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Retiree Life Insurance: Strategies to Effectively
Manage the Liabilities
Timothy J. Brown
A
s employees continue to assume more personal responsibility for their retirement security, employers and the benefits they provide
play a key role in helping employees build
a financial safety net. Particularly in a challenging
economic climate, a key consideration for whether or
not employers should continue to fund nonqualified
retirement benefits (such as retiree medical, retiree life
insurance, and retiree dental coverage) is how best to
manage the liabilities and costs associated with offering these benefits.
In order to understand the important role that retirement benefits can continue to play and how best to
manage them, it is important to recognize how they
are perceived by workers. A significant number of
employees working at all sizes of companies consider
workplace benefits to be the foundation of their financial safety net and many obtain the majority of their
financial products through the workplace. These percentages rise as firm size increases. Given employees’
reliance on the workplace, employers have a significant
opportunity to attract and retain key talent by providing the right mix of benefits—during an employee’s
working years and into retirement. Benefits that continue from active employment into retirement, such
as employer-paid group term life insurance, can be an
integral and affordable part of that mix.
Financial security in retirement is dependent, in large
part, on the retiree’s available monthly income and
savings, as well as the expenses and unexpected costs
that could erode them. Funeral costs and expenses
associated with a final illness, for example, could
have a potentially devastating impact on a retiree’s
spouse and family members who may be on fixed
incomes. Employer-paid group term life insurance
is a valuable retirement benefit that can help cover
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these costs and help the retiree’s family maintain
their financial security. Even a basic level of retiree
group term life insurance can help alleviate the burden of final costs and provide peace of mind for
retirees and their loved ones.
As retirement benefits contribute to an employee’s
safety net in retirement, they also play a significant role in an employer’s human capital strategy.
Employees often say that retirement benefits influence their sense of loyalty to their employer. These
benefits also offer an additional means to help the
employer transition some employees into retirement,
while developing existing talent or attracting new talent to revitalize the organization. With many employers offering retirement benefits, it is clear that many
employers recognize the strategic role these benefits
can play.
While employers understand the value of retirement
benefits, many have concerns related to the impact
of the benefit liabilities generated by postemployment benefits such as health care, especially with all
the change that health care reform has introduced.
However, unlike other retirement benefits, the liabilities associated with employer paid group term life
insurance are typically much smaller in size, and their
financing is much more predictable relative to retiree
health care liabilities. Finally, there are a number of
strategies employers can consider to effectively manage these liabilities.
Prefunding the Retiree Life
Insurance Liability
Unlike pension liabilities, employers are not required
to prefund other postretirement benefits, such as
retiree life insurance. However, there are significant
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advantages to prefunding retiree group term life
insurance liabilities for an employer to consider.
These generally include:
•Accelerating tax deductions and tax-free earnings,
so long as prefunding contributions are within the
limits set out under Sections 419 and 419A of the
Internal Revenue Code (IRC), while continuing
income tax-free proceeds to beneficiaries.
•Strengthening financial statements, because plan
assets offset FAS 106 liabilities on the employer’s
balance sheet and interest earnings on plan assets
reduce FAS 106 expense on the employer’s income
statement.
•Greater budgeting and financial flexibility, because
the employer retains control over the timing and
amounts (within IRC limits) to prefund. This
allows the employer to reassess and adjust their
strategy from year to year as business needs warrant and does not commit the employer to any
future funding contributions.
•Greater security in knowing that funds are available to continue to provide retiree group term life
insurance in the future.
Prefunding may be done through a 501(c)(9) trust,
also known as a Voluntary Employees’ Benefit
Association (VEBA) trust. This is a special taxexempt trust established by the employer to hold
assets for benefit plans. However, often a simpler
and more cost effective approach for prefunding retiree group term life insurance liabilities is
simply to establish a retired lives reserve as part
of the employer’s group term life insurance policy
with their insurance carrier. Similar to a VEBA,
this reserve allows an employer to prefund on a
tax-advantaged basis for continuing group term
life insurance on retired employees. A retired lives
reserve is easy to set up and provides the same
advantages noted above without the added costs of
establishing and administering a VEBA trust. The
various funding options and application of the tax
law to the employer’s own facts and circumstances
should be discussed with their own independent tax
counsel.
Regardless of the vehicle used, prefunding provides
the employer with flexibility on future cash outlays
and an effective budgeting tool through which retiree
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group term life insurance liabilities can be managed.
As such, it allows an employer to continue to provide
a valuable retirement benefit making funds available
to cover funeral and final expenses, and ultimately
enhancing the employees’ overall financial position
upon retirement.
Modify Retiree Life Insurance
Benefit Levels
Although a significant percentage of employers are
likely to continue to offer retirement benefits to
future hires, most employers have retained the right
to modify or eliminate the life insurance benefits
they provide to retirees in their plan documents.
Employers should carefully evaluate whether it
makes sense to reduce or eliminate this benefit. The
evaluation process includes:
•Deciding whether to grandfather, eliminate, or
reduce the benefit for just some or all classes of
employees such as current retirees, employees close
to retirement, all current employees, and/or only
future hires. It’s important to also consider whether
there will be any discriminatory issues.
