By Sherman B. Lieberman, F.S.A.     10/7/99
Director and Chief Actuary - Multiemployer.com

Much has been discussed and written about the so-called "Y2K problem".  For trustees of multiemployer welfare plans the year 2000 has implications reaching far beyond worrying about two digit years.  Thanks to recent rules promulgated by the accounting profession, those plans which provide employer subsidized benefits to retirees will now be required to report the actuarial value of such benefits directly on the plans' financial statements for plan years beginning January 1, 2000 or later.

Some may find these requirements a somewhat bitter pill to swallow, but trustees should not overlook the opportunities these calculations offer for a new understanding of how their retiree health plans will be operating now and into the future.

Background

The concept of financial accounting for retiree medical benefits began with the Financial Accounting Standards Board's FAS 106 in December, 1990.  (This was designed to parallel the Board's previous pension accounting standard, FAS 87.)  The purpose was to account for the accrual of future post-employment benefits (other than pensions) during the working lifetime of employees on an employer's financial statements and was generally effective for fiscal years beginning after December 15, 1992.

Most of the benefit obligations reported were related to retiree medical benefits and retiree life insurance and required detailed and costly actuarial calculations as well as the organization and collection of the plans' demographic and claims data.  In some cases, the accrual of benefit costs resulted in a balance sheet charge and a negative effect on the employers' stated earnings in the review year.

 Fortunately for multiemployer welfare plans, the standard treated them as "defined contribution" plans and called for only the reporting of the required employer contributions on a participating employer's financial statements.  This eliminated the necessity for the above mentioned detailed actuarial calculations for these plans.

Just when multiemployer plans thought it was safe to go into the water, along came the August, 1992 release of Statement of Position (SOP) 92-6 by the AICPA.  While FAS 106 was designed to create a standard for employer reporting of post-employment benefit obligations, the SOP dealt with plan financial reporting.

SOP 92-6 required similar actuarial calculations as FAS 106.  Thus single-employer plans who had already set up the mechanisms for FAS 106 compliance could satisfy the SOP standard using basically the same calculations.  Multiemployer plans, however, did not enjoy a similar exemption under the SOP as they had under FAS 106.  Like the single-employer plans, they would now have to report actuarial liabilities on the plans' financial statements based on detailed calculations that had not yet been performed.  For multiemployer plans, the SOP was effective for plan years beginning after December 15, 1995.

Plan Trustees then asked "What would be the implications if we decided not to commission the required actuarial calculations?"  Since the omission of the disclosure would amount to a break from GAAP reporting, the accountants replied that they would have no choice but to issue either a qualified or adverse opinion on the Plan audit depending on the materiality of the defect.

Under Federal law, the Department of Labor is permitted to reject the annual Form 5500 filing if there is a material qualification in the accountant's opinion.  If not corrected within 45 days, the DOL may assess civil penalties of up to $1,100 a day (increased from $1,000 for violations occurring after July 29, 1997 under the Federal Civil Penalties Inflation Adjustment act of 1990) against plan fiduciaries.  Thus, Plan Trustees may be personally liable for significant penalties (which may not be paid out of Trust assets) if the annual report is rejected.

As a result of lobbying by the multiemployer industry, the DOL announced in March, 1997 that 1996 and 1997 (and later, 1998) annual reports of multiemployer welfare plans would not be rejected if an accountant's qualified or adverse opinion was solely due to noncompliance with SOP 92-6.  This interim relief was offered to allow time for public comment on making this a permanent policy.

In November, 1998, the DOL published its decision not to adopt the relief as a permanent enforcement policy.  (The good news was that it had extended the interim relief period through the 1999 annual report.)  The Department concluded that it should not be responsible for addressing problems related to the application of accounting principles.  It recommended that the multiemployer community and the accounting profession continue to work together to solve these problems.  It was now apparent that, barring any further pronouncement by the DOL, multiemployer welfare plans would have to comply with the provisions of SOP 92-6 for Plan Years beginning on or after January 1, 2000 with comparative figures for the previous Plan Year.

What Multiemployer H&W Plan Trustees need to know

While SOP 92-6 retains the usual reporting of a plan's assets and liabilities, it creates a new category called "benefit obligations" to be reported separately on the financial statements.  Benefit obligations include charges already incurred by participants such as health and death claims due and unpaid, incurred but not reported claims, and the actuarial value of accumulated eligibility credits (such as an hours bank).  However, the largest (and most controversial) component of the benefit obligations category is clearly the "postretirement benefit obligations" or PBO.  The remainder of this discussion will focus on the characterization of the PBO and the difficulty in quantifying this amount.

Generally, a PBO will be included for any plan that provides non-pension benefits after employment which are paid for entirely or in part by employers.  In most cases, these are post-retirement health benefit and life insurance plans.

The PBO is the actuarial present value of the employer-paid portion of all current and future benefits.  For employees not currently eligible for benefits, the present value is pro-rated by the ratio of current accumulated service over projected service at full eligibility age.

Thus, if medical benefits are completely retiree  paid (including administration expenses), there is no reportable liability and no disclosure is necessary.  Caution: If there are any hidden employer subsidies (such as a level premium for active and retired participants), these subsidies must be valued and reported.  Also note:  Amendments to the SOP are currently being considered by the AICPA which will require even fully retiree paid plans to report the liability components.  We will keep you posted on any developments in this regard.

