Dietrich Papers May 2009

www.dietrichassociates.com Dietrich & Associates, Inc. (800) 966-8376

Retiree Medical Benefit Funding Alternatives for Employers

By Dana M. Dallara, CEBS

Unfunded post retirement medical liabilities are liabilities that employers are now realizing can “break the bank”. The magni-tude of the unfunded retiree medical liability has increased dramatically and has become a significant item on the corporate balance sheets of many employers. In recent years, medical breakthroughs, new cures for diseases, more advanced state of the art diagnostic equipment and medical advancing prescription drugs have all contributed to the significant increases in the cost associated with providing medical coverage to retirees. For all of these reasons the life expectancy of the retiree popula-tion has increased. Now that this liability is required to be disclosed on the corporate balance sheet, employers are facing the reality that the longer term funding of this benefit will have significant economic consequences. Commitments and past promises to provide medical insurance are now being questioned and reviewed. The purpose of this article is to examine op-tions available to employers as they try to manage and mitigate this liability. Today many employers have to make the difficult decision to either terminate or scale back the medical benefits provided to retirees. For those employers who continue to offer this valuable coverage, their contribution/subsidy has often been capped with future inflationary increases now passed on to the participants. Where existing programs are being terminated for future retirees, plan sponsors still want to examine ways to honor past commitments that were made. Even if current subsidy levels prove to be unaffordable, providing access to group medical coverage can be very valuable to the retiree group. Employers have several options available to them when considering how best to proceed with their retiree benefit offerings;

• Terminate plan and implement access only group program for post-65 retirees For employers who determine that they can no longer afford to provide the funding for retiree medical coverage this may be the best solution and most current plans reserve the right to make changes to the plan at any time. With this approach, some employers are replacing their traditional group plan with an access only/ voluntary plan. For post-65 retirees, these programs integrate very efficiently with Medicare and are readily available in the marketplace today. The employer is not responsible for any cost to provide this benefit therefore the full cost of the program would be paid by the retirees. This approach would give the retiree population access to group coverage that would not be available on an individ-ual basis. Active employees would also be eligible for this plan in the future as they retire.

• Continue with a pay-as-you go approach Employers that continue to offer medical coverage to retirees may not be able to fund the benefit in advance. Instead, ex-penses associated with providing retiree medical coverage are paid for on a pay as you go basis. In an effort to control cost, employers are capping the contribution and/or subsidy and changing the programs plan design from defined benefit type plans to defined contribution type plans. It has also proven cost efficient to separate the retiree population from the active group as this results in more effective Medicare integration for the post-65 population. A fully insured group program can be used to cover the post-65 eligible retiree population. This approach has many advan-tages over a self-funded plan and/or individual options for retiree medical coverage that may be currently be in place. Some of the advantages include the following:

√ Coverage is guaranteed issue √ Coverage is available nationwide √ Medicare network of hospitals and medical providers can be utilized √ Access to affordable group coverage at group rates √ Simplified administration for post-65 retiree population

Dietrich Papers May 2009

www.dietrichassociates.com Dietrich & Associates, Inc. (800) 966-8376

• Partial funding via a VEBA Employers are starting to address the problems associated with a significant unfunded retiree medical liability. Here a VEBA environment can be utilized. Funds are contributed to pay current retiree medical expenses as well as partial funding of the future liability. Once funds are contributed into the VEBA, they cannot be used for other purposes. Tax consequences may apply to the investment earnings of the VEBA. (UBIT- Unrelated business income tax) Subject to certain limitations, the employer contributions can receive favorable tax treatment. Over time, the unfunded liabil-ity associated with the retiree benefit offering is reduced by the excess annual contribution and the investment income from the trust. On a monthly basis VEBA funds are used to purchase medical coverage on the lives of the eligible retirees and dependents.

• Full funding with a specialized group annuity More recently, employers with the financial means have begun using a group annuity inside a VEBA environment to fully fund the retiree medical liability. This approach enables an employer to honor past commitments while giving the security of a fully funded (insured) benefit to the eligible participants. An advantage to this approach is that the mortality and invest-ment risk associated with this benefit is transferred to an insurance company. The unfunded liability is eliminated and the benefit subsidy is guaranteed for the lifetime of each retiree. The VEBA funds, along with possible contributions from the retirees, are then used to purchase a fully insured medical plan that integrates effectively with Medicare for the post-65 retirees and eligible dependents. Few companies are considering the inclusion of a new retiree medical offering in their benefit programs today. For those companies that are considering adding this valuable benefit, advance funding of some type is a common feature that is in-cluded.

Above are the four options available to plan sponsors today with regards to the funding of retiree medical benefits. As it can be noted, the funding and commitment levels will vary amongst options as will the security and guarantees offered partici-pants. About the Author: Dana Dallara is Vice President of Group Benefits at Dietrich & Associates, Inc., a leading employee benefits and con-sulting company specializing in funding solutions for Defined Benefit Pension Plans, and Retiree Medical Plans. Dietrich & Associates, Inc. offers clients solutions that are innovative and focused toward mitigating financial volatility and minimizing administrative and regu-latory responsibilities. For further questions regarding the information in this article Dana can be reached at (800) 966-8376, ext. 11.

Benefit Security for Retirees

Least Most

Funding Status

Terminate plan and implement access only

group program for post-65 retirees Partial funding via a VEBA

0 %

Continue with a pay-as-you go approach Full funding with a specialized group

annuity 100%