Retiree Medical Benefit Funding Alternatives for Employers

Employers are now realizing that unfunded post-retirement medical liabilities can “break the bank.” The magnitude of unfunded retiree medical liabilities 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 population 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 on their businesses. Commitments and past promises to provide medical insurance are now being questioned and reviewed. The purpose of this article is to examine options 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 increases in costs arising from inflation 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 by at least providing retirees access to health care. 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. Indeed, to that end, 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; the full cost of the program is paid by the retirees. This approach would give the retiree population access to group coverage that would not be available on an individual basis, although the individual retiree, not the employer, would be responsible for paying for the coverage. 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, expenses 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 converting retiree health programs 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 advantages 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.
• There is access to affordable group coverage at group rates.
• Administration is simplified for the post-65 retiree population.

• Partial funding via a VEBA. Employers are starting to address the problems associated with a significant unfunded retiree medical liability. Here, a Voluntary Employee Beneficiary Association (VEBA) can be utilized. Funds are contributed to the VEBA to pay current retiree medical expenses as well as to provide partial funding of the future liability. Once funds are contributed to the VEBA, however, they cannot be used for other purposes. Moreover, the employer should consider the tax consequences arising from investment earnings of the VEBA, such as unrelated business income tax (UBIT).

Subject to certain limitations, the employer contributions to a VEBA can receive favorable tax treatment. Over time, the unfunded liability associated with the retiree benefit offering is reduced by the excess annual contribution and the investment income from the trust, because 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 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 investment 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 included.

Above are the four options available to plan sponsors today with regard to the funding of retiree medical benefits. As noted in the chart, the funding and commitment levels will vary among options as will the security and guarantees offered participants.