What are employer’s options for reducing risk in retiree health plans?

While defined benefit pensions often make headlines when a company is struggling, there has traditionally been less of a focus on retiree benefits plans. The issue is paramount, however, in Sears Canada Inc.’s bankruptcy case.

After filing for protection under the Companies’ Creditor Arrangement Act in June, Sears sought to suspend payments under its post-retirement benefits plans while it restructures. The night before the hearing, it agreed to continue providing postemployment benefits but only until Sept. 30. The company has come under significant criticism for the move, particularly in light of retention payments allocated for key executives.

Read: Sears Canada agrees to continue special payments to DB plan, retiree benefits

So for companies hoping to avoid a similar fate, what options are available to those looking to get ahead of the issue by de-risking their retiree benefits plans?

Health trusts

Sears Canada isn’t the first employer to face challenges around retiree benefits. As a result of the restructuring saga at Stelco Inc., some retirees will now receive benefits through a health trust.

Lisa Mills, a partner at Brown Mills Klinck Prezioso LLP in Ottawa, expects health trusts to become more common because they allow an employer to pool longevity risk and mitigate rising drug costs while removing the liability from the balance sheet.

“From an employer’s perspective, it’s almost like a [defined contribution] plan, because their contributions are limited and don’t reflect the liabilities and the benefit cost,” she says, adding health trusts are managed by an independent group of trustees that can change a plan based on many factors, including the rising cost of certain drugs.

Read: Shift towards DC approach to health benefits inevitable

Health trusts may be suitable for larger organizations and collectively bargained plans but they’re not for every employer, notes Nabil Merali, vice-president and Toronto practice leader for health and benefits at Aon Hewitt. “There’s a lot of administration, actuarial and other costs that go into setting up the trust, plus the ongoing maintenance and governance of it,” he says.

Health-care spending accounts

A health-care spending account also limits employer liability and allows individual retirees to choose how they’re going to allocate their funds, says Mills.

Sandra Ventin, associate vice-president at Accompass Inc., notes that option is becoming more common because it limits an employer’s liability and reflects what it can afford. “The concept of, ‘We will earmark X amount,’ like they would under an active population, is a similar theme,” she says.

Moving to a health-care spending account is easier to do before benefits have vested upon retirement, but Mills warns of possible legal consequences. “Like any benefits change, a unilateral change could attract constructive dismissal risk if the change is considered a fundamental change to the terms of employment,” she says.

Read: Tips for boosting employee acceptance of benefits changes

In cases where the retiree benefits have vested, however, an employer can’t unilaterally change to a health-care spending account unless it has reserved the right to do so at the time of retirement, notes Mills. “HCSAs have also been used as a settlement tool; for example, where insured retiree benefits plans are removed and replaced with HCSAs or with a skinnier insured retiree benefits plan and a small HCSA.”

Voluntary buyouts

Another option is a voluntary buyout, which is a lump-sum, taxable payment in exchange for benefits. It is, however, a slightly trickier option, says Merali. “There are no rules dictating how much you have to give them in relation to the liability,” he adds, noting some companies go as low as 30 per cent while others provide 100 per cent because the lump-sum is taxable. “So, depending on what your financial objectives are and your overall objectives are, you give the member a certain percentage of the liability as taxable cash.”

From the employer’s perspective, the payment eliminates any liability down the road but it has to have the money to do it, says Merali. “Also, we don’t know what’s going to happen in the future. If the federal government announces a national seniors drug program and they’re going to start picking up these costs, then that would reduce the liabilities of plan sponsors.”

Restricting new drugs

Implementing caps to eliminate a plan’s open-ended nature is another way to lower risk.

Many plans allow for coverage of new drugs as they come onto the market and the cost passes straight to the employer, says Merali. “If you think about it, when the individual retires, the firm may or may not have made a promise to cover things that are on the market today. Ten years from now, when a new drug comes to market, why should we cover that drug at 100 per cent?”

Read: Drug Plan Trends Report: Alarm about costs sparks ‘monumental shift’

Freezing or capping the list of covered items and the reimbursement level at the year of retirement eliminates that cost pressure, notes Merali. “The employee would see their costs go up over time, but ultimately, this could knock 30 or 40 per cent off a company’s liability.”

Other options

Many employers are putting copayments in place or are pointing those close to retirement towards an insurer for a private health plan. “We’re starting to see those conversations where employers will say, ‘Here are some options, some tools, some education, and here’s how I can be a facilitator of it.’ But they’re not saying, ‘And we’re providing it,’” says Ventin.

Plan sponsors can also adjust eligibility requirements but they must be transparent when communicating those changes, she adds. “Employers are needing to really make sure they’re safeguarding themselves, so this eligibility and who’s qualifying for future benefits promises into their retirement years is very clear.”

Read: Stelco looks to inject funds into pension, retiree benefits through IPO

Indeed, employers could also promote long service by setting an amount of time an employee must work for the company before qualifying for retiree benefits. “For some of our clients, they’re starting to say, ‘We need to push that time horizon out longer,’” says Ventin.

Regardless of their obligations, most employers are looking at strategies to reduce their liabilities around retiree benefits, according to Merali.

“There are very few that don’t deem it to be a risk,” he says.

“Certainly, those in collective bargaining agreements realize it’s impossible to change . . . but the vast majority realize that they didn’t sign up for this 30 years ago when these were first put in place.”

Read: OPSEU and government reach agreement on retiree benefits

Jennifer Paterson is the managing editor of Benefits Canada.

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