This course is the fourth course in a five-course Financial Reporting Specialization. This course focuses on the recognition, measurement and subsequent accounting for equity, pensions, share-based compensation and cash flows utilizing the FASB Accounting Standards Codification and other resources.
Retiree Medical Benefits
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From the course by University of Illinois at Urbana-Champaign
Accounting Analysis II: Accounting for Liabilities and Equity
12 ratings
University of Illinois at Urbana-Champaign
12 ratings
Course 4 of 5 in the Specialization Financial Reporting
From the lesson
Module 2 Postretirement Benefits Part 2
In this module, you will continue your study of the employer's accounting for employee retirement benefits, including health care plans, multi-employer plans, and defined contribution plans. We will learn the definitions of curtailment and settlement and the impact of each on the financial statements. The module also describes defined contribution plans and multi-employer plans. The module will wrap up with a brief discussion of some of the major differences between US GAAP and IFRS.
Meet the Instructors
John HeppClinical Assistant Professor of Accountancy
Department of Accountancy
Welcome back. In this module,
we'll continue our discussion of Postretirement Benefits,
talking about retiree medical benefits,
defined contribution plans, and some other topics,
including curtailment and settlement of defined benefit plans.
But I will start in this lesson with a discussion of retiree medical benefits.
So, these are sometimes called OPEB.
You'll see this abbreviation, OPEB.
It stands for Other Post Retirement Employee Benefits
and they're mainly health care but they could be other things.
It could be insurance, for example,
that's included in that.
They're accounted for in a similar fashion to define benefit plans.
There are some unique assumptions that are required in order
to measure a postretirement healthcare benefit.
It makes it actually a little bit softer number than a pension plan.
Some of those unique factors include consideration of historical per capita claims,
their cost by age,
health care cost trend rates,
which have mainly been pretty steep in recent years,
and also medical coverage payments by
government authorities and other providers of health care benefits.
Some employees may have other insurance,
for example, available to them.
It's a little bit different doing the measurement.
Remember when we were doing pensions,
we had a separate projected benefit obligation and accumulated benefit obligation.
The projected benefit obligation included consideration of future salary increases.
Well, that's usually not a factor in healthcare benefits.
So usually, you just have
an accumulated post retirement benefit obligation, it's abbreviated APBO.
So, it is complicated.
You have to consider estimates of health care inflation,
changes and health care utilization,
how often people will go to the doctor,
and delivery patterns, how the services will be delivered,
technological advances and changes in the health status of planned participants.
Now, you can also have amendments to an employee benefit plan for health care.
Remember, we call that Prior Service
Cost or a Prior Service Credit when it's reducing the benefit,
when it was pensions plans.
With a notepad plan,
it's also recognized in OCI,
but the amortization periods a little bit different.
With pensions, we took the PSC and we amortize it
over the remaining service life of the employee.
Now, some people thought that was controversial and it was first put in,
that it should be expensed immediately.
Recall that IFRS is expensing these immediately today.
Well, when they issued the OPAP statement a few years later,
they chose a shorter period,
and that's the remaining period to
full eligibility for benefits when you're fully vested for the benefits.
And that may be a considerably shorter than your remaining service life.
So, there are other important reductions too.
An employee's share of the expected future post retirement health care plan
can be reduced for benefits from Medicare,
or other providers, or employee payments for cost sharing provisions.
So, that cost sharing can include deductibles,
co-payment provisions, out-of-pocket limitations,
caps and the limits of the employer provided payments,
meaning that the employee would be
required to pay for the rest of the cost of the insurance,
and also other retiree contributions.
A lot of insurance plans do require the employee to
pay least part of the cost of the insurance.
With prescription drugs, there was a change made back in the early 2000s,
the Medicare Prescription, Drug,
Improvement and Modernization Act,
which did include a couple of new features that
an employee would need to consider in determining the APBO.
There are government subsidies included in that act.
One is a subsidy that's paid to the employer and it's
a 20 percent of the retiree annual prescription costs for each individual,
that's between $250 and $5,000 subject and that's subject to indexation.
So, this is an amount paid to the employer that sponsors one of these plans.
It was paid to help encourage employers to continue
these plans instead of
eliminating them and pushing everybody into the Medicare drug benefit.
