Ever since the implementation in 1993 of FAS 106, corporations have been required to make actuarial projections of future health benefit liabilities using an assumed medical inflation rate and record the discounted value of the projected liabilities on the balance sheet. This change increased corporate awareness of the potential magnitude of the liability and made the income statement more sensitive to changes in medical inflation. Although the actuarial value of the liability may not be the true economic cost, the corporate response has been to limit materially retiree health benefits, guaranteeing a reduction in both the actuarial and the economic value of the program.
At a time when it is increasingly difficult to attract and retain qualified workers, this is an unfortunate–and perhaps unnecessary–consequence. Given that retiree health is an immensely attractive and valuable benefit to employees, it may be time for corporations to re-think their position and consider alternative plans that balance the value of the retiree medical benefit to the employee with the economic cost to the shareholder.
Finding alternatives requires an understanding of what companies provide workers with when they offer retiree healthcare. Retiree medical is economically equivalent to non-qualified deferred compensation in which employee pre-tax income grows at the rate of medical inflation–and insurance premiums, rather than cash, serve as payment.
Recommended For You
From a tax perspective, post-retirement medical benefits are no more costly to the employer than any other form of non-qualified deferred compensation, because all deferred benefit payments are tax deductible when paid. However, from the employee's perspective, retiree medical offers superior tax advantages. While deferred compensation paid in cash is fully taxable, corporate health benefit payments are tax-free to the employee.
Unfortunately, thanks to FAS 106 accounting, high levels of medical inflation and the inability to hedge the exposure have made retiree medical benefits an unattractive offering from the shareholder perspective. Thus, the trick for employers is to devise a way to offer retiree medical while limiting the exposure to medical inflation and FAS 106 accounting. Perhaps the easiest solution: Design a deferred compensation benefit in which the employee's pre-tax income would grow at selected market investment returns. The deferred balance could then be used to make health insurance premium payments in retirement.
This structure would allow the employee to enjoy the tax benefits of retiree medical and the cost benefits of group health insurance rates–while not exposing the employer to medical inflation and FAS 106 accounting. Although the employee would bear the basis risk between investment returns and medical inflation, the tax savings–compared to alternative deferral plans–would absorb a material amount of this risk. The result: a benefit where the economic value to the employee exceeds the cost to shareholders.
© 2025 ALM Global, LLC, All Rights Reserved. Request academic re-use from www.copyright.com. All other uses, submit a request to [email protected]. For more information visit Asset & Logo Licensing.
