In response to shifting demographics, increasing costs and risks, and other factors affecting their retiree medical benefit programs, U.S. employers have gone beyond tweaking plan designs. Many have taken different, though somewhat traditional, approaches to retiree health care in recent years. But an increasing number are realizing it's time to take a bold step in a new direction. In light of transformative changes in health care — notably reform legislation and new benefit delivery channels — employers are taking a fresh look at ways to keep their health care delivery promise to retirees over the long term.
In a recent discussion, Towers Watson experts on health care plans for retired employees explored our latest research findings on plan sponsors' attitudes and actions regarding their retiree medical benefit programs. With new options emerging for the management and delivery of these plans, our panelists offer advice for U.S. plan sponsors looking for innovative solutions.
Parson: Let's start off by looking at the impact of health insurance exchanges. How are private and public exchanges affecting benefit programs for Medicare-eligible and pre-Medicare retirees?
Tenner: For Medicare-eligible retirees, private exchanges are enabling employers to control or reduce their retiree health care spending, while offering their retirees access to guaranteed issue plans that can provide better coverage at less cost to the retiree than plans offered previously.
As for pre-Medicare retirees, the public marketplaces and private exchanges give them access to guaranteed issue plans for the first time. With or without coverage from their former employer, these retirees can consider various plan options and select one based on their health and financial situation. This is very significant, because before health care reform, pre-Medicare retirees' options were extremely limited. A number of factors — including underwriting, cost and accessibility hurdles — limited their access to good-quality, affordable health care services.
For retirees, the most valuable features of private exchanges are increased choice and, very often, affordability. For employers, exchanges allow them to offer retirees a wider array of affordable medical plan options.
Winkels: With exchanges in the picture, plan sponsors can now take a fresh look at both the plan design and financial management of their retiree medical programs. Exchanges help employers think seriously about de-risking, as well as the possibility of exiting retiree medical in a graceful, elegant way — a way by which the organization can benefit financially while keeping its promise to retirees. It's a great, new opportunity, particularly with regard to pre-Medicare retiree medical benefits.
Jareb: Our 2015 Survey on Retiree Health Care Strategies found that private exchanges for Medicare-eligible retirees are very popular with employers that provide retiree medical benefits. Thirty-nine percent of the employers we surveyed use a private exchange for their Medicare-eligible retirees, and another 39% are considering using one. In other words, nearly eight out of 10 are either using or considering using a private exchange. Transitioning these retirees to a private exchange can be a win for both the employer and the retiree: The organization can reduce its trend risk and cost, and the retiree, in many cases, can get richer benefits at a cost lower than that of traditional coverage.
Our research also found that 35% of employers think public exchanges will be viable for pre-Medicare retirees within two years. And with federal subsidies potentially being available to many, public exchanges could be a boon to those retirees over the next few years.
Parson: There are well-known risks associated with retiree medical, and the risks fluctuate. What risks do U.S. plan sponsors face today?
Jareb: I divide risks into three main categories. The first is the escalation of cost and trend. After employers have implemented plan design changes — including, for some, switching to high-deductible, account-based health plans — their cost of covering Medicare-eligible employees in 2015 will be 3.9% higher than their 2014 cost. That increase is similar to the cost increase for covering active employees, while the cost of covering pre-Medicare retirees this year will be around 5.5% more than last year. So the trend risk is huge, especially if the company's subsidy isn't capped. There's also the looming 2018 excise tax, which is also a cost and trend risk, particularly for employers whose benefit plans are rich or uncapped.
Another factor related to cost escalation is that many retirees don't fully understand the cost of medical coverage, and that poses a very large risk for employers. Only 17% of employers that provide retiree medical coverage think their retirees understand what that coverage costs the organization. When employer-provided plans hit their caps, often retirees aren't aware that the organization assumes much, if not all, of the trend risk. That's a threat to these programs. And now that they have other options, many retirees could opt out of employer-provided coverage.
The second type of risk comes from the misalignment of the organization's retiree medical and workforce management strategies. Only 38% of employers think their retiree medical plans are aligned with their attraction and retention goals. Many legacy retiree health care plans haven't been strategically realigned with workforce management plans in decades. For instance, we know that employees who have access to retiree medical coverage tend to retire earlier than those who don't. So for employers that offer retiree health care, it's important to ensure that the benefit offering will help them achieve the retirement patterns they want or need for the organization.
