PENSIONS- Introduction and Definitions



PENSIONS- Introduction and Definitions

Contributory (noncontributory) pension plan: Employees and the

employer (only the employer) contribute to the plan.

Defined contribution pension plan: The specific contribution that the employer has to make to the plan are set. (The employer discharges all responsibilities when the necessary contributions are forwarded.)

Defined benefit pension plan: Plans that promise specific monetary payments to employees (or their remaining spouses) upon retirement, The employer has the responsibility to make sure funds will be available to pay the future benefits. (The employer bears the risk of shortfall in funds.)

( Defined benefit (contribution) plan represent big (no) problem to accountant and investors. In defined benefit plans, until all future payments are made, the employer is liable for the benefits. Throughout the remainder of the lecture, therefore, o.nly defined benefit plans are discussed (impact on cash flows and long-term solvency).

Accumulated benefit obligation: The present value of pension benefits, promised by the company to its employees, on the basis of to date compensation levels.

Projected benefit obligation: The present value of pension benefits, promised by the company to its employees, on the basis of future compensation levels.

Economic Liability = Funded status of the plan

= the difference between the benefit obligation and the value of plan assets at the end of the year

( For Going Concern -- use projected benefit obligation (PBO)

( Liquidation Analysis-- use accumulated benefit obligation (ABO)

Balance Sheet Liability — Generally not equal to Economic Liability as for accounting purposes the following items need not be recognized immediately but can be deferred and amortized over time.

1. Actuarial Gains and Losses: Gains or Losses originate when the PBO is

recomputed each year due to changes in one or more actuarial assumptions, such as discount rate, quit rates, retirement dates, or mortality.

2. Pension Plan Gains and Losses- Accountant does not recognize actual returns on pension plan investments. Rather, they recognize expected returns based on long-term expected rate. Difference between actual and expected returns are pension plan gains and losses.

Items 1 and 2 are usually netted together as Net Gains and Losses.

3. Prior Service Cost : Pension Plan Amendments may increase (or decrease) previously computed pension benefit obligations. The changes relating to periods of employment prior to the amendment are known as prior service cost.

4. Transition Asset/Liability - Net economic asset/liability at time of adoption of SFAS 87 not recognized immediately but amortized over time

HOWEVER accounting deferrals must satisfy the minimum liability requirement:

Minimum liability At each balance sheet date, SFAS No. 87 requires reporting a liability on the balance sheet which is equal, at least, to the unfunded accumulated benefit obligation (i.e., accumulated benefit obligation minus the fair value of plan asset).

Thus if the balance of accrued benefit cost is less than the minimum liability we credit the liability in order to reach the minimum liability requirement: The corresponding debit bypasses the income statement and a certain portion is made to an intangible asset and the remainder is made to equity and a deferred tax asset.

Note: the adjustment is made on a plan by plan basis:

REQUIRED ADJUSTMENTS

1) Adjust balance sheet liability/asset to equal Economic Liability/Asset

• Corresponding entry should go to Equity [and deferred taxes if adjusting on after-tax basis]

• Definition of Economic Liability/Asset depends on whether analysis being done as going concern or liquidation -- see above.

2) If there is Minimum Liability, additional adjustment required -- that is; Credit intangible asset and debit Equity [and deferred taxes if adjusting on after-tax basis]

Example: HYPOTHETICAL COMPANY I

ABO $1,000

PB0 1,400

Plan Assets 900

PBO Greater than Plan Assets 500

Unrecognized:

Net Losses 150

Prior Service Cost 175

Transition Asset (25)

Balance Sheet Liability 200

Economic Liability as Going Concern = 500 (1400-900)

Economic Liability as Liquidation = 100 (1000-900)

Balance Sheet Liability = 200 differs from Economic Liability (Going Concern) as did not recognize liabilities of

(1&2) net losses 150

(3) prior service cost of 175

(4) transition asset of (25)

Adjustments:

