As retiree-related benefits have an increasing impact on earnings, Christopher Quinn and Chris Rutten contend that they have moved from being a `accounting thing' to an `expense thing'.

Employers' provision of employee pre- and post-retirement benefits is a significant component of human resource expenditure in many developed and developing countries in the world. Because of this, it is a substantial matter for many national and multinational corporations. It is also an element of payroll-related expense which is often largely outside the direct control of the organisation bearing the ultimate cost burden. Medical cost inflation, low investment returns, long-term health expectations, expanding treatment and benefit options as well as increasing longevity of retired workforces, all combine to add to the size, assessment complexity and control of the cumulative expense bill.

A tale of two standards
For companies reporting under US GAAP, the application of accounting standard FAS106 has emphasised the impact of retiree-related expense provisions on periodic earnings. This accounting standard is now effectively being combined in its application with the US Actuarial Standard Board's ASOP6 which establishes the most recent actuarial basis for the measurement of employer long-term non-pension obligations to retired workers.

The two standards when taken together now constitute a clear and supportable requirement that essentially says that an adequate financial reserve for all anticipated future costs of medical benefits provided for a company's retired workforce must be reflected in the employer's audited annual balance sheet. This reserve must also be regularly kept up to date: any variation in the assessment of the required reserve, for most companies usually upwards (mainly for the reasons cited above), will be reflected in the profit and loss account. It will therefore unavoidably impact annual earnings and quarterly earnings per share in the quarter in which the revision is made.

The accounting standard is not new, its introduction dating from 1990 with progressive implementation up to 1994. ASOP6, however, was produced in December last year, updating and strengthening earlier actuarial guidance which it now supersedes. Whether it is the most recent effects of the inter-relationship of the two professional standards, or persistent increases in health care cost for retirees, or an amalgam involving all three, the immediate financial statement recognition of estimated long-term cash flows seems to be of increasing concern to US corporations.

Cost recognition in accounting terms is one thing, but ultimate cost control and containment of this category of expense is as worthy of attention as any other long-term human resource cost. So far as the retiree workforce is concerned, the `productive value' to the enterprise of this cost and these actual and potential increases in expenditure is at best extremely limited, except perhaps in motivating existing employees and new hires concerning the value of their overall benefits package. This is widely recognised by many CEOs, CFOs, HR executives and risk managers. As a consequence, this issue transcends being just a quarterly and annual earnings `accounting thing' to a real `expense thing' which merits management attention to curtail risks and uncertainties.

In Europe and elsewhere
Increasing consciousness of these kinds of expense issues, as well as the accounting recognition and actuarial assessment of them, is not just a US phenomenon. It is of growing concern to European and other employers, many of which are faced by reporting under US GAAP and have a substantial worldwide employee workforce, as well as an aging retiree population. For others, established employment practice vis-à-vis healthcare costs in their home market has often lead to the employer progressively taking up a material proportion of the burden. Whilst the accounting recognition issue may not be as stark under local rules as in the US, nevertheless, the management of the associated long-term expense obligation is just as significant an opportunity.

Accounting and costs
The good news is that tax-efficient insurance-based solutions exist that can confine and control this expense and accounting burden. The long-term nature of these benefit risks is in large part determined by increased life expectancy in old age, medical cost inflation and the adequacy of investment returns. This is familiar territory for a handful of reinsurers that specialise in the life insurance sector, in particular in running-off existing blocks of life, health and annuity insurance reserves. Compared to costly and inflexible traditional insurance solutions, such reinsurers are accustomed to evaluating large and complex transactions without involving administrative overhead.

The core requirements for effective insured risk transfer and cost limitation are:

  • the development of health plan parameters that aid affordable block reinsurance cost;

  • the selection of a financially strong partner that has sophisticated investment strategies and actuarial expertise, and also has experience in doing transactions quickly and efficiently; and

  • managing expectations with respect to data requirements, financial objectives, interaction with other employee benefit programs and the involvement of insurance captives.

    Pioneering corporations
    A handful of such insurance and reinsurance approaches have been used by corporations addressing the retiree medical expense issue in the last 24 months or so. This has enabled them to cap or limit ultimate exposures at a reasonable dollar cost, to access higher investment returns than they are likely to obtain on any dedicated assets they may currently hold against these obligations, while at the same time achieving a tax deduction on the premium paid in consideration for the transfer of the liabilities.

    Appropriately-structured transactions have eliminated the earnings impact of FAS106 for clients and achieved the core economic benefits of externalising these risks. Through its specific life/health sector capabilities and investment management focus, Max Re has been able to generate substantial cost and risk management benefits to companies seeking to contain the economic and accounting impact of these benefit packages provided to their retired workforces.

    By Christopher Quinn and Chris Rutten
    Christopher Quinn is a managing director of Max Re Europe based in Dublin, Ireland with responsibility for life, annuity and health transactions. Chris Rutten is senior vice president of Max Re Ltd in Hamilton, Bermuda. They can be contacted by visiting the website

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