And then, there's the prescription drug benefits
that are available under Medicare itself.
You would not net those subsidies.
So, you're going to disclose the gross amount of benefit payments that
the employer is responsible that's paid and expected,
and you're going to include prescription drug benefits in that number,
and you'll disclose separately the gross amount of
subsidies that you've either received or expect to received.
The expected amount gets included in the calculation of your net obligation.
Now, there's another difference too with pension plans.
In that, the plan assets of plans may be subject to income tax because
there's really not that many tax-exempt vehicles
available to fund retiree medical benefits.
And this is true, even if the benefit plan assets are
restricted and segregated within a trust,
as they need to be a lot of plans aren't.
Actually, a lot of medical plans aren't funded at all.
They're very weakly funded compared to a pension plan.
So, if the benefits are taxable,
the income from the plan assets is taxable to the trust,
then you're going to reduce,
you're going to reflect that and your expected income from the plan,
from the plan assets,
the expected long-term rate of return will be net of that actual tax.
Now, if they're taxable to the employer,
you won't do that because
the employers are going to pay that and it's going to be reflected in
the employer's income tax expense and then the
deferred tax asset or liability that they may have.
It won't be within the trust.
So, it doesn't get reflected within
the actual measurement of the expected return on plan assets that will be separate.
So, if it's taxable to the trust you reflected in
the measurement of the planned obligation, the net obligation.
If it's taxable to the employee, you don't.
There isn't a difference between pension benefits and open benefits.
Pension benefits, at least in the United States,
are regulated and guaranteed by the Employee Retirement Income Security Act.
It's commonly referred to as ERISA.
That means that generally,
even if an employer goes bankrupt and there's not enough money in the plan,
there is a government program,
an insurance program that will come in and step in and make payments.
Maybe not as much as the employees would have otherwise gotten but there is security and
an employer can't just arbitrarily
and a pension plan that employees are already invested in.
All paid benefits generally are not guaranteed
by ERISA and they can be terminated by the employer,
pretty much at any time without compensation.
So, what are the journal entries?
The journal entries for an OPEB plan are nearly
identical to the entries for a defined benefit plan.
The main differences typically are consideration of
employee payments and government subsidies.
So, let's take a look.
Here's a side-by-side comparison from
an actual financial statement of pension and OPEB payments.
You see the pensions are the two columns on the left and
the OPEB health care and life insurance are the two columns on the right.
You can see that the amount of assets for the OPEB plans is much lower,
relatively speaking, than the amount for pension plans.
Now, again, there's a movement lately to fund more of these OPEB plans.
But in general, a lot of OPEB plans are underfunded or are even unfunded in their amount.
You can see that the amounts are similar,
you've got interest class,
you've got service class,
you've got actuarial gains or loss,
you've got amendments, that's all the same.
Benefits paid, that's all the same as we
had in our study of pensions, defined benefit pensions.
And then, there's a couple of new ones.
There's your health care subsidies that are coming in.
These are payments under that Medicare Act that we talked about.
And also, there's an employer contribution and settlements and curtailments.
Now, this plan does not appear to have any contributions by the employees.
But if they did, that would show up as in
the plan assets and also as a reduction in
the planned benefit with the expected contributions in future years.
In addition to corporations,
the public sector also has major issues with
pensions and there have been some major changes in recent years to
how the states that use government accounting standards are measuring public pensions.
It's just with GASB 78 and GASB 73 did
require state and municipal governments to participate in defined benefit plans,
to recognize the unfunded portion in their statement of net position.
And then, GASB 73 does the same for retirement health care benefits.
A major difference between the two is the discount rate.
Many states previously were using the expected return on planned assets as
the discount rate instead of the rate of AA bonds,
for example or a high-quality bond portfolio.
The rate at which you could settle the liability today,
which is what we discussed using for
pensions and pretty much what we would use for OPEB as well.
It's still different.
It's still not quite the same.
What you're going to use is that investment rate or return for the funded part in
a low-risk rate for the unfunded portion of the liability.
So, you are going to still use the investment at
a somewhat higher discount rate for
the funded portion but you're going to use a lower rate,
the same rate you would use for FASB obligations for the unfunded portion.
So, that concludes our discussion on retiree medical benefits.
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