- Background
Employers often promise post–retirement benefits to their employees. The most common forms of benefit include defined benefit pensions (DB Plans) and retiree health and life insurance (Other Postretirement Benefits or OPEB). Some forms of benefit are funded, some are guaranteed by governmental agencies while others are not funded and employers can rescind others at will.
Post–retirement benefit promises pose a significant financial obligation to many employers. The very long duration of the benefits, the wide variety of terms, the different levels of security all lead to uncertainty about the obligation's value. Current accounting standards are widely viewed as inadequate.
The predominant actuarial view regarding post–retirement benefit measurement can be summarized in the following three concerns:
- The post–retirement benefit obligation should reflect the security of the promise;
- Future salary increases should not be reflected in the post–retirement benefit obligation unless those increases are guaranteed;
- The post–retirement benefit obligation should reflect the possibility that the employer can rescind its promise.
A review of available literature suggests that the actuarial view is close to the view held by financial economists who have written in this area.
The Financial Accounting Standards Board (FASB) is now engaged in a comprehensive project to revise pension and OPEB accounting in light of widespread user dissatisfaction with current standards. In 2005, FASB split the project into two phases. Phase 1 addressed balance sheet issues and some disclosure matters and resulted in the September, 2006 publication of Statement of Financial Accounting Standards 158 (SFAS 158). Phase 2, expected to take at least three years and not yet initiated will address all other aspects of pension and OPEB accounting. It will be coordinated with other major accounting projects (convergence with international standards, revision of the comprehensive income statement and finalization of the fair value standard). FASB has indicated that it would take up the postretirement benefit measurement issues in depth in Phase 2.
Actuaries who participated in recent discussions with FASB felt that the actuarial view received less than appropriate consideration. The principal reason may have been a lack of support from users of financial statements, especially investment analysts. A secondary reason may have been inconsistency between the actuarial view and the accounting literature.
In order to determine if the actuarial view is viable, there is a need for published material that reflects both a financial economics perspective and a deep understanding of the accounting literature. A research project undertaken by academic accountants and economists could have immediate and potentially long–lasting impact on actuarial practice and, in turn, on accounting standards.
Thus, Phase 2 of the FASB project on retirement benefit accounting provides concerned parties with an opportunity to rethink current measurement standards. A joint effort by financial economists and accounting academicians, with actuarial involvement, can also help to engender mutual respect among the professions, and lead to opportunities for public discussion and further research in this area.
- Purpose
The Society of Actuaries (SOA) seeks academic research into whether employer obligations for post–retirement benefits can be represented in financial statements more effectively than is the case under current accounting standards (FAS 87 and 106 principally). In particular, can relevant insights from financial economics regarding market value be integrated into future accounting standards in which DB and OPEB liabilities are reported at fair value?
Research teams will presumably include person(s) with knowledge of and experience in the fields of financial economics and accounting theory. Actuarial assistance, if needed, may be obtained through inclusion of actuaries in the research team, consultation with outside experts, or limited consultation with members of the Project Oversight Group (POG) appointed by the SOA to oversee this project. The proposal should explain what form actuarial assistance, if any, will take.
This project should be completed in time to influence the outcome of Phase 2 of the FASB project. The desired output is a paper or papers intended for submission in a peer–reviewed journal and which can lead to discussions with user, accounting and actuarial groups.
- Research Objective
As previously stated, the overall objective of this project is to investigate how an employer's post–retirement benefit promise can be best reflected in the employer's statement of financial position (balance sheet). The security of the employer promise ranges from an over–funded government–guaranteed DB pension plan (most secure) to an unfunded immediately rescindable retiree health plan (least secure).
The following questions are intended neither to define nor limit the scope of the research, but to help interested researchers formulate a response to this RFP:
- What is the economic nature of the DB plan promise?
- What is the economic nature of the OPEB plan promise, particularly RH?
- What distinctions in the promise change the economics?
- Is there an economic distinction between a promise and a contract? If so, can that distinction be measured?
