Fortune 1000 companies reported an estimated $285 billion in retiree medical obligations for 2013, according to calculations based on required Securities and Exchange Commission financial disclosures as of December 31, 2013. Total liability for 2013 was down from total liability for 2012, which was $338 billion. The decrease was mainly due to increases in discount rates.

Towers Watson (NYSE, NASDAQ:TW), a global professional services company, performed the analysis, which showed that 501 Fortune 1000 companies have retiree medical liability, while 499 do not. Of the 501 companies that do, 67% had no assets backing the liability.

“While total liability for retiree medical is in the billions — much of it unfunded — the undercurrent issue is that companies are exposing themselves to the risk of a variety of unknown variables with adverse consequences,” said Mitchell Cole, managing director of Towers Watson Retiree Insurance Services.

Cole points to four such risks:

  • Volatility of the discount rate makes the obligation variable and unpredictable. Based on a Towers Watson analysis, on average, a 1% decrease in the discount rate will increase the balance sheet obligation by 12%. Changes in the discount rate are especially problematic for companies with unfunded or underfunded plans. As of October 16, 2014, discount rates have decreased by about 80 basis points since year-end. If this trend continues, or yields don’t recover, corporations can expect significant losses due to market movements for their December 31, 2014 disclosures for retiree medical obligations.
  • Tax reform legislation could wipe out billions in deferred taxes overnight. If Congress enacts new tax laws eliminating or reducing the tax deductibility of amortized retiree medical obligations, the result would be adverse tax consequences for companies counting on those tax deductions. The tax deduction for employer contributions to health plans is one of the largest tax expenditures, and the Obama administration, key Senate Republicans and independent budget commissions have all suggested changes to it to raise revenue. (See below for descriptions of tax reform proposals being considered.)
  • Longer life expectancies could increase the projected obligation. An independent analysis of newly published mortality tables by the Society of Actuaries suggests that future retiree medical liabilities could increase by 8% to 10% by the end of 2014 or in 2015.
  • Boards and shareholders view dedicating balance sheet capacity to a nonstrategic benefit as an inefficient use of capital. Retiree medical is a liability that doesn’t attract or engage talent, yet it creates balance sheet volatility and income statement expense, has administrative costs and diverts management time.

To eliminate these risks, Cole advises companies to end their legal obligation to retiree medical, which is now possible with Longitude Solution, a retiree medical exit solution introduced by Towers Watson in March 2014.

“In today’s financial landscape, it’s prudent for plan sponsors to consider taking this opportunity to exit retiree medical,” said Cole. “It’s the first time they have the option to exit their legal, accounting and regulatory responsibilities for retiree medical benefits without adverse tax consequences. Plus, this solution gives retirees security and peace of mind with a lifetime annuity that guarantees tax-free funding for medical benefits from a highly rated insurance company.”

Here is a breakdown of companies with retiree medical liability and their funding levels based on the Towers Watson analysis:

Number of
companies
with liabilities

% of
companies
with liabilities

% of liabilities funded

 
334 67% Zero
68 13% More than zero but less than 33.33%
40 8% More than or equal to 33.33% but less than 66.67%
40 8% More than or equal to 66.67% but less than 100%

19

 4% More than 100%

501 — total companies in the Fortune 1000 with retiree medical liabilities as of December 31, 2013
 

“Longitude Solution creates economic value for both companies and their retirees, eliminates a wasteful use of time and enables companies to put shareholder money to better use,” said Cole.

Click here for more information about Longitude Solution.

About Towers Watson

Towers Watson (NYSE, NASDAQ: TW) is a leading global professional services company that helps organizations improve performance through effective people, risk and financial management. With 15,000 associates around the world, the company offers consulting, technology and solutions in the areas of benefits, talent management, rewards, and risk and capital management. Learn more at towerswatson.com

*Tax reform proposals that would affect employer retiree medical plans include the following:

From President Obama’s budget proposal for fiscal year 2014. The Obama administration’s fiscal year 2014 budget includes last year’s proposal to reduce the tax value of certain other specified deductions and exclusions, including pretax employee contributions to defined contribution retirement plans and individual retirement accounts, and employer-provided health insurance paid for by employers or by employees with pretax dollars.

Hatch-Coburn bill. On January 27, 2014, Senate Finance Ranking Member Orrin Hatch (R-UT), along with finance committee members Senator Richard Burr (R-NC) and Senator Tom Coburn (R-OK), unveiled specifications for the Patient Choice, Affordability, Responsibility and Empowerment Act, legislation they plan to introduce to repeal and replace the Patient Protection and Affordable Care Act. Of particular note, the proposal calls for capping the tax exclusion for health coverage at 65% of the average plan’s costs (indexed for inflation in future years).

National Commission on Fiscal Responsibility and Reform. The President established the National Commission on Fiscal Responsibility and Reform, also known as the Simpson/Bowles Commission, to look at the current budget situation and report back with recommendations. One of the issues the commission focused on was tax reform. It recommended that the current exclusion for employer-provided health insurance be capped at 75% of the premium levels in 2014, which would eliminate the unlimited exclusion under current law. This would likely result in the elimination of most cafeteria plans, flexible spending arrangements and health reimbursement arrangements, since their favorable tax treatment is dependent on the exclusion for employer-provided health insurance.