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Fundamentals
of Retiree Group Benefits
Dale H. Yamamoto
ACTEX Publications, Inc.
Winsted, CT
ActexMadRiver. com
Copyright © 2006, 2009 by ACTEX Publications, Inc.
All rights reserved. No portion of this
textbook may be reproduced by any
means without prior written permission
from the eopyright owner.
Requests for permission should be addressed to
ACTEX Publications
P.O. Box 974
Winsted, CT 06098
Manufactured in the United States of Ameriea
1098 7 6 543
Cover design by Christine Phelps
Library of Congress Cataloging-in-Publication Data
Yamamoto, Dale H., 1952-
Fundamentals of retiree group benefits / Dale H. Yamamoto,
p. em.
Ineludes bibliographical references and index.
ISBN-13: 978-1-56698-586-4 (pbk. : alk. paper) 1. Retirees—United
States. 2. Postemployment benefits—United States. 3. Insuranee,
Group—United States. I. Title.
HQ1063.2.U6Y36 2006
331.25’50973-dc22
2006033452
ISBN: 978-1-56698-586-4
Preface
This book should have been first written 25 years ago. In 1980, several
employers offered retiree group benefits to their employees in the U.S.
because of the tax-effective benefit and relatively low current costs. With
retirees representing a small percentage of the overall covered population,
it was an inexpensive fringe benefit. Some employers even paid for the
Medicare Part B premium for the retiree and spouse. A few employers
provided free coverage to their retirees—absolutely no contribution re¬
quirement for the former employees. These benefits were at the top of their
game at this time.
Besides the tax-effectiveness of the benefit back then, most employers did
not understand what the long-term cost of this obligation was. Unlike pen¬
sion plans that were subject to the newly required minimum funding rules
of the Employee Retirement Income Security Act (ERISA), retiree group
benefits were largely unfunded and accounted for on a pay-as-you-go ba¬
sis. For companies who did want to prefund their obligations, they could
find vehicles that allowed them to almost fund as much as they wanted,
sheltered the investment earnings from taxes and paid tax-free benefits.
Life was simple with very few mles and relatively low cost. Tax legisla¬
tion passed in 1984 that restricted prefunding retiree obligations and sub¬
jected the investment earnings to taxes for certain types of funds. The Fi¬
nancial Accounting Standards Board (FASB) adopted new accounting
standards in 1990 that required companies to accrue for future retiree
group benefit payments during an employee’s working career—similar to
pension plans. This new accounting requirement along with high medical
cost trends in the late 1990s sparked a major revolution in the design and
employer financing. Other influences on retiree group benefit design in¬
clude court decisions, new legislation, overall retirement strategy changes,
and the health care market in general.
Much has changed in 25 years. There is a great variety of designs and
financing arrangements utilized by employers that are very different
from three decades ago. Few employers can claim to just have one
“plan.” Most have different programs for salaried versus hourly employ-
iii
ees; vary the plans by location, retirement date or employment date; have
legacy plans due to prior mergers and acquisitions; and even have em¬
ployees without a plan.
Retiree group benefits have earned a reputation for being difficult to un¬
derstand. Half retirement benefit and half group insurance—few profes¬
sionals have mastered both fields. In addition, complex finances blend
the world of pension mathematics and health plan pricing.
This book attempts to provide a fundamental understanding of almost all
of the elements that make up the world of retiree group benefits. Some
things may have been missed and things will definitely change. I hope
there is something of interest to everyone.
Because of the complex nature of the subject, I owe a great deal of grati¬
tude to several friends who volunteered their time to review the drafts of
this book. In alphabetical order, they are Paul Fronstin (Employee Bene¬
fit Research Institute), Randy Johnson (Motorola), Frank McArdle
(Hewitt Associates), Tricia Neuman (Kaiser Family Foundation), Jeff
Petertil (independent consultant), Adam Reese (Hay Group) and Allen
Steinberg (Hewitt Associates). Each one of these reviewers is well-
known in this field and provided invaluable input to make this a much
better book.
I also want to thank Gail Hall of ACTEX for her encouragement to com¬
plete this project. This book was started four years ago as a collection of
various articles and papers that I had authored over the years. Updating
that material turned out to be more work than I had anticipated. And,
there were several topics that I had never written about. Gail did what all
great leaders do, she gave me a deadline. Material was further updated
because of changes in the last four years and expanded with new text.
And, this book is the result.