Going concern Economic Liability = 500

B/S Liability = 200

Equity 300 or after tax assume 35% tax rate

Liability 300 Equity 195

Deferred Tax Asset 105

Liability 300

OR

Liquidation Economic Liability = 100

B/S Liability = 200

Liability 100 or after tax assume 35% tax rate

Equity 100 Liability 100

Deferred Tax Asset 35

Equity 65

Example: HYPOTHETICAL COMPANY II

ABO $1,200

PB0 1,400

Plan Assets 900

PBO Greater than Plan Assets 500

Unrecognized:

Net Losses 150

Prior Service Cost 175

Transition Asset (25)

200

Minimum Liability Adjustment 100 (charged 100% to intangible asset)

Balance Sheet Liability 300

Economic Liability as Going Concern = 500 (1400-900)

Economic Liability as Liquidation = 300 (1200-900)

Balance Sheet Liability = 300 differs from Economic Liability (Going Concern) as did not recognize liabilities of

(1&2) net losses 150

(3) prior service cost of 175

(4) transition asset of (25)

Therefore without minimum liability adjustment B/S liability would be

500-150-175+25 = 200. However as must equal liquidation economic liability, accountant made minimum liability adjustment of 100 to bring B/S liability to 300.

Adjustments:

Going concern Economic Liability = 500

B/S Liability = 300

(1) Equity 200 or after tax assume 35% tax rate

Liability 200 Equity 130

Deferred Tax Asset 70

Liability 200

(2) Remove Intangible asset

Equity 100 Equity 65

Intangible Asset 100 Deferred Tax Asset 35

Intangible Asset 100

For Liquidation only need (2) -- removal of intangible asset

DEERE CO.

Pension Benefits

The company has several pension plans covering substantially all of its United States employees and employees in certain foreign countries. The United States plans and significant foreign plans in Canada, Germany and France are defined benefit plans in which the benefits are based primarily on years of Service and employee compensation near retirement.

Provisions of FASB Statement No.87 require the company to record a minimum pension liability relating to certain unfunded pension obligations, establish an intangible asset relating thereto and reduce stockholders’ equity. At October 31, 1994, this minimum pension liability was remeasured, as required by the statement. As a result, the adjustment to recognize the minimum pension liability was increased from $515 million at October 31, 1993 to $545 million at October 31, 1994; the related intangible asset was adjusted from $181 million to $158 million; and the amount by which stockholders’ equity had been reduced was adjusted from $215 million to $248 million (net of applicable deferred income taxes of $119 million in 1993 and $139 million in 1994).

The components of net periodic pension cost and the significant assumptions for the United States plans consisted of the following in millions of dollars and in percents:

1994 1993 1992

Service cost $79 $74 $63

Interest cost 286 283 259

Return on assets:

Actual gain (86) (590) (157)

Deferred gain (loss) (218) 324 (87)

Net amortization 43 32 18

Net cost $104 $123 $96

Discount rates for obligations 8.0% 7.25% 8.0%

Discount rates for expenses 7.25% 8.0% 8.25%

Assumed rates of compensation increases 5.0% 5.0% 5.7%

Expected long-term rates of return 9.7% 9.7% 9.7%

A reconciliation of the funded status of the United States plans at October 31 in millions of dollars follows:

1994 1993

Assets Accumulated Assets Accumulated

Exceed Benefits Exceed Benefits

Accumulated Exceed Accumulated Exceed

Benefits Assets Benefits Assets

Actuarial present value of benefit

obligations

Vested benefit obligation $(1,522) $(1,693) $(1,555) $(1,689)

Nonvested benefit obligation (73) (270) (94) (276)

Accumulated benefit obligation (1,595) (1,963) (1,649) (1,965)

Excess of projected benefit obliga-

clan over accumulated benefit

obligation (340) (20) (378) (21)

Projected benefit obligation (1,935) (1,983) (2,027) (1,986)

Plan assets at fair value 1,756 1,767 1,805 1,510

Projected benefit obligation in excess

of plan assets (179) (216) (222) (476)

Unrecognized net loss 35 415 114 373

Prior service cost not yet recognized

in net periodic pension cost 9 154 3 176

Remaining unrecognized transition

net asset from November 1, 1985 (73) (10) (83) (13)

Adjustment required to recognize

minimum liability ----- (545) ----- (515)

Pension liability recognized in the

consolidated balance sheet $ (208) $ (202) $ (188) $ (455)

Source Deere, 1994 Annual Report

Other Postretirement Benefits

The parent company and certain subsidiaries provide medical dental and life insurance benefits to pensioners and survivors. The associated plans are unfunded, and approved claims are paid from company funds. Under the terms of the benefit plans, the company reserves the right to change, modify or discontinue the plans.