- Must the contract be entirely explicit for there to be a balance sheet liability, or do implicit promises also give rise to balance sheet liabilities?
- Accounting standards seek to link the timing of postretirement benefit liability recognition with the provision of services by the employee to the employer. When does the exchange of labor for promise take place?
- What is the value of the employee's postretirement benefit asset? Does the employee's asset equal the sponsor's liability in respect of that employee?
- Prior to first vesting, is there a valuable implicit contract?
- Is there a distinction between a liability and a debt that should be reflected in the balance sheet?
- When, if ever, should estimates of future salary increases be recognized?
- When, if ever, should estimates of future health care cost changes be recognized?
- When a benefit is rescindable, or ambiguous as to the long–term guarantee, should the obligation's measurement be affected by the sponsor's past performance in paying benefits to retirees (or giving salary increases to employees)? In those situations should the economic value measurement be affected by the sponsor's financial viability? Since fulfilling the sponsor's obligation is not only a question of ability to pay but willingness to pay, how might the latter be measured?
- Future salary increases, retirement decisions, staff size, medical cutbacks and full rescissions may all be tied to sponsor performance. Should financial reporting take account of correlations between these items and other corporate securities?
- What relationship might be anticipated between corporate creditworthiness and benefit cutbacks?
- Should a relationship between the sponsor's stock and the level of salaries and benefits be anticipated?
- How could the sponsor's right to rescind nonguaranteed benefits be modeled? Do rescindable benefits give rise to balance sheet liabilities? Should payments that are several decades off and rescindable be given equal current weight in measurement with guaranteed benefits of the same duration? Why might a rational sponsor choose not to rescind?
- What asset pricing models are relevant to the measurement of DB and OPEB obligations?
- Does accounting and economic literature provide useful guidelines for when to use risk free discount rates versus risk adjusted discount rates?
- Rescindable retirement benefit obligations do not appear to be measurable through an option–pricing model. Does a practical model exist?
- What footnote disclosures, or management discussion and analysis, would be appropriate to give the statement user a reasonable understanding of the benefit liabilities, given the uncertainty?
- Supplementary Information
Section XI of this document contains an appendix with background information on OPEB benefits for respondents with limited familiarity with them.
- Proposal
To facilitate the evaluation of proposals, the following information should be submitted:
- Resumes of the researchers, including any graduate student(s) expected to participate, indicating how their background, education and experience bear on their qualifications to undertake the research. For this effort, the research team is required to include one accounting academician. For communication purposes, one team member should be designated as the primary contact. The person submitting the proposal must be authorized to speak on behalf of all the researchers as well as for the firm or institution on whose behalf the proposal is submitted. If the team intends to seek actuarial assistance, the proposal should note this information.
- An outline of the approach to be used, noting issues that require special consideration. Details should be given regarding the techniques to be used, collateral material to be consulted, and possible limitations of the analysis.
- Cost estimates for the research, including computer time, salaries, report preparation, research costs, etc. Such estimates can be in the form of hourly rates, but in such cases, time estimates must also be included. Any guarantees as to total cost should be given and will be considered in the evaluation of the proposal.
- A schedule for completion of the research, identifying key dates or time frames for research completion and report submissions.
- Ideas regarding the distribution of the final report, which is intended as a journal quality paper or papers. Appropriate peer–reviewed journals for submission of the work should be noted in the proposal. Although the paper(s) is intended for submission into a peer–reviewed journal, the SOA reserves the right to use the content of the paper for other purposes to the extent that it does not jeopardize journal consideration.
- Other related factors that give evidence of the proposer's capabilities.
- Selection Process
The SOA is responsible for the selection of the proposal to be funded. Input from other knowledgeable individuals also may be sought, but the SOA will make the final decision. The SOA Research Actuary will provide staff actuarial support. A POG composed of representatives from the SOA will be appointed to oversee the project and provide guidance.
