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Results of OPEB field test show impact on corporate expenses.

Results of OPEB field test show impact on corporate expenses A field test, sponsored by the Financial Executives Research Foundation, measured the financial impact on 25 companies of the proposed FASB standard on other postemployment benefits. What did the test have to say about corporate America's future balance sheet? If the FASB exposure draft on postretirement benefits other than pensions is adopted, the financial statements of companies sponsoring these benefit plans could be significantly affected, because expense under accrual accounting is greater than current pay-as-you-go costs. How much greater was the subject of a field test of 25 companies sponsored by the Financial Executives Research Foundation (FERF).

Corporate America is particularly concerned about this proposed new accounting requirement because these plans are generally unfunded and, therefore, earnings on plan assets are not available to offset the effect of higher expense. Moreover, the specific impact on a particular company's financial statements--either at the time of initial application or in later years--cannot be predicted without substantial analysis.

Understanding the impact of these proposed changes on an individual company requires detailed information about its plan(s) and an analysis of many factors, including the unique features of the benefits offered, the company's specific demographic characteristics, and the assumptions used in the actuarial measurements. Even so, some general observations can now be made about the impact based on the results of the field test.

Field test results The actuarial valuations conducted for the field test demonstrated that company demographics and the specific benefits offered by the company significantly affect the measurement of retiree health obligations and expense. In particular, the ratio of retirees to active employees is important in understanding the impact of accrual accounting.

First-year expense under the ED was compared to pay-as-you-go expense for the field test companies. (We're using the term "expense," rather than "net periodic postretirement benefit cost" as defined in the ED.) As with many other variables examined, expense under the ED as a multiple of benefit payments varied with the ratio of active employees to retirees. First-year expense was between three and five times the pay-as-you-go amounts for most field test companies (predominantly mature companies). However, some "highly mature" companies had multiples of expense to benefit payments of under three times. At the other extreme, some immature companies had multiples of expense to benefit payments of over 10 times the pay-as-you-go amounts.

While company demographics is a key indicator of the multiple of expense to benefit payments, other factors influence this multiple, including plan provisions that limit the companies' benefits (e.g., low life-time maximums) and the assumed health-care cost trend and discount rates.

To understand the factors contributing to expense under the ED, it is important to focus on the components of expense. These components in the year of adoption for an unfunded plan will include service cost, interest cost, and amortization of the transition obligation. The components of first-year expense as a percentage of total expense for field test companies are presented.

Interest cost (interest on the APBO) is usually the largest component of expense under accrual accounting, exceeding 45 percent for all but three immature companies tested. Unlike pensions, companies have generally not funded retiree health obligations and thus there is no offset, by interest or earnings on plan assets, to this large interest cost component.

Interest cost plus transition amortization exceeded 74 percent for all but three immature field test companies. Amortization of the transition obligation will vary by the average remaining service period used to amortize the obligation. This period is influenced by the average age of active employees, the plans' eligibility criteria, and actuarial assumptions as to the expected retirement date. For most field test companies, the average remaining service period under the ED exceeded 18 years, in excess of the optional 15-year transition amortization period proposed by the FASB.

Sensitivity to assumptions Expense levels under the proposed statement can vary significantly depending on the actuarial assumptions used to measure retiree health benefits. Under the ED, each significant assumption should reflect the "best estimate" with respect to that individual assumption.

Due to the substantial uncertainty about future health-care benefit costs, expense for each company was determined under a best-estimate assumption selected by each company, as well as under two other health-care cost trend assumptions--one optimistic and the other pessimistic. In addition, to analyze the ED's sensitivity to disclosure requirements, the best-estimate assumptions selected by each field test company were decreased by one percentage point in each future year.

The assumed discount rate tends to counterbalance the effect of the health-care cost trend assumption. The higher the discount rate, the lower the present value of projected obligations. The opposite is true for assumed health-care cost trend rates. Also presented is the effect of using a company-specific discount rate that was generally two-to three-percent higher than the rate based on the exposure draft.

Analysis of the exposure draft components To analyze the impact of alternative approaches to various provisions contained in the ED, two key elements contributing to expense were isolated and examined: the attribution period and the amortization of the transition obligation.

The ED would require that companies use a single attribution method based on the terms of the plan (a benefit/years-of-service approach) to allocate the cost of a participant's benefits to individual years of service. Where benefits are not defined by a plan formula, costs would be allocated ratably to service from date of hire to the date the employee is fully eligible for benefits (the attribution period). Some observers of the FASB project have called for the attribution period to extend to the employee's expected date of retirement (that is, the full-service period).

The use of an attribution period extending over the full-service period was analyzed for each field test company. The average remaining service period was found to be generally three to five years longer than the period to eligibility.

Under the ED, the transition obligation would be amortized on a straight-line basis over specified future years (or 15 years if longer). For each field test company, alternative amortization techniques and periods were used to amortize the transition obligation, including: * 30-year straight-line amortization. * A mortgage-type amortization approach with an increasing amortization amount. * A "grandfathering" approach with pay-as-you-go accounting continued for retirees at transition and accrual accounting applied to active employees.

All in all, the issues involved in accounting for retiree health benefits are complex and should be addressed not only from a financial viewpoint but also from a broader business perspective. Since virtually every employer sponsoring a retiree benefit plan would be affected, companies should seriously weigh the consequences of the FASB's proposal. The authors and the Financial Executives Research Foundation strongly urge companies to make their views known to the FASB through comment letters and presentations at the public hearings.

PHOTO : A banjo clock, made in the 1850s and frequently found in Wells Fargo offices Mr. Akresh, Ms. Bald, and Mr. Dankner are co-authors of the FERF field test report. Mr. Akresh is a national accounting and SEC manager with Coopers & Lybrand, and Ms. Bald and Mr. Dankner are a director and partner, respectively, in the firm's Actuarial, Benefits, and Compensation Consulting Unit.
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Title Annotation:impact of the proposed Financial Accounting Standards Board standards on post-employment benefits; includes related article on the Overview of Post-employment Benefits field test
Author:Dankner, Harold
Publication:Financial Executive
Date:Jul 1, 1989
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