In 1992, the company adopted SFAS No. 106, “Employers’ Accounting for Postretirement Benefits Other Than Pensions.” Medical, dental and life insurance costs for these plans and related disclosures are determined under the provisions of SFAS No.105. Cash expenditures are not affected by this accounting change. At January 1, 1992, the accumulated postretirement benefit obligation was $5,990, and related accrued liabilities were $68, resulting in a transition charge of $5,922. Other postretirement benefits cost includes the following components:

Health Life

Care Insurance Total

1994

Service cost—benefits allocated

to current period $56 $17 $73

Interest cost on accumulated

postretirement benefit obligation 288 77 365

Amortization of net gains and

prior service credit (78) 8 (70)

Other postretirement benefits cost $266 $102 $368

1993

Service cost—benefits allocated

to current period $ 55 $ 12 $ 67

Interest cost on accumulated

postretirement benefit obligation 305 69 374

Amortization of net gains and

prior service credit (94) — (94)

Other postretirement benefits cost $266 $ 81 $347

1992

Service cost—benefits allocated

to current period $ 82 $ 11 $ 93

Interest cost on accumulated

postretirement benefit obligation 431 67 498

Other postretirement benefits cost $513 $78 $591

The lower health care costs in 1994 and 1993 versus 1992 were due to changes in the company’s health care benefits programs in the United States, which were announced on December 31, 1992. These changes provide for increased cost control through prevention and managed care, and for increased cost sharing by employees and pensioners. The impact of these changes resulted in an unrecognized prior service credit of $1,219 at the beginning of 1993; the accumulated postretirement benefit obligation was reduced by a similar amount

The following provides a reconciliation of the accumulated postretirement benefit obligation to the liabilities reflected in the balance sheet at December 31 1994 and 1993.

Health Life

Care Insurance Total

1994

Accumulated postretirement benefit

obligation for:

Current pensioners and survivors $(2,366) $ (570) $(2,936)

Fully eligible employees (139) — (139)

Other employees (674) (319) (993)

(3,179) (889) (4,068)

Unrecognized net loss/(gain) (1,267) 3 (1.264)

Unrecognized prior service credit (1,059) — (1,059)

Accrued postretirement benefit cost $(5,505) $ (886) $(6,391)

Amount included in Other

Accrued Liabilities (see Note 18) $ 333

Amount included in Other Liabilities

(see Note 21) $ 6,058

1993

Accumulated postretirement benefit

obligation for:

Current pensioners and survivors $(2,933) $ (692) $(3,685)

Fully eligible employees (146) — (146)

Other employees (934) (404) (1,338)

(4,073) (1,096) (5,169)

Unrecognized net loss/(gain) (285) 252 (33)

Unrecognized prior service credit (1,139) — (1,139)

Accrued postretirement benefit cost $(5,497) $ (844) $(6,341)

Amount included in Other

Accrued Liabilities (see Note 18) $ 343

Amount included in Other Liabilities

(see Note 21) $ 5.998

The health care accumulated postretirement benefit obligation was determined at December 31,1994 using a health care cost escalation rate of 8 percent decreasing to 5 percent over 8 years and at December 31,1993 using a health care escalation rate of 10 percent decreasing to 5 percent over 10 years. The assumed long term rate of compensation increase used for life insurance was 5 percent The discount rate was 9 percent at December 31, 1994 and 7.25 percent at December31, 1993. A one percentage point increase in the health care cost escalation rate would have increased the accumulated postretirement benefit obligation by $251 at December 31, 1994, and the 1994 other postretirement benefit cost would have increased by $44.

October 25, 2000

Retiree-Medical Plans Are Transformed Into Source of Profits by Sears, Others

ELLEN E. SCHULTZ Staff Reporter of THE WALL STREET JOURNAL

Sears Roebuck & Co. has figured out how to turn its medical-benefits program for retirees into a source of corporate income.