- Questions
Any questions regarding this RFP should be directed by fax, or e–mail to: Steven Siegel, SOA Research Actuary (f: 847.273.8578).
- Notification of Intention to Submit Proposal
If you intend to submit a proposal, please send written notification by November 30, 2007 to Jeanne Nallon or (f: 847.273.8592).
- Submission of Proposal
Please e–mail a copy of the proposal to: Jeanne Nallon.
Proposals must be received no later than December 15, 2007. It is anticipated that all researchers who have submitted proposals will be informed of the status of their proposal no later than January 15, 2008.
Note: Proposals are considered confidential and proprietary.
- Conditions
The SOA reserves the right to not award a contract for this research. Reasons for not awarding a contract include, but are not limited to, a lack of acceptable proposals or a finding that insufficient funds are available to proceed. The SOA also reserves the right to redirect the project as is deemed advisable.
- Appendix on OPEB Benefits
This section contains introductory information for respondents with limited familiarity with OPEBs. Common benefits include: healthcare after retirement (sometimes for life); life insurance after retirement; disability benefits in the event the employee becomes disabled; and long–term care benefits. The most expensive types of OPEBs are those that insure health care costs, which have trended steeply upwards over a protracted period of time. Lifetime retiree health benefits should be the primary OPEB focus in this research project. Accounting standards treat OPEBs (like pensions) as "earned" by the employee during employment and paid out after employment.
The following are general observations about OPEBs:
- The accrual pattern of an OPEB plan is difficult to determine since a retiree's benefit is not earned in discrete intervals of money or time. Benefits rarely "vest" before retirement (many do not vest after retirement either). If a plan is not more specific, FAS 106 prescribes a projection and straight–line pro–rate attribution from hire date to first full eligibility. Some plans do specify an attribution rule.
- Most pension benefits are guaranteed, but most OPEB plan sponsors reserve the right to change benefit provisions or discontinue plan coverage.
- The OPEB sponsor's close–to–unilateral ability to make changes after the employee is retired argues against the concept of a mutually understood economic exchange between the sponsor and employee during the working years (see FAS 106 Paragraph #7).
- While a clear contract, mutually agreed upon between employers and employees, would assist actuaries in establishing an OPEB valuation model, such contracts are rarely seen except in collective–bargaining situations of limited duration, usually three to five years. In practice, terminations occasionally take place "all at once" for an OPEB plan, but are usually accomplished through gradual reductions over many years.
- For retiree health benefits, the possibility of major reductions should be conceptually distinguished from the periodic changes in plan provision that attempt to keep the plan current in the midst of ever–changing medical practices and prices. For example, a deductible increase by $50 could be viewed as a minor benefit reduction or, given rising plan payments, a way to maintain cost sharing between sponsor and beneficiary near some generally understood equilibrium. Most measurement of retiree health obligations (including under FASB and GASB standards) assumes these "substantive" plan understandings rather than fixed dollar provisions.
- Likely future health cost increases make most lifetime retiree health obligations heavily back–loaded, since the value of future health care costs rises rapidly as the employee ages. As a result, these health care OPEBs are similar to pensions in being obligations of extremely long duration.
- Most actuaries value substantive plan provisions using a deterministic model based on actuarial estimates of initial–year claim levels and trend projections for future years. While future health cost levels could, in theory, be modeled through stochastic methods, most retiree health actuaries feel the deterministic model is adequate and more practical.
- Retiree uncertainty about plan changes diminishes the value to the retiree of the OPEB asset held. The sponsor's ability to make the changes may reduce the value of the OPEB liability owed by the sponsor. Some recommend that actuarial valuation models include higher discount rates or explicit assumptions about future cutbacks as practical ways of valuing the sponsors' option to stop paying benefits.
- Uncertainty about whether the plan will provide coverage when needed correlates somewhat to the financial fortunes of the plan sponsor. It may be important to distinguish between the sponsor–specific credit risk and the risk, inherent in most OPEBs, due to the sponsor's unilateral ability to change the plan.