Chapter 15: Pensions and Other Postretirement Benefits

Benefit plansDefined contribution

Defined benefit

Postretirement benefits other than pensions

What is a pension?

an arrangement between an employer and employee for the payment of post-employment income, hereafter called pension benefits

Defined Contribution Plans

Benefit is defined as the future value of pension fund contributions made on an employee’s behalfExact value is unknown prior to retirement ; depends on future earnings of fund investmentsBenefits are solely a function of accumulated contributions; therefore, the term defined contribution Value of benefits is variable, dependent on contribution levels and earnings made on invested contributions

Defined Contribution Plans

Contribution rates normally stated as a percentage of wages or salaries

noncontributory, in which all contributions are made by the employer

contributory, where funding is shared by the employer and employee

assets are set aside for the sole purpose of paying pension benefits...pension fund

Defined Benefit Plans

Benefit is defined either as a specific dollar amount or by a general formula based on salary

Benefits may be expressed as a specific dollar amount, normally multiplied by years of membership in the plan (years of service) to determine the value of the benefit

Defined Benefit Plans

Value of pension benefits is directly related to the employee’s years of service

Benefits may be paid in one of two ways

as a single lump sum amount at retirement date

as a life annuity

Vesting

Refers to a qualifying period of pension plan membership that must be met before pension benefits legally exist

Pension benefits do not come into legal existence before vesting requirements are satisfied

Once benefits vest, there is a formal obligation between the plan and employees as set out in the terms of the plan

Single and Multiemployer Plans

Pension plans can be either single-employer or multiemployer plans

A multiemployer pension plan is one that is subject to collective bargaining agreements in which two or more employers are plan sponsors.

Under statutory requirements, one employer can contribute no more than 50 percent of initial contributions and

no more than 75 percent thereafter

Actuarial Funding of Defined Benefit Plans

Derive a time series of annual pension fund contributions that will accumulate to produce a projected pension fund balance sufficient to meet the cost of projected pension benefitsBuilds up a pension fund to the same future balance needed to meet expected retirement benefits

Actuarial Funding Methods

Accumulated benefits

Projected benefit

For very young plans, the accumulated benefit method would recognize substantially less each year than projected benefit methods, and the reverse would be true for very old plans

Accumulated Benefits Method

A separate contribution may be calculated to supplement service costService cost can be recalculated in such a way that the deficiency is implicitly funded as part of future service costsA literal measurement of the value of current accumulated benefits based on the benefit formula in a plan

Projected Benefits Method

Individual methods develop contribution rates for individuals, which are then summed to derive the total contribution for the plan Aggregate methods make funding calculations for the plan as a wholeA more even distribution of contribution levels with projected benefit methods.

ERISA, Social Legislation of 1974

Membership eligibility and vesting requirementsMandatory funding requirementsInvestment diversification requirementsThe guarantee of certain vested benefits in the event of plan terminations Pension Benefit Guaranty Corporation (PBGC)

Are pension funds well protected?

1980s overfunded pension plans and corporate raiders

Reduction of pension benefits

Convert existing plans into “cash balance plans”

Legal Relationships in Defined Benefit Plans

Sponsoring employer

A pension fund

Plan participants

The PBGC for plans subject to ERISA

Pension Accounting Standards

ARB 36

ARB 47

APB Opinion No. 8

FASB Interpretation 3

SFAS No. 35

SFAS No. 36

SFAS No. 87

SFAS No. 88

SFAS No. 106

SFAS No. 112

SFAS No. 132

SFAS No. 87 and SFAS No. 88

achieved greater uniformity in measuring accrued pension expense by mandating use of one actuarial method, the benefits/years-of-service approach

used service cost rather than the term normal cost

SFAS No. 106: 1990

OPEB costs are a form of deferred compensation in which the employer receives current services in exchange for future benefits

Requires recognition and measurement of OPEB costs and obligations

SFAS No. 132 Amended SFAS Nos. 87, 88, and 106

Relative to certain disclosuresReconciliation of beginning and ending balances of projected benefit obligation and fair value of plan assetsthe components of pension and OPEB expensesthe balances of unamoritized prior service costs and unrecognized gains or lossesdiscount rates, expected return on plan assets, and health care trend rates

Disclosures pertain to both pensions and OPRBs where applicable

Postretirement Benefits Other than Pensions

health carelife insurance outside of pension plansadditional welfare benefits such as

legal serviceshousing subsidiestuition assistanceday care

Improving Accounting Standards

Remove actuarial gains and losses from pension expense and OPEB expense measurements and show the result below operating income. Also modify the corridor amortization so that a greater portion of actuarial gains or losses are recognized each year.OPEB benefits should be spread over the working life of employees and not just to the full eligibility date. Hence the expense would be recognized in accordance with how benefits are received. Any differences between the OPEB expense and liability can be easily handled as a non-current asset.

Chapter 15: Pensions and Other Postretirement Benefits

Benefit plansDefined contribution

Defined benefit

Postretirement benefits other than pensions