Settling Post-Retirement Medical Benefits, the Auto Sector, and Employee Life and Health Trusts

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1 Settling Post-Retirement Medical Benefits, the Auto Sector, and Employee Life and Health Trusts June 22, 2010 Challenges in Post-Retirement Benefits Plenary Session CBA Pension and Benefits Section /IPEBLA: Quebec Conference

2 Agenda Karen Millard: The accounting landscape Gregory Winfield: Key goals for stakeholders Steven Friedman: US solution Norman C. Tobias: Canadian solution (Employee Life and Health Trusts)

3 Landscape Historically Canadian plan sponsors did not realize/anticipate that retiree medical plans would ever represent a significant cost Agreed to self-insure private health services plans No intervention by provincial insurance regulators Traditional retiree programs carry open-ended liability Covering, generally, all prescription drugs Usually, for retiree s lifetime, plus survivor benefits (surviving spouse) In forecasting costs Annual medical trend, past 20 years: 5% to 15%+ New high cost drugs (Biologics) Soaring utilization Increased life expectancy Future of public coverage uncertain Extremely long time horizon (tail) 55 year old retiree, 30 years +

4 Landscape Traditional insurance approach of having young individuals (i.e. active employees) subsidize the costs for older individuals (i.e. retirees) no longer workable In part because retiree benefit programs being reduced, terminated for active employees Insurers unwilling to underwrite unlimited paid-up risk Multi-employer benefit plan trusts (joint union/employer managed) unwilling to accept paid-up risk No fully tax-effective vehicle for pre-funding retiree medical costs

5 The Landscape PRB liability reporting employee future benefits CICA 3461, since January 1, 2000 FAS 106, ASC , IAS-19 Total estimated future benefit Cost for each year of retirement Current annual claims costs With current plan design and current government program offsets Adjusted for any expected (automatic) improvements Adjusted for health trend assumptions Current value at retirement Discount rate Assumptions on age of retirement, mortality

6 PRB Liabilities Expected benefit obligation (EBO) The present value of all expected future claims that will be paid For all individuals already meeting eligibility criteria For all active individuals that may grow into entitlements for retiree benefits Adjusted for assumptions on termination and date of retirement Accrued benefit obligation (ABO) That portion of the EBO that has accrued for active employees EBO accrues over an attribution period The projected unit credit method: an equal portion of the total estimated future benefit is attributed to each year of service in an attribution period Attribution period may be over employees full career (prior to full eligibility date) or depending on the eligibility criteria, some period before the date full eligibility is reached Adjusted for assumptions on termination/retirement Equal to the EBO for individuals who already qualify for full entitlements (i.e. retirees)

7 Settlements Plan sponsors can eliminate future year retiree group benefit obligations (reporting requirements) on settlement Must be irrevocable and relieve the plan sponsor of primary responsibility for the accrued benefit obligations Practically, must have no legal responsibility to in relation to the benefits, administration or funding Recognized for the period in which the settlement occurs Once the settlement becomes probable Periodic settlement may require recognition over time

8 Key Goals of Stakeholders Employer viewpoint desire to Control absolute costs Typically, contribute finite amount but over several years; perhaps match deductions with contributions Remove volatility from financial statements Eliminate/reduce administration of benefit Notwithstanding the foregoing see the retirees receive the promised benefits

9 Key Goals of Stakeholders Employee/Union Viewpoint desire to See retirees receive promised benefits Secure the benefit promise from insolvency risk to the maximum extent practical greatest possible contributions as soon as possible ensure independent structure allows fair treatment of all (i.e. right to reduce benefits should the assets be running out) (UNION)

10 Key Goals of Stakeholders Government viewpoint desire to Eliminate one potentially press-worthy element of employer insolvency Facilitate benefits security but at reasonable cost to the fisc Maintain a regime that is not vastly different from H&W Trust, but yields sufficiently favourable tax treatment to trust to make economically viable to employers and retirees

11 General Challenges For employer to terminate its obligations to retired persons, there is a need to either obtain consent from an employee or obtain a binding court order Where large number of retirees, it may well be necessary to use a class proceeding Employees may need to accept that payments will be made over time but to ensure commitment may require delivery of debt instrument by employer

12 General Challenges (cont d) Need new tax regime Federal and provincial Need to agree on appropriate contribution (may include debt terms) Need to find qualified trustees Trustees need to develop Investment policy which will allow funds to satisfy benefits to all retirees many contingencies Strategy for allocation/distribution of funds between groups and over time

13 The Employee Life and Health Trust (ELHT) CATALYST FOR THE DRAFT AMENDMENTS TO ACCOMMODATE ELHT

14 ELHT Status The determination of ELHT status is a year-by-year determination If a trust is an ELHT for none of a particular taxation year, such an arrangement could fall into any one of a number of existing statutory categories of employee benefit plan, retirement compensation arrangement or salary deferral arrangement, each of which is subject to its own specific tax regime