You read that correctly. Last year, the giant retailer's retiree-medical plan added $46 million to the Sears bottom line. And that was on top of the $38 million the benefits program contributed in 1998.

The key to these surprising profits is an arcane accounting rule introduced in the early 1990s. The rule required companies for the first time to report their total anticipated costs for retiree-health coverage. Many companies used the rule to justify cutting that coverage, or shifting its cost to retirees. As a result, a lot of older Americans are struggling to pay their medical bills.

The rule also offered companies a way to arrange their financial statements so that retiree-benefit programs actually became new profit centers. Employers and benefits consultants have received heat recently for turning pension plans into sources of corporate income. Now, the transformation of retiree-medical programs into opportunities to bolster earnings demonstrates that these companies and their outside advisers possess multiple subtle methods to squeeze profits from their current and former employees

Using Trust Funds to Pay Retiree Benefits Can Help the Bottom Line

This latest corporate maneuver was made possible by Financial Accounting Standard 106. Accounting authorities required that large companies adopt the rule by 1993. At a time when medical-cost inflation was running in double digits, the rule was supposed to force companies to acknowledge the potentially huge retiree-medical liability many of them seemed to face. Some of the charges that companies initially reported on their income statements under the new rule were indeed gargantuan, and they fueled an atmosphere of crisis surrounding corporate health-care costs. Many companies invoked the mammoth liabilities to explain why they had to reduce retiree benefits.

But the crisis turned out to be exaggerated. An analysis of corporate filings with the Securities and Exchange Commission reveal that over the 1990s, companies faced lower medical-cost inflation rates than they had predicted when standard 106 took effect and, as a result, smaller retiree-health liability.

What's more, many companies actually had incentives to err on the side of taking overly large initial charges under the new rule. One incentive was that excessively pessimistic estimates of future health-care liability provided a rationalization for reducing retiree benefits. That spelled bad news for millions of retirees, such as Elaine Russell, a 77-year-old former Sears worker in Seattle, whose rising medical premiums have forced her to rely on a free food bank. Retired Unisys Corp. accountant Albert Shaklee, 70, was forced to go back to work at a minimum-wage factory job for a time to keep up with his increased premiums.

Companies had a second incentive to take inordinately huge retiree-benefit charges: If the estimates proved too big -- which is, in fact, what happened in many cases -- companies knew they could adjust their retiree liability downward by recognizing a series of paper gains on their income statements. This pool of potential gains could be drawn upon over a period of years and used to offset retiree-medical expenses.

The New Math

The kicker is that at numerous companies, including Sears, the paper gains not only erased the retiree-benefit expenses, but exceeded them. And that is how benefit plans came to boost the bottom line.

Taking a Scalpel to Retiree-Medical Benefits

This sort of income isn't like cash that can be spent. But it can be used to buff a company's financial image by smoothing over dips in operating income. "It can sand the rough edges in a bad quarter," says Jack Ciesielski, an independent accounting expert who publishes The Analyst's Accounting Observer, a newsletter.

Consider the case of Sears. In response to accounting standard 106, the retailer took a whopping one-time charge of $2.9 billion in 1992 to reflect the present value of its entire obligation to pay for retirees' health care. Wall Street analysts didn't fret much about this accounting estimate because it had no immediate effect on operating cash flow. The analysts also knew that unlike vested pensions, which under federal law, companies must pay out, health coverage generally may be curtailed, either by killing benefits outright or making beneficiaries pay some or all of the bill.

Sears used the charge as justification to increase substantially the amounts that retirees would have to pay for health coverage. Shifting the financial burden to retirees has been the only way for Sears, based in Hoffman Estates, Ill., to "remain competitive with the retail industry, as far as costs go," company spokeswoman Peggy Palter says. Over the course of the 1990s, however, the rate of inflation of medical costs levelled off and decreased, making the initial Sears charge vastly overblown. In addition, the company's shifting of costs to retirees reduced its own obligation. To illustrate: In 1992, Sears reported an annual expense of $301 million for retiree-health benefits. The comparable figure for 1996 was just $76 million, a 75% drop.