The third type of risk comes from retiree health plans' administrative burden. And plan administration isn't only a risk, but also a compliance burden due to ERISA obligations and funding requirements.
King: I see some additional risks associated with these benefits. For employers that carry retiree medical obligations on their balance sheet, the low interest rate environment and interest rate volatility pose a risk related to the cost recorded on the organization's income statement. As most of these plans aren't funded, employers don't have corresponding assets to offset the obligations.
Also, there's the longevity risk inherent in offering this type of lifetime benefit — a risk highlighted by the latest mortality tables from the Society of Actuaries. The longer expected life spans of today's retirees mean that employers will be paying for these benefits for a lot longer than they might have anticipated when they began offering the benefit decades ago.
Finally, legislative and regulatory uncertainties always pose risks. For example, there's a good deal of talk in Washington about reforming tax laws, including potentially reducing or eliminating the deductibility of retiree health care costs as part of a trade-off for a lower corporate tax rate.
Parson: So you're saying change is coming from the outside, and employers will be forced to address the misalignment of their retiree medical plans and their workforce objectives. Pre-Medicare retirees, in particular, have health care coverage alternatives they didn't have before, and those options are affecting their financial readiness to retire and their retirement timing. This, plus people living longer, will likely change retirement patterns in the U.S., and employers need to have a plan for mitigating the negative effects of those changes or at least managing the related risks.
Winkels: In 2014, retiree medical plan sponsors saw their liabilities grow by 15% to 20% due to falling interest rates and growing risks related to increasing longevity. Today, many employers — some of which have acted to de-risk their pension plan — find their retiree medical program is the primary source of their balance sheet risk related to the interest rate and longevity.
Parson: Employers have a great opportunity to educate their medical plan participants — both retirees and active workers — about the projected cost of health care in retirement. Not only the cost next year, but the expected cost over a person's estimated remaining lifetime. Sponsors can help participants understand what all of these changes mean for them personally, particularly how the changes, including the new retiree health care options, affect their financial ability to retire.
Parson: We're hearing a lot about de-risking benefit plans. What de-risking approaches can employers explore for their retiree health care and retiree life insurance plans?
Winkels: Today's plan sponsors have many options. In the past, sponsors have mostly considered strategic plan design changes, including switching from a defined benefit to a defined contribution (DC) approach, capping the retiree medical program's exposure to trend risk and taking actions such as those Cara mentioned earlier. But with the availability of private exchanges for Medicare-eligible retirees, which involve more of a true DC approach, employers need to think about ways to de-risk the balance sheet via financial management.
We're seeing renewed interest in a form of trust fund called a voluntary employee beneficiary association (VEBA). With a VEBA, a retiree medical plan sponsor can de-risk the balance sheet by setting aside assets during good times to protect the organization against downside risk in bad times and using liability-driven asset strategies within the VEBA.
Sponsors can explore risk transfer strategies as well as true exit strategies. They can think about offering individuals lump sum payouts, which provide more liquidity — particularly helpful as retirees think about accessing public and private exchanges. Lump sum offerings allow plan participants to decide when and how they take their money, which might be more valuable than an annual contribution from the employer.
Plan sponsors can also consider insured solutions, including life insurance buyouts and retiree medical annuities. These give retirees lifetime income without subjecting the plan sponsor to the risks we've mentioned. Such options transfer risk to insurance companies, whose core business is risk management.
King: I'll interject a caveat about VEBA funding strategies: While they help the employer fund the benefit and provide assets to back the obligations, they're complex. There's the potential for an unrelated business income tax, known as an UBIT, on nonunion VEBAs. Also, there's regulatory uncertainty regarding VEBAs, as well as investment risk associated with the capital markets if the sponsor doesn't have some sort of long-term investment strategy.
Winkels: That's a great point, Cindy. When it comes to the financial and risk management of retiree medical programs, there's no one-size-fits-all solution. Because of the challenges involved in effectively managing the various vehicles available to plan sponsors, a combination of elements tends to work best.
Parson: How can employers eliminate their retiree medical obligations while ensuring that their retirees will have long-term benefit security? How can they balance those two potentially competing goals?
King: Since retiree medical coverage isn't a vested benefit, many employers have reserved the right to amend, modify or terminate coverage at will. Some have either closed their plans or eliminated future benefits, both of which can hurt retirees by shifting the risks and costs of health care coverage to them.