15 Conditions for ELHT Status The only objects of the trust are to provide designated employee benefits to or for the benefit of employees of a participating employer and to benefit on a pro rata basis any remaining beneficiaries of the trust (excluding key employees ) on wind-up; The trust is resident in Canada under common law principles; Each beneficiary of the trust is an employee or former employee of a participating employer, an individual related to such an employee or another ELHT; It cannot reasonably be considered, having regard to all circumstances, that the trust is maintained primarily for the benefit of one or more key employees of a participating employer; The rights under the trust of each key employee of a participating employer are not more advantageous than the rights of each member of a reference class of beneficiaries; The terms of the trust do not provide any rights to a participating employer or to any person who does not deal at arm s length with a participating employer, as a beneficiary or otherwise, except rights to designated employee benefits; The trust is administered in accordance with its terms and objects; The trust has a legal right to enforce payment of contributions to the trust; and Representatives of one or more participating employers do not constitute the majority of the trustees of the trust.

16 Employer Contributions An employer may deduct in computing income in respect of the employer s taxation year an amount in respect of its contributions to an ELHT that may reasonably be regarded as having been contributed to fund designated employee benefits payable in the year to, or for the benefit of, its employee. The non-deductible contribution to an ELHT in a particular year is deductible in computing an employer s income in a subsequent year in which the related designated employee benefits become payable to or for the benefit of employees. The amounts deducted in total in the year of contribution and in subsequent years in respect of a contribution made to an ELHT cannot exceed the total amount contributed by an employer to an ELHT.

17 Employer Contributions Promissory notes or other evidence of indebtedness issued to an ELHT by an employer in respect of its obligation to the ELHT is deemed not to be a contribution; rather payments (whether self-styled as principal, interest or any other amount) by an employer in full or partial satisfaction of the employer liability under the promissory note or other evidence of indebtedness will be deemed to be employer contributions to the ELHT.

18 Employer Contributions For purposes of the tax treatment of periodic disability benefits, the amount of prescribed employee benefit for group life insurance coverage and the medical expense tax credit, employee contributions to an ELHT, to the extent that they are and are so identified as contributions in respect of a particular designated employee benefit, are deemed to be payments by the employee in respect of that particular designated employee benefit. According to the Explanatory Notes, it is anticipated that this will be accomplished in most cases by the trust notifying the employer and the employer reporting the contributions on the employee s pay stub. According to Department of Finance officials, in the case of retired employees, any reasonable, and reasonably timely, method of identification, such as monthly statements to retired employees, should suffice.

19 Tax Treatment of Benefits An amount paid to any person as a distribution from a trust that is, or was at any time, an ELHT is includible in income of the recipient, except to the extent the amount is a payment of a designated employee benefit or a distribution to another ELHT that is a beneficiary of the distributing ELHT. A designated employee benefit may be includible in income under a specific provision of the Income Tax Act (e.g. periodic payments in respect of the loss of all or any part of income from an office or employment pursuant to an income replacement plan to or under which the recipient s employer has made a contribution).

20 ELHT vs H&W Trust The most important distinction between an ELHT and the CRA administratively-recognized health and welfare trust ( H&W Trust ) is that there may be deducted in computing the income of an ELHT for a taxation year amounts that become payable by the trust in the year as designated employee benefits. By way of contrast, the income of a H&W Trust, net of expenses incurred to earn the income and administrative-related expenses, is subject to tax (whether to the H&W Trust or to its beneficiaries, depending upon whether the income is payable in the year or not to its beneficiaries). Apart from this distinction, the differences between these two categories of health benefits trusts are arguably trivial in nature. We understand that CRA is giving serious consideration to bringing to an end its administrative recognition of H&W Trusts, with a phase-out period, having regard to the new statutory category of ELHT and the discomfort with two more or less parallel regimes governing health benefits trusts.

21 Tax Treatment of ELHT If the amount of designated employee benefits that become payable by the ELHT in a year is not less than its income, there will be no income subject to tax in the ELHT. If the amounts of designated employee benefits that become payable by the ELHT in a year exceeds the ELHT s income, the excess will be a non-capital loss eligible for carry-forward three (3) years and carry-back, three (3) years, in computing taxable income for those years. According to the related Explanatory Note, the shorter carry-forward period should be sufficient to allow ELHTs to avoid paying income tax in most situations where they have not been overfunded. It should be noted that nowhere in the current version of the draft legislation does there appear to be a requirement that an ELHT be funded on a sound actuarial basis. If a trust is an ELHT for none of a particular taxation year, the taxable income of this taxation year is not reducible by non-capital losses carried forward from taxation years throughout which the trust was an ELHT

22 Election Where contributions have been received by an ELHT from more than one employer, the trust is deemed to be a separate trust in respect of the property held for the benefit of eligible beneficiaries in respect of a particular employer if (i) the trustee designates the property to be so held in an election made on or before the filing due-date of the first taxation year of the (deemed) separate trust and (ii) under the terms of the trust, contributions from the employer and the income derived therefrom accrues solely for the benefit of that particular constituency of beneficiaries.

23 Questions?