To reflect its own earlier overestimate of its liability, Sears posted credits in its financial statements in the mid- and late-1990s. The combined effect of these accounting adjustments and the retailer's continued benefit cuts was that by 1997, the Sears retiree-benefit plan was adding $41 million to overall net income. Ms. Palter of Sears confirms this account. Other companies that have boosted their bottom lines by this method include R.R. Donnelley & Sons Co., Sunbeam Corp., Tektronix Inc., and Walt Disney Co., according to the analysis of corporate filings with the SEC.

How It Worked at One Company: Walt Disney

Step #1: Following its 1993 change in accounting standards, the company took a $202 million pre-tax charge to reflect retiree-health liability.

Step #2: Citing the accounting change and large liability, Disney slashed retiree-health benefits, reducing its expenses by more than half the next year.

Step #3: But then, estimates of benefit liability turned out to be excessive, so the company began to report paper gains to reflect lower-than-anticipated expenses. In 1995, Disney's gain was $43 million. The company reported a total of $47 million more in gains from 1996 through 1998. Thus, its retiree-health plan boosted its bottom line.* *Disney confirms the figures but declines further comment.

Meanwhile, retirees like Ms. Russell of Seattle are paying the price. She stopped working for Sears in 1984, after nearly four decades of full-time clerical duties at the retailer. When she turned 65, the federal Medicare program began reimbursing her for routine doctor and hospital bills. Her Sears retiree coverage provided supplemental reimbursement for prescription drugs.

In 1998, when her prescription costs were about $50 a month, the premium for her supplemental coverage doubled to $58. That might not sound like a lot, but proportionally, it was a huge bite out of her monthly Sears pension of $183.

The premium increase prompted Ms. Russell to drop out of the Sears plan in 1998. That gamble has hurt, because today she needs additional medications for colitis and a thyroid condition. He monthly prescription bill has leapt to $180.

"I've always saved," says Ms. Russell, a widow who collects $974 a month in Social Security. She drives a 1977 Datsun station wagon and makes her own clothes. Still, it wasn't until Sears doubled the cost of her benefits in 1998, she says with evident embarrassment, that she started taking advantage of a Seattle senior center's free food bank for herself and her two cats. One day recently, she picks out hot dogs donated by a local grocer because they are close to their expiration date. She also chooses overripe bananas, which she says aren't bad if cooked.

Sears maintains that even after shifting costs to retirees, it is "far more generous with benefits than others in our industry," says Elisabeth Rossman, vice president for benefits. "We have taken measures to prudently reduce our costs," she adds. "We were trying to strike a balance between duty to shareholders, so they could get an adequate return on investments, with our duty to retirees."

Coming Soon: More Cuts

Next Jan. 1, the company plans to cease paying anything for health coverage for employees over 65 who retire after that date, Ms. Rossman says. However, in 1998, she points out, Sears doubled, to 20%, the discount retirees may receive on clothing purchases.

Companies such as Sears stand to gain when retirees like Ms. Russell drop out of the medical plan, because that ends a company's obligation to pay anything for coverage. Of the roughly 120,000 Sears retirees today, only about 80,000 are receiving medical coverage. Ms. Palter, the company spokeswoman, says costs may be one reason people drop the coverage, but that some retirees do so because they receive benefits under a spouse's plan or they return to work.

Bill Rodino, a 72-year-old retired Sears appliance repairman and supervisor in Brooklyn, N.Y., got a new job to help pay for his Sears coverage. He now works 10 to 15 hours a week as a receptionist at a funeral home. That provides the extra cash to afford last year's 600% jump in his Sears premium, which is now roughly $80 a month. His prescription co-payments have risen to $75 a month.

Even with his part-time job, he and his wife, Jeanne, have gradually drawn down their savings for day-to-day expenses. They weren't aware of the improved Sears clothing discount, says Mrs. Rodino, because they haven't bought new clothes in years.

