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"Buy-out" of retiree medical liability


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Employer currently provides retiree medical coverage, but would like to remove the liability from its financial statements. One option being considered is offering a lump-sum payment to retirees to "buy-out" their medical coverage. In other words, for $X retiree agrees to waive the right to continued employer-provided medical coverage.

Has anyone seen such an arrangement? I can't think of any reason why the employer couldn't implement this proposal. I understand there are other options and that there are many nits that must be picked to proceed. At this point, I'm just trying to identify major roadblocks, not speed bumps.

Thanks. :unsure:

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Section 125 will tax everyone on the cash whether they take it or the coverage, but that probably won't be a problem because I assume it is structured so that no one keeps the coverage. I don't see any other obvious problems. It sounds pretty generous.

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Do the employees have vested rights to retiree health coverage? Most plans do not vest employees in retiree medical for life but provide that the benefits can be reduced or terminated at any time by employer. If employee has vested right to lifetime retiree medical benefits why would he trade it in for a lump sum payment?

mjb

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Well, he/she might trade it in. The retiree may know his/her life expectancy is shorter than average, which may change the comparison. (It does not necessarily argue in favor of a lump sum.)

If the employer has a defined benefit pension plan, the offer could be for an increase in the monthly benefit, rather than a lump sum. This may be possible even if the retiree took a lump sum distribution from the pension plan in the past. This structure may make the tax consequences a bit easier.

The employer should be cautious and review terms of the medical plan with ERISA counsel. Also, note that there may be more than one plan, due to prior changes, acquisitions, collective bargaining agreements, etc.

I'm a retirement actuary. Nothing about my comments is intended or should be construed as investment, tax, legal or accounting advice. Occasionally, but not all the time, it might be reasonable to interpret my comments as actuarial or consulting advice.

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I think that you might have some serious valuation issues and resultant potential fiduciary liability issues pertaining to disclosure.

If that employer or one of its advisors is savy enough to be able to accurately predict what the inflation rate in medical costs will be each year for the next 20 or 30 years, I think that Warren Buffet should retire and let that person handle his investments.

If the person can't accurately predict the costs, the employer will be very vulnerable to a lawsuit and possible liability if the medical costs escalate at a rate faster than what that person predicted.

Unless that employer has an extremely high risk tolerance level or its continued existence is seriously threatened by the costs associated with the retire medical plan, I would advise against it.

Mbozek: You said:

Most plans do not vest employees in retiree medical for life but provide that the benefits can be reduced or terminated at any time by employer.

While that is true of retiree medical plans drafted today, that is not true of retiree medical plans that were drafted in the 1950s and 1960. Your comment should be limited to those that were drafted after the onslaught of litigation relating to the termination of retiree medical plans.

Kirk Maldonado

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How many retirees? Average monthly contribution? Is contribution flat or indexed to something? Extent of unfunded liabilities?

Can you do it? I suppose you can try. But if I'm a retiree with almost any kind of chronic condition, you don't have enough money to buy me out. How will I purchase coverage anywhere else with my condition?

If some take you up on the offer and others don't, you'll be left with the sickest of the sick. Not a good formula for an ongoing plan.

Why not contribute the money to funding the liability? Or, if it is not a vested right, terminate the program, hopefully in a humane way that gives participants time to make whatever other arrangement they can. (If it is a moral issue for the company to provide the benefits, or some alternative, I applaud you. Far too little integrity left showing in the world today.)

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There is no need to have crystal ball accuracy on the unkown value of future medical care as long as the participants execute a waiver of rights in return for the cash payment. Courts have upheld waiver of rights by participants for future claims under ERISA.

mjb

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I don't think that a court would uphold a waiver if it was based on false and misleading information or based on patently absurd assumptions, such as that there will be no inflation in the cost of providing health care.

At the very least, the fiduciaries of the plan need to verify that the disclosure information is complete and accurate. The disclosure document should say what assumptions were made in computing the buyout amount and what data backs up the use of those assumptions.

Kirk Maldonado

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An employer can unilaterally cease future benefit accruals unless there is a collective bargaining agreement or other contractual agreement not pre-empted by ERISA. A simple way to remove the liability would be to terminate the plan outright. That causes a myriad of employee relations problems. Read the IBM case on a unilateral conversion to a cash balance plan for an example of "bad facts make bad law".

I would suggest an approach patterned after the DB to 401(k) conversions pulled off between 1985 and 1993 by more than half of the Fortune 500 companies. Employees must receive something perceived to be of equivalent value when a benefit is lost, or all hell may break loose.

I suggest the use of a conversion from the current DB retiree health plan to a funded HRA retiree health plan, with the actuarial equivalent of the accrued benefit being funded into the plan. Such a conversion can be spun in such a way as to create perception of value. A "wearaway" choice may be offered to those within 10 years of their NRD, that converts only their future contributions to the HRA and freezes the liability at the current level.

Another method of "removing" the liability from the financial statements is to fund it. I recently assisted a company in establishing a VEBA trust with a $30 million contribution to fund their retiree medical benefits. This did not eliminate the liability, but it did "remove" it from their financial statements (at least for recognition though not for disclosure purposes).

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Guest rubindj

There are A+ rated insurers that will take over the liability for providing benefits. This is probably the cleanest method; however, I have no idea what the costs involved are.

Do a google search on your original topic to find at least a few (I can't remember which one's actually do it, but was looking at a brochure yesterday).

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vebaguru:

I don't think that the analogy to DB plans is apt. The present value of the future pension benefits can be accurately computed using the actuarial assumptions contained in the DB plan. There is no comparable way of computing the present value of future benefits in a retiree health plan.

Kirk Maldonado

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Of course it's possible to calculate a present value of future medical liabilities. Actuaries do not base their calculations on the assumptions described in the plan except for IRC Section 411 benefits. An employer can adopt any actuarial assumptions, reasonable or not, in the plan, while the actuary is required to use reasonable actuarial assumptions and appropriate methodologies. Section 411 calculations do not require an actuary while Section 412 calculations do.

Read FAS 87 and FAS 106 for guidance on actuarial methods and assumptions, as well as the disclosures provided for thereunder.

The method of computing the present value of retiree medical benefits is very close to the method used for pension calculations: the probability of each benefit is multiplied by the value of the benefit and the interest discount factor. The sum of all of these calculations is the present value of benefits.

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