FAS 106 Accounting Rule on Retiree Health Benefits

Source: AARP.org | July 30, 2007

Numerous reports have been written about General Motors’ multi-billion dollar loss against earnings because of retiree health benefits. The reason that GM and other companies must show this charge on their balance sheets is FAS 106, a rule issued by the Financial Accounting Standards Board, a private but government-sanctioned organization that sets standards for corporate accounting and reporting. FAS governs accounting for postretirement health care benefits.

FAS 106 requires that employers must replace pay-as-you-go accounting with accrual accounting. That is, their balance sheets must show the expected cost of providing retiree health and welfare benefits for all employees and retirees eligible to receive such benefits, currently or in the future.

This rule applies to single-employer defined benefit postretirement plans and other pensions. A single-employer plan is sponsored by only one employer for its employees, retirees, and their dependents. A defined benefit plan is one that defines retiree benefits in terms of benefit coverage (e.g., all hospitalization charges, or 80% of physician charges) rather than in dollar values.

There are two aspects to this disclosure on the employer’s financial statement.

• The amount of the accumulated postretirement benefit obligation, that is, the cost of the previously promised retiree health benefits accrued to date. Employers may account for the cost either in one lump sum or spread it out over a longer period of time.
• The current yearly cost of the postretirement benefit obligation that is charged against the company ’ s earnings each year.

Although some companies — such as McDonnell Douglas, Primerica, and Unisys — have cited FAS 106 as a reason for eliminating or cutting retiree health benefits, this rule does not change the actual cost of retiree benefits. This only makes them more visible to employees, shareholders, and the public. The rule makes the accounting for retiree health benefits comparable to the accounting required for pension benefits, which are earned during the working years and paid out in retirement.

The implications of FAS 106 have a significant impact on the employer’s compensation and retirement plan philosophy for current and future retirees. In particular, before human resource decisions are made concerning the company’s health benefits, it is important for staff to be aware of how these decisions are affected by the FAS 106 so that they can ensure that the money will be there to cover the costs of health benefits promised to employees.