Seeds of a Windfall

The seeds of the retiree-health windfall for many companies were planted in the late 1980s, when the Financial Accounting Standards Board, the accounting industry's rule-making body, began to develop standards for reporting retiree-health obligations. Major companies, such as General Electric Co. and International Business Machines Corp., played an active role in the process, suggesting ideas to the accounting board. Companies showed the board computer simulations of how various proposals would affect corporate bottom lines.

Corporations would have preferred not to have to report retiree-medical liability at all. But once that became inevitable, big companies urged the board to give them flexibility in how they projected their retiree-benefit costs, according to people involved in the process. The accounting board went along with many of their suggestions when it issued standard 106. Jeffrey Petertil, an independent actuary who was an adviser to the accounting-board task force that drafted the new rule, warned in 1992 that standard 106 was so flexible that it would permit companies to overstate or understate their liabilities. But when he expressed this dissenting view in a newspaper opinion piece, his largest client, a major accounting firm, fired him the next day, Mr. Petertil says. He declines to name the firm.

Smoothing the Dips

One illustration of the flexibility is the great leeway standard 106 allowed companies to adjust the medical-cost inflation rate used to estimate retiree liability. Having pegged that rate very high early in the decade, companies were able in later years to report income-statement credits that could be used to smooth earnings dips, says Mr. Ciesielski, the independent accounting expert.

Sears, for example, initially used a 14% medical-inflation rate to estimate its liability in 1992, which was in line with national trends. By 1997, Sears had lowered its estimate to 11%. In 1998, it slashed the rate again to 6%.

The proportionally huge rate reduction in 1998, along with less generous benefits, permitted the retailer to report credits that allowed its retiree-health plan to contribute income to the company's bottom line. In 1998, the $38 million credit was the equivalent of a 2% increase in operating income.

The rate changes were made at a time when the company was struggling with credit-card delinquencies and weak apparel sales. Mr. Ciesielski says it's fair to assume that Sears and other companies have used credits from these plans "to smooth earnings during rough times."

Ms. Palter, the Sears spokeswoman, confirms the medical-inflation figures but stresses that the company didn't act to smooth its earnings. Sears changed the inflation assumptions "to be consistent with industry trends," she says. "It was a fiduciary duty to be as accurate as we could. Our experience was already showing that our estimates were too high, and the expenses would be lower."

Donnelley was another company that used standard 106 to justify benefit cuts and improve its earnings numbers. The company said in a letter to retirees in October 1992 that the new accounting rule would have "a serious negative impact on our earnings." The letter noted that because of "skyrocketing" health-care costs, the Chicago-based printing company was forced to begin charging retirees for their once-free medical benefits. Otherwise, Donnelley warned, it would fail to remain "competitive."

Thanks to the new fees, the company slashed its annual retiree-medical expense by more than half in 1995. By the next year, Donnelley's retiree-benefits plan was adding income to the company's bottom line. (Donnelley and some other companies also saw their benefits expenses fall, thanks to investment returns in trust funds set up to finance retiree-health benefits.)

A Donnelley spokesman confirms this account but stresses that the company had reserved the right to change retiree benefits. Richard Mebane retired from Donnelley in 1993, at 60, when the Chicago plant where he worked closed. He qualified for a $277 monthly pension, on top of his Social Security check of $936. With expensive prescriptions for high blood pressure, cholesterol and a bladder problem, he felt the squeeze when Donnelley in 1996 imposed a $250 annual deductible, which since has doubled to $500, for health coverage that supplements Medicare. He also pays an $18-a-month premium.

"Most of the time, I take the medicine every other day, to keep the cost down," says Mr. Mebane, now 67. Even with the company coverage, he's responsible for a 30% co-payment for prescriptions. By cutting his dosage, he saves about $40 a month, he says. "If I start to feel light headed, I take it every day until I feel better."

Three years ago, Mr. Mebane took a part-time janitor's job at St. Elizabeth's preschool on Chicago's Southside, where he polishes floors and swabs out toilets. He receives no medical benefits from the minimum-wage post.

Another company that wasted little time between adopting standard 106 and slashing retiree-health benefits was McDonnell Douglas Corp. In January 1992, the aeronautical giant reported a $1.5 billion after-tax retirement-benefits charge. In October 1992, it announced that over four years, it would phase out all health-care coverage for its 20,000 nonunion retirees.

