New Solution from Towers Watson Lets Employers Transfer Their Retiree Medical Obligation to a Highly Rated Insurer

April 21, 2014

Retirees receive funding for benefits for life

A new retiree medical exit solution announced March 24th by Towers Watson uses customized group annuities and an innovative transaction structure to overcome the traditional hurdles to an exit — with positive tax implications for employers and preservation of benefits for retirees.  Longitude Solution is available to existing and prospective clients of the Towers Watson OneExchange private Medicare exchange.

Both public and private sector employers have long sought an exit solution to address the high cost of retiree medical benefits as well as the many regulatory and legal obligations associated with a retiree medical program. Rising health care costs, especially for older individuals, make offering retiree medical increasingly unaffordable, even for the largest organizations.

In addition, retiree medical creates balance sheet liabilities and income statement expense while diverting management time from more strategic benefits strategies.

Why haven’t employers exited retiree benefits before?

The fact that more employers haven’t simply stopped providing the benefit speaks to the complexity and risk of an exit.

Public sector employers and many private sector companies have long-standing contracts with unions that guarantee funding of retiree medical benefits for life. Even without a union or written contract, no employer wants to be sued by its retirees.

Beyond the possibility of a lawsuit is the concern employers have about ending a benefit that seniors on fixed incomes depend on as well as the negative press that might be associated with doing that.

Hurdles (and their solutions) to an annuity-based exit

Employers and their benefits consultants have long known that the ideal way to exit retiree medical is through a group annuity. However, to be successful, the annuity would have to do the following three things: 1) end an employer’s legal obligation once and for all, 2) avoid adverse tax consequences for both employers and retirees, and 3) create economic value for both parties.

But before a group annuity could be part of a retiree exit solution, the following four hurdles had to be overcome:

Hurdle #1: Medical inflation is a risk that cannot be hedged, and an annuity for retiree medical benefits cannot be issued unless medical inflation risk has been eliminated.

Solution: Medical inflation risk is eliminated when an employer moves from defined benefit (DB) approach to a defined contribution (DC) plan because benefits are capped to a fixed dollar amount per year.

If the transition is made with Towers Watson’s OneExchange private Medicare exchange, the added benefit is that the employer has a platform for administering the annuity and retirees don’t have to change how they purchase plans and get reimbursed for medical claims.

Hurdle #2: Retirees do not pay taxes on medical benefits funded through a tax advantage account such as an HRA, but they would have to pay taxes on existing annuity benefits as income.

Solution: By specifying that distributions can only be used for medical insurance premiums and other medical costs, an employer can mirror its existing plan design while shielding distributions from taxation.

Hurdle #3: Employers cannot deduct the full annuity payment at the time of purchase because premiums paid for long-term contracts, like annuities, must be amortized for tax deductions.

Solution: The annuity solution includes a series of transactions that are commonly used in retirement benefit plans that make the purchase price deductible right away.

Hurdle #4: Employers must address commitment made to retirees before removing the retiree medical liability from the balance sheet.

Solution: The certificates issued under the annuity are irrevocable commitments that transfer an employer’s liability to the insurance company, eliminating the employer’s obligation.

Fulfillment of obligation, peace of mind

With these hurdles overcome, both public and private sector employers can use the Towers Watson annuity-based exit solution to fully exit their legal, accounting, and regulatory responsibilities. The solution should also give retirees peace of mind because they would have tax-free funding for medical benefits from a highly rated insurance company for the rest of their lives. 

This type of retiree medical exit solution is the end of a journey that many employers began decades ago — at the time, with no clear path to exit in sight — and can now finish, in a way that meets the needs of employers and retirees alike.

For more information about the Longitude Solution, read the article in Tower’s Watson Corporate Finance Matters.

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