Should you fund your retirees' health care?

• Author: DeHaven, James W.
• Position: Employee Benefits

As FAS 106 steals a march on Corporate America's balance sheets, companies are divided on the best way to guard their bottom lines. Read how two financial executives on different sides of the fence are coping with the specter of retiree medical benefits.

At Upjohn, we wanted to fund our retiree medical liabilities because we were concerned about the increasing impact an unfunded FAS 106 liability would have on our future operating margins. What helped us in managing the new standard was breaking it into its four components--amortization of prior service, normal cost, interest and return on assets.

Like many companies, we wrote off the prior service cost when we adopted FAS 106 because we felt that we could control normal cost going forward through plan design. We knew there was little we could do about the interest component, and we felt we should concentrate on the return component by beginning the funding process as quickly as possible.

In reviewing funding alternatives, we preferred to stick with one funding vehicle that could attain a high level of funding in a reasonable period of time. We were concerned that a patchwork of several vehicles would be difficult to administer, especially if tax legislation were to change, so we decided on trust-owned life insurance (TOLI), operating with a voluntary employee benefits association (VEBA) trust. Both aspects--the tax-deferred buildup of cash in a life insurance contract and the VEBA trust--had long legislative histories.

The mechanics of a TOLI are quite simple. The company makes contributions to the trust that are tax-deductible up to the qualified asset account limit. The contributions are used to purchase life insurance, and the trust uses the resulting death proceeds to help pay the retiree's medical and dental claims.

One of our first steps was setting up the trust. We were fortunate in being a large Michigan employer, because Michigan was one of the first states to codify the idea that a VEBA trust has an insurable interest in its employees.

After setting up a Michigan trust, we needed to select a carrier. We chose to use a consultant to help us work out the detailed negotiations with potential carriers. A major factor in selecting our carrier was the strength of its investment team. Some carriers handled investments externally, some handled them internally and others did both. Plus, the track records of their investment products varied significantly.

Assessing our administrative...