Communication to employees of DB cost

[AndyH]

I've had a few DB clients request the DB "cost" for purposes of comprehensive benefit statements covering everything from pay to Social Security to fringe benefits.

Each time we struggle with the best way to communicate the DB cost in dollar terms that can be added to other benefit costs.

I've used the 404 cost / eligible comp x employee comp as an average employee cost, the pv of the expected increase in the accrued benefit in the current year, and a couple of other methods. Each of these has it's problems.

I wondering whether others have run accross this, what method they typically use, and what experiences have resulted.

The plan size I'm talking about is 50-1,500 employees.

I realize that some companies present only the benefits, not the costs, but for those who present cost, what method is typical?

[Larry M]

I would keep it simple and include it as part of the total cost of the fringe benefits, using the actual contribution to the plan for the year, and allocating it among the employees in proportion to a normal cost for the participants or in proportion to the salaries of the participants.

Presumably medical and death benefit plans, workers comp, sick pay, paid leave, etc are included in the total of the fringe benefit costs and each of these requires some decision as to how to allocate.

For death, disability, or health benefits, the average premium (either adjusted for family status or not) should be used as opposed to using the actual benefit costs incurred by the individual.

similarly, the db plan's costs should be an averaging among the participants.

[david rigby]

No disrespect to Larry, but I strongly disagree that individual cost of a DB plan should be shown by prorating the actual contribution. There are several problems with doing that. The most obvious ones are:

First, the total cost usually includes inactive participants, so it could overstate the cost of an active participant.

Second, the actual cost of each individual is related to age, service, comp, etc., so that a proration based on comp (which is simple) will overstate the cost of participants who are younger than average and understate the true cost of those older than average.

I have seen first-hand the problems this one caused, when a division of a large plan was sold, and the participants were given lump sum options. The younger employees (which were most of this division) were very unhappy with the amount. They had previously seen EE statements showing a prorated amount of contribution "for that employee", which had averaged about 5%. As you might expect, they perceived this as an "account" and did not understand the actuarial equivalent concept.

Third, what if the plan is limited by the full funding limitation? The actual cash contribution may be zero (although the accounting expense might not be). There is still a cost to the plan for that individual and the increase in benefit.

My suggestion is to find a way to use the actual cost of that employee's *increase* in benefit. Some approximations may be necessary.

[Larry M]

pax,

I agree with most of your comments - and do not consider them disrespectful - you just pointed out I did not express my self properly...and I oversimplified by suggesting the use of salaries only without a further adjustment.

However, the major thrust of my response was:

Any pension "cost" should not be shown as a separate item.

I would never (never?) show the cost of a pension benefit to individual employees as a separate item on an employee benefit statement.

The method I am suggesting is to include an approximate cost allocation in the statement only as part of the total approximate cost of all fringe benefits.

We should not show the individual costs of the defined benefit plan in any statement. To show an individual defined benefit "cost" has to lead to problems down the road.

The usual purpose of these statements is to let the employees know a significant amount of money was spent by the company on behalf of the employee for items other than salary.

The statements enumerate the benefits (in detail) and then show an allocation (in total) of the company's total expenditure for those benefits.

We can argue about the specific methods of allocation for almost all the benefits. For example, if group life is provided, should the average term cost per thousand be used, or should the cost be allocated using a cost which increases by age? Or should there be no cost for those employees who did not die in the year?

For medical benefits, should we vary the costs by age or sex? Or should we use an allocation based upon the premium paid for that employee's class?

For workers comp, we can use an average rate/unit of salary or one which varies by occupational class.

In a defined benefit plan, if the full funding limit has been reached and there has been no contribution, should the statement include any cost for the plan in that year? I can argue that no cost be included. Or I might argue we use an artifical rate for every year.

All of these depend upon what the client wishes to accomplish and how much time he wishes us to expend on (and for which he is willing to pay) the allocations.

[AndyH]

Larry M., you had me completely sold. I never thought of the insurance analogy. You are correct, claims are not individually cited in a salary negotiation (as far as I know), rather it would be the cost of the premium.

Pax, I agree with your comments as well.

I'm not troubled by the full funding limit. I think the cost can be determined without regard to the FFL. I wouldn't get hung up on amortization bases, either. I think the cost without regard to those matters is the appropriate figure to use, not the contribution.

So, it seems we're back to square one, agruments for and against individual cost assignment. I don't know the best answer, other than some generic "premium" method which does make sense to me.

Further comments or thoughts would certainly be welcome.

Surely, others must do this. Thanks.

[david rigby]

Yes, it is back to the basic question. Larry makes some very good points.

Even if you decide that showing individual cost is a bad thing, that may not be an acceptable answer to the client, or some other vendor. If you are forced to show it, i suggest that you use some standard method, preferably applicable to all clients and all situations.

To me, that leads directly to use of the Normal Cost. Then you must decide which. I don't think the funding method is relevant in this case. For example, if you are using the Aggregate method, then that provides you no help in this regard. My preference is to use Entry Age normal cost, because this is typically a "truer" measure of the underlying cost, spread over the employee's working lifetime. Also, note that if you were to use the PUC Normal Cost, you might end up with an individual cost that is small when you (and the employee) don't expect that. This is likely if the plan has a service maximum, which can also lead to one year's normal cost being less than the prio year's normal cost.

In any case, I believe that the text is just as important as the number. Here is the text I used once:

"During (year), (Company) contributed over $ to fund these benefits, including $ in Social Security contributions. None of these amounts are placed in an individual account under your name, but are contributed in total to fund benefits for all eligible employees and beneficiaries."

[Edited by pax on 08-07-2000 at 01:20 PM]