•Completing a comprehensive review of all prior
communications to employees/retirees can ensure
that the employer has not inadvertently contradicted its right to modify or eliminate the benefit
by promising the benefit to the employee/retiree.
•Determining any potential impact on collectively
bargained agreements.
•Considering any potential negative impact on
employee morale and public perception of the
employer.
Employers that ultimately elect to eliminate or
reduce retiree life insurance benefits typically only
do so prospectively for future hires and/or for those
current employees who are furthest from retirement
age with the least years of service. This reduces the
impact to current retirees or those close to retirement who may have counted on the benefit as part
of their financial security in retirement, and who
may be least likely to be able to replace the coverage
on their own. Freezing or closing the eligible class of
employee helps control future growth of the liability; however, the benefit c­ urtailment generally does
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not produce a significant reduction in the employer’s
current liability. Thus, employers may discover that
continuing to provide retirees with a small amount
of group term life insurance to enhance the employees’ retirement financial well-being while effectively
communicating its value to employees and prefunding the liability may assist in their goals of attracting
and retaining talent.
Transfer the Retiree Life
Insurance Liability
Through mergers, acquisitions, and various other business changes employers often have multiple frozen or
closed groups with retiree life insurance plan designs
that may no longer be offered. Administering multiple
legacy plan designs may become burdensome, and
employers may wish to transfer this responsibility
along with removing the liability from their books.
Thus, they may want to consider a retiree life insurance buy-out to transfer the liability. Under a retiree
life insurance buy-out, the employer typically makes
a lump sum payment to an insurance carrier that
assumes the mortality, investment, and expense risks
along with the administration and recordkeeping functions for a closed group of retirees. In doing so, the
liability is effectively transferred from the employer to
the insurance carrier.
There are several factors for employers to consider
in determining if and when a transfer of the liability
makes sense and with whom to execute a transfer of
the liability. These include:
•Size of the liability, funded status of the plan, competing capital needs, and/or available cash to allocate toward the cost.
•Accounting treatment—if treated as a settlement,
any previously unrecognized gains/losses will be
recognized in the year the liability is settled.
•Cost of delaying until future date—a rise in
interest rates would produce a lower price of a
buy‑out. However, a delay means an older population. Thus, aging and higher mortality risk may
actually increase the price if interest rates don’t
rise quickly or substantially.
•Tax implications to the employer—tax laws typically
limit prefunding to the first $50,000 along with cer-
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tain requirements for key employees. Therefore, the
employer must carefully consider the structure of the
buy-out, tax laws, and whether or not costs of buying out coverage limits above $50,000 and/or on key
employees could be deductible in the year paid and/
or may cause any unrelated business income tax or
other issues. Each employer should discuss its own
facts and circumstances with its independent tax
advisors.
•Impact on retirees—if the benefit qualifies as group
term life insurance under IRC Section 79, retirees
receive favorable tax treatment of this employerprovided benefit, generally up to the first $50,000 of
coverage. Therefore, employers must carefully consider the structure of the buy-out so as not to jeopardize the favorable tax treatment the retirees receive
under Section 79 for this benefit and inadvertently
cause the benefit to be immediately taxable to the
retiree.
•Insurance carrier financial strength, commitment,
reputation, and experience—the employer must
­carefully consider its fiduciary obligations in insurance carrier selection, since actual claims on some
covered lives may not be incurred for 30 or more
years. The insurance carrier should have the experience and expertise to help properly structure the
buy-out, along with the financial strength and track
record demonstrating its commitment to this specialized business now and into the future.
Many employers like the idea of a buy-out as a means
to fulfill the promises to their current retirees while
transferring liabilities, recordkeeping, and administration responsibilities. The cost to transfer the liability
will seem high compared to the employer’s annual
group term life insurance premiums for the covered
class, but may be similar to the liability carried on its
financial statements with respect to the obligation.
However, when considering that a buy-out removes
future annual premium costs to the employer and
associated mortality, expense, a­ dministrative, and
­investment risks which may be impacting future group
life insurance rates, a buy-out may make sense. If the
employer is not currently in a position to execute a
full buy-out, it can consider funding the liability until
it has the resources to transfer the remaining liability,
or in certain cases, financing the transfer over time.
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Conclusion
Because each employer situation is unique, often
some combination of prefunding, transferring, and/
or reducing benefit liabilities is most effective in helping to manage liabilities and costs associated with
retiree group term life insurance. Retiree group term
life insurance can help relieve the burden of paying
final expenses, allowing for greater savings to be used
for retirement income. Properly structured, a reasonable amount of group term life insurance provided at
retirement can be a viable, low cost retirement benefit
for employers to attract and retain talent. b
Timothy J. Brown, CLU, ChFC,
is vice president, Post Retirement Benefits, MetLife,
and can be
reached at [email protected].
Posted from Employee Benefit Plan Review, January 2011, with permission from Aspen Publishers,
a WoltersKluwer Company, New York, NY1-800-638-8437, www.aspenpublishers.com.
For more information on the use of this content, contact Wright’s Media at 877-652-5295.
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