In an Oct. 7, 1992, letter to retirees, John McDonnell, then the company's chief excutive, said: "The problem we have been wrestling with is not 'just' that health-care costs continue to skyrocket, as everybody knows." In addition, he wrote, standard 106 "threatened to deal a heavy blow to our bottom line."

In fact, by ending retiree benefits, McDonnell Douglas generated $698 million in pretax income reported in 1992. A separate benefits reduction affecting a group of retired unionized engineers generated another gain, this one a more-modest $70 million, reported in 1993. A spokesman for Seattle-based Boeing Corp., which has acquired McDonnell Douglas, confirms the numbers and the letter's authenticity but declines any further comment. McDonnell Douglas retiree Robert Taylor couldn't believe the news about the benefits cut in 1992. He was especially outraged that the company's pension plan was lavishly overfunded, but McDonnell Douglas wouldn't use that surplus to pay for retiree-medical benefits, as companies are legally allowed to do.

Mr. Taylor, who had joined McDonnell Douglas shortly after World War II and retired as supervisor of technical publications in 1979, died at the age of 79, just before the cut took effect. His wife, Rhada Taylor, now 87, chose to have the new $168 monthly premium for coverage supplementing Medicare deducted from her widow's pension of $420 a month. But the premiums have increased every year. By 1999, her pension money had shrunk by roughly 60%. After another premium increase scheduled to take effect Jan. 1, her monthly pension will be only $79.

McDonnell Douglas's health-care reductions have "wiped me out," says Ms. Taylor, who receives a monthly Social Security check of $1,009. She says she has cut back on wedding and graduation gifts.

As McDonnell Douglas was dispensing bad news to its retirees in October 1992, Unisys was doing the same.

That month, the Blue Bell, Pa., computer company dispatched a letter to 25,000 former employees, saying that "increasing medical costs and growing world-wide competition" were forcing it to "replace" their coverage. The new plan, Unisys said, "will be cost-effective, will provide financial protection against the high cost of illness or injury, and will continue to be available at group rates."

The bad news was that the company, which had paid for past coverage, would now shift the entire cost to retirees over a four-year period. The missive angered the retired Unisys accountant, Mr. Shaklee, then 61. When deciding in 1989 to retire early, he says he had relied on the company's written promises that he and his wife would have medical coverage for life. Such promises of lifetime coverage were common in the downsizing waves of the late 1980s and 1990s.

Despite his irritation, Mr. Shaklee bought the coverage at first, because his wife Doris, then in her late 50s, had been diagnosed with breast cancer. The Lake Kiowa, Texas, couple couldn't have bought insurance for Doris elsewhere because of her illness, and she hadn't yet hit the Medicare-eligibility age of 65. By 1996, the couple's monthly premium had jumped to $784, exceeding Mr. Shaklee's pension of $727. So, Mr. Shaklee dropped the Unisys coverage and sought a job that would offer more-affordable insurance. Retiree health-care coverage typically costs more than group plans that include younger, healthier people. At the Gainesville, Texas, parts-grinding factory where he applied for a midnight-shift job "they kept looking at my resume, asking me whether I knew it was minimum wage," he recalls. He had earned $70,000 a year at Unisys. Hesitant to state the real reason he wanted the job -- the $110-a-month health insurance -- Mr. Shaklee told his interviewers he wanted to work with his hands.

He held the factory job, and got the insurance, for two years, quitting when his wife got closer to qualifying for Medicare. But today they are scrimping. Prescription drugs cost the Shaklees about $220 a month. To save money, they scratched visits to their grandchildren in California for three years. "If we have a medical catastrophe, we'll be in trouble," says Mr. Shaklee. He is one of a group of Unisys retirees who have sued the company in U.S. district court in Philadelphia, seeking restoration of their benefits.

A Unisys spokesman declines any comment on retiree benefits, citing the pending lawsuit. The company has maintained in the court case that it had reserved its right to terminate the disputed benefits.