Why are these calculations so difficult and costly?  First there are the data requirements.  If the covered group also participates in a pension plan, some of the data collection may already be available (assuming those participating in the retiree medical plan can be identified separately).  For active participants, a date of hire or accumulated service information is necessary, which may not be readily available for multiemployer plans.  Also required is date of birth, sex, plan eligibility codes and any special subsidy indicators.  For eligible retirees, plan election codes, spouse date of birth (if participating), covered dependent information and disability codes are additionally required.  Data on eligible surviving spouses should also be available.  Information on inactive participants is not usually necessary since they are rarely covered for postretirement benefits.

It would seem that the calculation of these obligations would be similar to that of a pension plan valuation.  To a certain extent this is true.  The actuary values a stream of future benefits (e.g. health claims) based on the occurrence of certain qualifying events (retirement from active service, disability, etc.).  This value is based on a mathematical model utilizing a series of actuarial assumptions including such pension assumptions as to mortality, terminations, disability, and retirement and a present value interest discount rate.

In effect, the calculations are actually a hybrid of pension funding and health cost projections.  Unlike a pension plan, the stream of future benefits is not a constant.  Health claims vary from year to year because of medical inflation, Medicare integration at age 65 (or disability), and changes due to age.  So, additional non-pension assumptions which are unique to these calculations include health care claims cost by age and sex and medical trend (inflation) rates by calendar year.  Development of these assumptions can be extremely time-consuming.  Also unlike a pension plan, benefits are not actuarially reduced for Early Retirement, so the selection of a retirement rate set is crucial to cost sensitivity.  If more participants are assumed to retire prior to Medicare eligibility, the PBO will increase accordingly.  Other non-pension assumptions include participation rate (if employee shares cost), choice of plan at retirement (each with different cost attributes), dependent coverage, and post-retirement participant contributions or premiums which may vary by age, plan, dependent coverage, etc.

There is no direct requirement in the SOP that the individual performing these calculations belong to one of the professional actuarial organizations.  However, it may be advisable to hire a professional actuary for the following reasons:

a. The SOP requires the consideration of a set of specified actuarial assumptions, although the practitioner is not limited to this assumption set; and

b. The Plan Auditor is responsible for assuring that the reported figures are determined in accordance with both generally accepted accounting and actuarial principals.

 In any case, the individual(s)  should be familiar with both pension and health actuarial methodology and qualified to perform these calculations based on their education and experience.

What do we do with these calculations anyway?

Okay, we've hired some competent professionals to develop the SOP numbers and the auditors are happy.  What now?  Although the reported figures do not appear to provide any direct insight as to the ability of the Plan to provide future benefits, the sophisticated actuarial model used in the calculations can produce a number of extremely useful cash flow projections and sensitivity studies for multiemployer plan Trustees as a by-product of the original calculations.  (Sensitivity studies show the net effects on future cash flow requirements resulting from incremental changes in plan design and/or actuarial assumptions.)  Here are some examples:

1. Short term (e.g. over the term of the collective bargaining agreement) and medium term (8-10 years) cash flow projections can be an indicator of the sufficiency of current and future employer contribution rates to fund benefits over these horizons.

2. Early Retirement Sensitivity - if the Trustees are considering liberalizing the pension plan's early retirement provisions, this study can show the effect on the retiree medical plan's cash flow requirements before and after such a change.

3. Inflation Sensitivity Analyses - illustrate the effect of a 1% change in the medical inflation rate assumption on the Fund's cash flow requirements.

4. Sensitivity to Cost-Sharing - retiree cost-sharing can lead to a leveraging of employer costs if the retiree portion does not keep pace with medical claims inflation.  The actuarial model can show Trustees how to limit the employer-retiree cost disparity over time under various inflation assumptions.

5. Sensitivity to Medicare Changes - Inclusion of a Medicare Risk option can have a significant effect on cash flow for over-65 retirees.  The impact of future government changes in the Medicare program can also be analyzed.

If the actuarial model for the SOP calculations is constructed properly with a sufficient set of actuarial assumptions, these types of studies can be performed for very little additional cost.  They provide Trustees with practical tools to evaluate the operation of the retiree medical plan that may not have been previously available.

What should Administrators be doing now?

With the January 1, 2000 deadline rapidly approaching, Trustees should be directing their administrators to do a thorough review of any plans providing employer-paid postretirement non-pension benefits.  This review should include (but not be limited to) the following:

1. Segregation of individual medical claims information by age for retiree plan only.

2. Organization and classification of eligible retiree and dependent data.

3. Accumulation of demographic data for actives (if not available from pension plan data) including "date of hire" or service information.  Historical retirement age experience should be accumulated to aid the actuary in the development of the retirement rate assumption set.

4. Establishment of an internally consistent set of codes to cover all of the possible plan types, subsidy types, participant premium rates, and dependent coverage combinations.

5. A written description of the plan and how it operates, if this does not currently exist.  It should enumerate all eligibility requirements and employer provided subsidies, including administration costs.

Before beginning, the nature of this review should be discussed with the auditor and actuary.  The review will offer a firm foundation for all those involved to enable completion of the SOP process on a timely basis.

In Conclusion

While the SOP medicine may not taste all that great to many trustees, it appears that the multiemployer community will have to live with it for at least the near future.  Choosing the right professionals can help ease the burden and, in many cases furnish meaningful cash flow and sensitivity illustrations as a by-product of the initial calculations.  For well-informed trustees, careful planning will assure that the "Y2K problem" does not include any SOP 92-6 ramifications.