Cost, Scrutiny Prompt Reviews Of Post-Employment Benefits
By: Ronald O. Olsen & David H. Hart
Stock analysts are starting to question the financial implications of the differences between recorded post-employment benefits and the likely magnitude of the actual long-term liability. Ronald O. Olsen, of The Segal Company, Ltd., and David H. Hart, a freelance practitioner on post-retirement benefits, examine how employers are dealing with this.
Traditionally, Canadian employers have been generous with their employees. But, one important way they have shown that generosity – maintaining their health insurance in retirement – is becoming the focus of significant attention, even anxiety. In particular, companies are beginning to come to grips with the need to manage the financial implications of so-called “other postemployment benefits” (other than pensions, that is), or OPEB. Here are four key reasons why:
- OPEB has become a significant operating statement cost and balance sheet liability
- The actual OPEB liability may be considerably larger than the reported liability
- Stock analysts are starting to question the financial implications of the differences, if any, between the recorded OPEB liability and the likely magnitude of the actual long-term liability
- Employees, who value OPEB, may turn to litigation if they perceive that these benefits are vulnerable
With respect to the magnitude of these liabilities, research by The Segal Company, Ltd. suggests Canada’s 50 largest public companies (measured by their number of employees) that offer OPEB had total OPEB liabilities of $15.5 billion in 2003 – a liability for which there are no dedicated assets.
Further, that figure is simply based on the companies’ published estimates – which may not be accurate. Indeed, the $15.5 billion figure may be low, particularly if estimates of future medical cost inflation prove to be understated. In past years, as a result of OPEB, sponsors that computed their respective liabilities using longterm assumptions about future healthcare cost inflation in the four per cent to five per cent range incurred actuarial losses (increases in liabilities not anticipated by the underlying accounting assumptions).
In particular the past practice of assuming longterm medical care cost inflation at four per cent at times when supplementary health plan costs have been trending at double-digit rates has resulted in unanticipated OPEB liabilities that now need to be amortized. Using actuarial assumptions that closely match actual past experience would, according to Segal’s estimates, more than double the OPEB balance sheet liability.
As noted earlier, stock analysts are beginning to look at these issues. Just as pension fund deficits have been recognized as balance sheet distress factors, unfunded – and, perhaps, understated – OPEB liabilities are also coming under increased scrutiny by financial analysts. The result could be that companies sponsoring OPEB may experience difficulties in raising equity or debt capital to either build or maintain their operations. There is also a threat of employee litigation. Many workers perceive – correctly – that OPEB is a significant promise upon which their future economic security is partly dependent. Evidence is building that employees and retirees feel strongly enough about the importance of these benefits that they are prepared to challenge employers in court if they see that those benefits are reduced or eliminated.
For example, employers are closely watching a class-action suit launched by former employees of the Ontario government who are fighting an attempt to reduce the benefits of employees who have already retired. Last year, the Ontario Supreme Court certified Kranjcec v. Her Majesty the Queen for class action status. (Plan sponsors should rely on legal counsel for authoritative advice on the implications of this case and any other legal issues associated with OPEB.) Employees may also be concerned that future OPEB payments will only be made on a pay-as-you go basis without any prefunding. But, there is a more positive perspective for OPEB. The following are the basic advantages to addressing the issue promptly:
- Limiting the OPEB expense and its growth
- Improving the balance sheet, thereby increasing shareholder value
- Minimizing the risk of litigation
Now what? Effective OPEB management entails a number of steps. The first is to develop a strategic plan. A well-defined strategy is essential to guide discussions about plan design and liability. The strategy should reflect the employer’s philosophy and goals regarding benefit security – total rewards, workforce renewal, recruitment, and retention. It must also reflect limits on the employer’s ability to afford providing OPEB benefits. The strategy may suggest different approaches for current and future retirees, as well as for salaried and collectively bargained employees.
Measuring The OPEB Promise
Getting down to basics, before an employer can begin an informed consideration of design and financing alternatives, it must have a clear and realistic understanding of its current obligation. That understanding can come only from an actuarial valuation that considers current plans and their costs, the current population of employees and retirees, and a host of assumptions about how plan costs and the population are expected to change in the future. Some actuarial consultants have proprietary tools that allow for efficient, accurate plan valuation, and for measurement of plan costs and the value of plan changes. From this benchmark measurement, alternatives can be developed and their value measured.
Documenting OPEB plans is also generally a good idea. Unlike pension plans, there is no regulatory requirement to file a plan document for OPEB. Nevertheless, having a precise OPEB plan document can be helpful if the employer’s objectives include a more accurate measurement of the benefit liabilities, more precise annual accounting costs, improved plan administration, and/or better communications or alignment with participants’ expectations. Since the rising cost of healthcare is, ultimately, what has put the OPEB issue on the table for so many employers, a costmanagement component is essential to a comprehensive solution. As previously noted, a large portion of the overall OPEB liability and related annual accounting expense for many OPEB plan sponsors derives from projected cost (for example, medical cost inflation increases in future years).
However, there may be opportunities to limit those increases and, thereby, control the liability. There are numerous options for managing the cost of OPEB. Key areas to focus on include:
- Plan features such as deductibles, coinsurance, and annual and lifetime maximums
- Eligibility including the age, service, or other criteria for entitlement to OPEB
- Care management to help ensure the most cost-effective delivery of benefits and most efficient co-ordination with public plans Subsidy management under which a claim-reimbursement program is replaced with a tax-effective cash support program
Employers should also take a step back and look at the big picture. For example, surprisingly few employers focus on the interrelationship between pension benefits and OPEB, yet both are important components of an overall retirement security program.
The financial security afforded by the pension plan needs to be considered in concert with the supplemental health benefits provided by OPEB in order to assess whether the overall program adequately (or, perhaps, over-adequately) meets retirees’ income and health security needs; whether there is the right balance between income and health benefits; and, whether the pension and health plans are sending consistent messages about when and on what terms employees should retire.
A final, key issue for consideration in wrestling with OPEB is the matter of setting aside funds to cover future expenses. Pre-funding all or a portion of the OPEB obligation may have numerous desirable benefits that a plan sponsor could consider including consumer- directed cost management, reassuring employees, and even tax effectiveness where opportunities to use the pension plan exist. Any one of these benefits provides a powerful incentive to consider the possible merits of pre-funding. Nevertheless, there are employers – and circumstances – where pre-funding may not be advantageous. Determining whether, to what extent, and how to pre-fund is a by-product of a given employer’s strategy, current plans, and financial objectives.
Managing OPEB is a worthwhile undertaking. The stakes are high, but so are the opportunities to reduce costs and taxes while preserving employee appreciation and security.
Ronald O. Olsen is vice-president and Canadian retirement practice leader for The Segal Company, Ltd. David H. Hart is a freelance practitioner on all aspects of OPEB.
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