EMAs: Retiree Medical Plans of the Future?

by Ronald H. Snyder, JD, MAAA, FCA

  America´s workforce is getting older. After a brief reprieve, medical costs are again increasing more than 10% per year. Employers are faced with a dilemma: with an aging workforce ever more aware of post-retirement medical needs, how can companies provide retiree medical benefits and retain valuable employees without becoming locked into a commitment they cannot afford? A new solution to this problem has been developed by Benefit Strategies Group, Inc.

How can employers attract and retain valuable, trained employees? All companies at some time must address this problem. In addition to offering competitive rates of compensation, employers must offer competitive benefit packages. A simple current health plan and a 401(k) Plan with a modest match are simply not enough. Nor do they provide employees with sufficient retirement security.

One of the benefits most in demand as the baby boom generation nears retirement age is a retiree medical benefit. Although employers are not expected to pay the entire cost of such benefits, most larger employers simply must provide a mechanism for coverage of employees, and fund a portion of the cost of providing such benefits, in order to compete for the most desirable employees.

When employers undertook such obligations many years ago, it did not seem like much of a commitment: they voluntarily chose to supplement Medicare coverage by allowing employees to remain on their health plans after retirement to cover expenses excluded by Medicare. They could charge the employee a nominal amount ($10 to $30 per month) and, since the plan was voluntarily undertaken, they could terminate it at will.

It hasn´t exactly worked out that way, ERISA (along with subsequent amendments) has clarified employees rights and made it very difficult to get out from under such an obligation. Moreover, Opinion 106 of the Financial Accounting Standards Board ("FAS 106") requires financial statement recognition of such liabilities and expenses employing to a methodology which considers the present value of future benefits to be provided. In many cases employers were required to recognize an unfunded liability on their balance sheet of millions of dollars, and are required to recognize costs in a way which has negatively impacted the company´s bottom line.

Now with the cost of medical benefits increasing at a rate in excess of 10% per year, and with no relief in sight, employers are between a rock and a hard place: how to stop the bleeding before the company is financially crippled by the retiree medical commitment.

DB to 401(k) Conversion Experience

In the view of PBRS, the solution to such a problem lies in borrowing a chapter from the late 1980s and early 1990s. Between 1985 and 1995 approximately 50% of Fortune 500 companies and hundreds of other smaller corporations terminated their defined benefit pension plans and replaced them with 401(k) plans of various incarnations. In doing so, they cut their average cost of benefits from almost 15% of payroll to about 6% of payroll. And they accomplished this conversion without most workers perceiving that they were losing benefits.

How did companies accomplish such a bold transformation? With a combination of "smoke and mirrors". Since most employees didn´t really understand their pension plans anyway, the employers were able to "sell" the employees on the idea that they were now in control of their own economic destiny. Employees would now control their investments rather than the trustees. Employees could contribute as much as they wished up to the limits imposed by IRS. And the employer would even magnanimously "match" the employees´ contributions up to a predetermined level.

Never mind that most of the contributions were now being made by employees rather than the employer. The 1980s signaled the replacement of "paternalism" in retirement benefits with "economic Darwinism." Employers successfully replaced the strong second leg (employer-provided retirement plan) of the "three-legged stool" which was spoken of at the time Social Security was enacted with a weak second leg and a stronger third leg (personal savings).

Are health benefits and retirement benefits alike?

Will the same approach work with respect to retiree medical plans? Only time will tell. However, the same elements exist: most employees are not really sure what Medicare covers and what the employer´s retiree medical plan covers anyway. Moreover, by adding the elements of investment control by employees and flexibility of contributions and benefits purchased, employees can develop a personal strategy to prepare for the medical uncertainties after retirement.

In their book, Patient Power, economists Goodman and Musgrave make the point that if current trends remain unchecked, the cost of medical expenses will surpass the Gross National Product in the year 2043. Obviously, something has to give.

EMAs

Employee Medical Accounts (or "EMAs") may be just the answer. The employer establishes a tax-exempt trust fund to which it makes contributions at a level it can afford comfortably. The contributions are allocated to the individual accounts (EMAs) of the eligible employees. In addition, employees may add their own employee contributions to the fund. Employees direct the investment of such funds and receive statements as under a 401(k) plan.

At retirement, the employee selects how he wishes his funds to be used from among the choices offered. Such choices typically include: purchase of Medicare supplement insurance; purchase of long-term care insurance; payment of the employee´s share of the cost of the employer´s health plan; or direct payment or reimbursement of uncovered medical costs. Upon the employee´s death, unused funds are distributed to his beneficiary.

The EMAs grow tax-free inside the trust fund. And all amounts distributed from the plan for medical benefits are tax-free to the employee.

Such an arrangement has the positive elements of several types of benefit plan:


Like Flexible Benefit Plans under Section 125 of the Internal Revenue Code (a form of Cafeteria Plan), funds may be spent on whatever benefits the participant desires.

As with Medical Savings Accounts (Section 220 of the IRC), healthy individuals are rewarded for not utilizing their account balances.

And, similar to a 401(k) plan, participants direct the investments with no limit on growth.


These elements have all of the comparative advantages that 401(k) plans had over defined benefit plans a few years ago. Moreover, in adopting or converting to VEMAs, Employers seem to avoid the problems of more traditional retiree medical plans: no FAS 106 liabilities to report, costs are limited to current year commitments, and such plans can be terminated at will (except for collectively-bargained plans). However, the biggest advantage is that the employer is not committing to pay a future uncertain amount which may be exceed its ability to pay. Uncertainty has led many employers who genuinely would like to help their employees and can afford it today to avoid or abandon such plans.

Will retiree medical plans go the way of defined benefit plans? It´s too early to tell, but with EMAs it is likely that more and more employers will choose the safe, responsible route of funding what they can afford and passing the risks on to their employees.

Ronald H. Snyder is an Attorney and an Enrolled Actuary in Salt Lake City, Utah, specializing in employee benefit plans. Ron is a member (MAAA) of the American Academy of Actuaries and a member of the Employee Benefits Committee of the Tax Section of the American Bar Association. He may be reached at (800) 815-0129.