Many U.S. employers that still provide retiree health care benefits expect to continue the benefit in some way, shape or form for their current retirees and possibly other workforce cohorts. Their reasons vary: to honor a promise to former employees, to sustain their brand and reputation, or to avoid the litigation and related publicity that ending the promised benefit could trigger. And while many employers have taken steps to reduce risk through plan design changes or funding strategies, there really hasn't been a way to eliminate risk completely while preserving retirees' security — until recently.
Towers Watson has developed an innovative way for organizations to eliminate the financial obligations and administrative burden of their retiree medical program while securing the benefit for retirees for life. We call the solution Longitude. It's a turnkey way for employers to exit their health care benefit program for Medicare-eligible retirees, using a customized, group annuity to transfer the liability to a highly rated insurer.
Think about the pension world: Many employers have transferred their pension plan risk by offering buyouts to plan members. Longitude allows you to do a buyout in your medical plan for your Medicare-eligible retirees while preserving the benefit's tax advantage for the retiree. Also, employers can get a one-time tax deduction for purchasing the annuity for these retirees. The retiree has access to health care coverage through a private exchange. The growing popularity of private exchanges for Medicare-eligible retirees actually prompted us to develop this de-risking solution.
Longitude also has four other significant advantages for employers in the area of de-risking and benefit security. It ends the organization's retiree medical liability for accounting purposes for both U.S. generally accepted accounting principles and International Financial Reporting Standards, which helps to deleverage the balance sheet. And it accelerates and monetizes the deferred tax credits at the time of the annuity purchase, which helps the employer address some of the tax and regulatory risk we've talked about.
Longitude also eliminates the employer's ERISA obligations, as well as the reporting, disclosure and fiduciary responsibilities that come with administering the plan. Finally but most important, the solution enables the employer to meet its health care benefit commitment to retirees without burdening them with taxable income today or in the future.
In a nutshell, it's an innovative way for employers to explore how they can financially and administratively exit retiree medical while keeping their promise to retired employees.
Parson: Longitude also seems like a good hedge against potential legislation on the corporate tax front. Is it?
King: Yes, Longitude allows you to take the full tax deduction now at today's corporate tax rates, which is on your books as your deferred tax asset. So it monetizes an unproductive asset for you at today's tax rates without exposing you to the effects of future rate changes.
Winkels: For the first time, employers committed to keeping this benefit promise can eliminate their obligation in a way that's fair for retirees and the company, and is also good for shareholders.
Parson: It seems U.S. employers have done all they can on the plan design front, particularly regarding Medicare-eligible retirees. For the future, should they focus on reducing some of the risk that traditional retiree medical plan sponsorship will continue to pose?
Winkels: It's important for plan sponsors to remember two things: First, there isn't necessarily one final step they must take, and second, they don't need to do everything at once.
Employers have been on a journey, slowly reducing their risks related to medical trend and plan design. Between now and when they exit retiree medical entirely, they can do many things to prepare for exiting, including examining various investment strategies and funding options. A sponsor that doesn't want to exit abruptly might want an approach for funding the plan over the next five to 10 years while it develops an exit strategy. Creating such a plan might be the logical next step along the path.
Parson: Yes, it's time for more creative solutions that go beyond plan design changes. With all of the legislative changes, retiree health care has become much more complex. We've seen the private insurance market respond with new plans and ways for sponsors to provide the benefit. And with new approaches such as Longitude, plan sponsors can follow the de-risking path that's increasingly being taken in the pension world.
Jareb: As employers move toward a DC and stipend approach to retiree medical programs, educating retirees about the costs of these benefits and the need for financial planning will be extremely important. The average life expectancy in the U.S. is approaching 90 years, which means many Americans can look forward to long retirements. As employers help their employees plan for retirement, education will become more and more crucial. There are new tools available to help with that, such as Towers Watson's FiT Age, which helps employees determine the age at which they'll likely have the financial resources to retire comfortably.
King: I'm realizing that the complexity of retiree medical programs is partly due to the fact that employers must consider layers upon layers of various cohorts. Often, the best way to make sense of it all is to determine which groups' benefits involve the most and the least risk, and also where it makes the most sense to change the plan design to reduce risk and administrative burdens.
Parson: In sum, there's a wide range of strategies and tools that retiree medical plan sponsors can use to minimize their risk exposure. Sponsors that don't take action soon could be saddled with costs their competitors don't have. It's very important for employers to take advantage of the available opportunities with an eye on their workforce management objectives, and now's the time to do it.