Beyond standard 106, another accounting-rule change that became effective in 1992 also has helped employers. Financial Accounting Standard 109 allowed companies to take credit immediately for certain tax deductions expected in the future. The deductions in question are those associated with liabilities such as retiree-medical benefits. Companies could use standard 109 to reduce -- or even cancel out -- their initial charges for retiree-health liability. Unisys, for instance, took a charge in 1992 of $195 million for retiree-medical benefits. But under Standard 109, the company was permitted to show a $425 million credit on its 1992 income statement for anticipated tax deductions associated with all manner of liabilities. The result was that in 1992, Unisys reported a net one-time gain of $230 million, courtesy of the changes in accounting standards.

Utilities Forced to Pay Refunds

The one industry where at least some employers have faced public criticism for their retiree-health accounting is the utility field. Certain state regulators have been willing to act in this area by using their authority to require consumer refunds.

Warning of escalating retiree-health benefits in 1993, Pacific Gas & Electric Corp. sought additional funds to pay the costs. The California Public Utilities Commission said PG&E could raise rates $181 million that year. Simultaneously, PG&E adopted plan changes that limited the amount it would actually contribute to retiree benefits. The company also used layoffs and attrition to cut its payroll by 17% from 1993 through 1995, further reducing its retiree-benefit burden. PG&E's annual retirement-benefits expense stood at only $12 million last year, down 90% from 1993. In 1998, the California utilities commission said the company shouldn't have been rewarded for overestimating its retiree-health costs. The commission required the utility to credit a total of $191 million to ratepayers for the years 1993 through 1995. PG&E didn't restore any benefits to retirees. Chris Johns, a vice president and controller at PG&E, says the company didn't deliberately overestimate its benefit costs. Instead, the costs fell because of strong investment gains by the company's retiree trust fund, he adds. The refunds were made as a part of the routine regulatory process, he says.

For retirees across the country, health coverage soon could get even more scarce and expensive. Companies are running out of the paper gains they can take because of their early-1990s overestimates of retiree-health liability. And health-care inflation is creeping up again.

In marketing material sent to current and potential corporate clients, the benefits-consulting firm Towers Perrin says employers need to think about "new strategies and approaches to managing health benefits." Among those strategies: new benefits cuts.

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Illustration:

For each year of service, a firm promises to pay an employee at retirement an amount equivalent to one week’s salary for 15 years. Our assumptions are:

Employee’s age =30 Retirement Age =65

Current Salary Level = $1 ,500iWeek Interest rate = 10%

Projected Salary at retirement = $2,000/week

Obligation Based on Current Salary Levels:

Accumulated Benefit Obligation (ABO) after the first year of work is equal to the

Present Value of a 15 year annuity of $1,500 discounted 35 years;

Using Table 4 and Table 2 for an interest rate of 10% yields

ABO= (1,500 x 7.606) x .03558 = 11,409 x .03558 = $406

Obligation Based on Projected Salary Levels:

Projected Benefit Obligation (PBO) after the first year of work is equal to the

Present Value of a 15 year annuity of $2,000 discounted 35 years;

PBO= (2,000 x 7.606) x .03558 = 15,212 x .03558 = $541

Tallying the Cuts

The figures in the left-hand column are the expense amounts a company reported in the first year of operating under the new accounting standard for retiree-health benefits. In some cases that was 1992, in others 1993.

Figures in parentheses reflect income-statement gains.

Company 1992/1993 (in millions) 1999 % DECLINE

Anheuser-Busch 75 16 79%

Black & Decker 21 (0.5) 100

Campbell Soup 46 14 70

Eastman Kodak 255 15 94

Walt Disney 30 10 66

R.R. Donnelley 20 (4) 100

Dow Chemical 165 50 70

Gannett 18 10 44

GTE 386 106 73

Hartford Financial 28 (3) 100

Hewlett Packard 32 0 100

Merck 90 6 93

J.P. Morgan 26 (16) 100

Norfolk Southern 35 8 77

Pacific Gas & Electric 124 12 90

Procter & Gamble 3 (336) 100

Sears Roebuck 301 (46) 100

Sunbeam 4 (0.5) 100

Tektronix 6 (2) 100

Unisys 25 6 76

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