointing the FASB's seven members and are lobbying hard at the Securities & Exchange Commission (SEC) for more SEC control over the Financial Accounting Standards Board. The chairman of the Business Roundtable's Accounting Principles Taskforce, John S. Reed, is leading the campaign to reign in the FASB and is urging much closer SEC supervision. However, the House Oversight Committee is against the SEC interfering with the FASB (Norman and Garland, 1988). At any rate, some critics are convinced corporate opposition through the lobbying process will so weaken the new retiree health care rules they will have only a negligible impact if they do take effect.

Cost/Benefit Questions

The critics' goal is not only to blunt the new retiree benefit rule, but also to slow down the near-frantic pace of standard-setting by the FASB (Norman and Garland, 1988). They feel the FASB is churning out too many statements that cannot be accurately quantified. Critics are also griping the Financial Accounting Standards Board has a captive market and the benefits of providing information about medical and life plans (as well as some other new FASB statement rules) in the financial statements will not outweigh the costs.

An additional cost consideration is taken when measuring postretirement benefits: the cost most companies will incur to hire an actuary (or actuarial team) to estimate and maintain their plans (a cost the stockholders will have to bear). The critics feel even with an actuarial team, there's still one major question to be answered: Can the costs be quantified with reasonable accuracy when medical costs are spiraling upwards at an increasing rate? No one has been able to accurately predict what medical costs will do for one year, much less 20 years in the future (Flaum, 1988).

To the previous question, critics have one more: Will placing these arbitrary amounts in the financial statements provide the user with more accurate information? Most feel it will not. They predict company profits will be driven down as a result of having to write off a cost not occurring until some time in the future. This, in turn, could reduce the company's stock prices or market value because the price of a company's stock is heavily affected by earnings (another price the stockholders have to pay) (Faum, 1988).

FASB Appears Steadfast

The Financial Accounting Standards Board is standing its ground on quantifying retiree health care costs. They insist they have not created the problem or changed the costs, but they will be the ones who may be clobbered for being the messenger (Norman and Garland, 1988). They have advised companies to start gathering this data in advance of the effective date of the statement in order to comply with SFAS # 106 and to get a handle on what they are actually up against in their individual plans.

In an interview with the Employee Benefit Plan Review, Diana Scott stated the FASB intends to continue working hard to develop accounting standards so financial statements will be "faithful, relevant and reliable" to their users. She also stated the Financial Accounting Standards Board is listening to the criticisms on the postretirement benefits issue, but may not agree they should drop it (Employee Benefit Plan Review, 1988). The FASB members believe stockholders and potential investors have a right to know the most accurate information available about the current financial condition of their companies. This means taking into account expenses the company may not be reporting but are accruing nonetheless.


There seems to be a consensus on two major ideas surrounding this issue:

1. Implementing the statement will cost more than the benefit received; and

2. There is a problem with accurately estimating the future of medical benefits due to skyrocketing costs.

Whether this will spell doom to the implementation of SFAS # 106 is yet to be determined. Since the Financial Accounting Standards Board requires firms to reflect these costs in their financial statements, all firms having a postretirement medical and life benefits plan will monitor them much more closely and probably will cut them back. With a price tag at an average 12% of a company's payroll, (Narod, 1988) firms are going to have to get a handle on their plans and work with their valued employees so as not to lose their goodwill with them.


ABC News. The Health Show, 30 October 1988.

DiBlase, D. "Employers Urged to Gather Retiree Data." Business Insurance. (25 April 1988): 29.

Employee Benefits Plan Review. "Designing Benefit Strategy for a Changing Labor Force." (June, 1988): 71-72.

Employee Benefits Plan Review. "Why Medical Costs Rise." (June, 1988): 72-73.

Employe Benefits Plan review. "FASB Proposal on Retiree Health Benefits in Works." (April 1988): 85-86.

Financial Accounting Standards Board. Exposure Draft. "Employers' Accounting for Postretirement Benefits Other Than Pensions." (14, February, 1989): 1-212.

Financial Accounting Standards Board. "FASB Action Alert, No. 88- 39. (28 September 1988): 1.

Financial Accounting Standards Board. "Postretirement Benefits Other Than Pensions." Highlights of Financial Reporting Issues. (December, 1988): 4.

Financial Accounting Standards Board. Statements on Financial Accounting Standards, SFAS #81: 793-798.

Financial Accounting Standards Board. Statement of Financial Accounting Standards No. 106: Employer's Accounting for Postretirement Benefits Other Than Pensions. (December 1990): 1-205.

Financial Accounting Series. Status Report No. 197. (11 October 1988): 6-7.

Flaum, David. "Accounting Shift May Affect Employee Benefits." The Commercial Appeal. 25 September 1988, 1(c) and 4(c).

Gleim, I. N. and P. R. Delaney, CPA Review Volume 1, 14th edition. chapter 8: 988.

Journal of Accountancy. "Special Report: FASB Focusing on Postemployment Benefits Accounting." (August, 1988): 144-145.

Kutz, Karen S. "FASB Pursued Health Benefits Cost Accounting." Pension World. (April 1988): 12-14

Loomis, Carol J. "Will 'FASBEE' Pinch Your Bottom Line?" Fortune. (19 December, 1988): 93-108.

Mackie, James Jay, and Monica E. Oss. "Reducing Retiree Health Care Liabilities." Management Accounting. (April, 1989): 21-26.

Narod, Sharon. "FASB Retiree Rule Looming." National Underwriter, Profits & Casualty/Employee Benefits. (22 February, 1988): 29-30.

Nelson, Thomas G. "Postretirement Benefits: The Tip of the Financial Iceberg." Management Accounting. (January, 1987): 52-55.

Norman, James R. and Susan Garland. "First Thing We Do Is Kill All the Accountants." Business Week. (12 September 1988): 94-95.

Norwood, Janet L. "Measuring the Cost and Incidence of Employee Benefits." Monthly Labor Review. (August, 1988): 3-8.

Randall, Robert F. "The coming Crunch in Employee Benefits."

Management Accounting. (January, 1989): 18-22.

Van Remortel, Fe. "Retiree Health Benefit Liability Reaches the Crisit Point." Pension World. (August, 1988): 47-48.

Janie Gregg is an instructor of business at Mississippi State University, Meridian Branch. She has served as Director of Public Relations of the Golden Triangle Chapter of the Institute of Management Accountants (formerly National Association of Accountants) during the organization of the chapter and for three years hence.

Clyde Herring, CPA, PhD, is an associate professor in the School of Accountancy at Mississippi State University. He is currently serving as president of the Board of Directors of Golden Triangle Chapter of IMA and has served in several positions in the past. He also serves on the Education and Scholarship committee of the Mississippi Society of CPA's. Dr. Herring has published articles in the National Public Accountant, Arkansas Business and Economic Review, and Southern Business and Economic Review.
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Author:Gregg, Janie; Herring, Clyde
Publication:The National Public Accountant
Date:Nov 1, 1992
Previous Article:FAS 105: the future of disclosure standards for financial instruments.
Next Article:The $1,000,000,000,000 dilemma: accounting for post-retirement benefits under FASB statement # 106.

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