Finally, I thank my wife Louise and son Ben for sacrificing valuable va¬
cation time so that I could write this book. It made for great conversation
after taking two four week vacations, when most of the writing was done,
to tell friends what I did on my time off of work. Typical response was,
“are you nuts?” with a few just shaking their heads. Most days comprised
of writing in the morning, doing something fun mid-day and back to
writing in the evenings. So, the next vacations will include a lot more of
the “fun” during the day.
Dale H. Yamamoto
October 2006
Table of Contents
Preface iii
Chapter 1 Introduction 1
Chapter 2 Erosion of Retiree Health Benefits 11
Chapter 3 Medicare 21
Chapter 4 Retiree Benefit Design 57
Chapter 5 Funding 117
Chapter 6 Legal Issues 151
Chapter 7 Accounting under FAS 106 171
Chapter 8 Other Accounting 211
Chapter 9 Actuarial Methods and Assumptions 251
Appendix A Retiree Group Benefit Design A-1
Appendix B Medicare Part D B-1
Appendix C Key IRS Code and Regulation C-1
Appendix D Cases Regarding Retiree Health Care D-1
Appendix E Health Practice Note 2006-3 E-1
Appendix F Measuring Retiree Group Benefit Obligations F-1
Bibliograp^ 295
301
Index
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Introduction
Retiree life and medical benefits were introduced to U.S. employee benefit
programs in the late 1960s. The medical plans were first designed to
supplement the Medicare program and were viewed as a “no cost” benefit.
At the time, the benefits were very inexpensive because medical costs
were relatively low and there were few retirees. Life insurance benefits for
retirees were often added as a natural expansion of retiree benefits.
In recent years, some employers have expanded their post-employment
offerings to include long-term care insurance and continuing-care retire¬
ment communities. These benefits are usually offered to employees at their
own cost (i.e., employee-pay-all). Others include severance, dental, vision
and hearing benefits.
In some respects, these benefits are similar to pension plans. They are
provided to employees after they have contributed their services to their
employer. Many times, the benefits are continued for the retirees’
lifetime. Like pension plans, some plan designs even vary based on ser¬
vice. But, unlike pensions, these retiree group benefits are generally not
extensively prefunded.
Retiree group benefits have gained much more attention since the early
1990s. The primary reason is the accounting rules that became effective
for most companies in 1993, issued by the Financial Accounting
Standards Board (FASB). These rules (FAS No. 106)* require employers
to account for retiree group benefits while an employee is working rather
than waiting until he or she is retired and the payments are made. A
similar rule just released by the Governmental Accounting Standards
Board (GASB) will have a similar effect on U.S. states and municipali¬
ties starting in 2006.
* Financial Statement of Accounting No. 106, Employers Accounting for Postretirement
Benefits Other Than Pensions, Financial Accounting Standards Board, December 1990.
2 ❖ Chapter 1
Other factors have also forced attention on retiree group benefit plans. In
1960, when many employers were adopting retiree health care plans, the
U.S. spent $28 billion on health care-related costs. This represented 5.2
percent of the gross domestic product (GDP). By 1980, the spending
grew to $255 billion or 9.1 percent of the GDP and in 1990 $717 billion
or 12.4 percent of GDP. Spending continued to grow in the 1990s,
reaching $1 trillion in 1995 or 13.8 percent of GDP.^ And health care
spending is expected to reach $2 trillion in 2005 and $3 trillion by 2011.^
Most executives are very aware of how their companies' medical plan
costs have increased over the same period. Couple this with an increasing
number of retirees due to maturing populations (in some cases
exacerbated because of recent layoffs and early retirement incentive
plans) and greater financial pressures. One can conclude very quickly
that retiree medical plans cost REAL money!
The purpose of this book is to provide the reader a fundamental knowledge
of the key issues with retiree group benefits. It is important to recognize
how both pensions and health care interact with each other as well as
differences in the delivery of the benefits. A secondary purpose of this
book is to put under one cover, all of the disparate focuses of these
complex benefit offerings, including the history of the benefits. Medicare,
design strategies, funding options, legal considerations, accounting and
actuarial calculation methods.
Employer-sponsored retiree group benefits continue to be an important
source of coverage for Medicare-eligible retirees with 35 percent of
Medicare beneficiaries covered under employer plans in 2002.
^ Centers for Medicare & Medicaid Services, Office of the Actuary, Data from the National
Health Statistics Group. February 2006.
^ Borger, Smith, Truffer, Keehan, Sisko, Poisal, and Clemens, Health Spending Projections
Through 2015, Health Affairs, February 22, 2006.
