So how do employers cope? To avoid reducing(or worse, eliminating)postretirement benefits, one argument put forth by consultants and companies is prefunding, setting aside money to grow and accumulate for postretirement health benefits. This prefunding system could be something similar to the Canada Pension Plan, in which both the employer and employee make contributions. The employer gets the tax write-off and the retiree has his healthcare coverage.
Joseph Ricciuti, client solutions leader in the group and healthcare practice with Watson Wyatt Worldwide in Toronto, advocates prefunding for postretirement benefits. “If it could be prefunded and earmarked, essentially retiree health becomes guaranteed and not subject to what it’s going through now, where companies simply just can’t afford it.”
So what’s stopping companies from prefunding? Although the current Income Tax Act(ITA)does not preclude employers from funding postretirement health benefits, “certain criteria must be satisfied before allowing an employer to deduct an amount related to the cost of health benefits paid or payable by the employer,” according to the Department of Finance Canada. “In order to get the tax-preferred treatment, we would need to have modification in the ITA,” says Eric Laberge, senior vice-president with Aon Consulting in Montreal. “And I have a feeling from a political standpoint, there’s not much appetite for that.”
But even if the government agreed and did rewrite the tax law, there would still be pros and cons, says Ricciuti. And the government itself would face the biggest con. “From Canada’s perspective, whatever you intend to do tax-efficiently is being funded by the government. [It’s] giving up the tax dollars that [it] would normally get by allowing the tax deductions,” he says.
Employers, too, could experience obstacles to a tax-effective prefunding system. Some may discover that prefunding would use capital that could otherwise be invested in the company. Some may stress over government requirements for such a health benefits fund and the administration costs around it. Plus, employers will still have to determine how to finance the fund. “Even though I get the tax efficiencies, how do I fund for an unknown?” asks Ricciuti. “How do I define my plan for the future, knowing that it’s tied to costs that are running rampant?”
Nevertheless, Ricciuti feels the pros outweigh the cons. “You set aside money now so you have a pot of money that’s there when you need it. You have the tax efficiencies of it—both in getting the write-offs when you contribute and having the money grow tax-free. At the end of the day, those make sense.”
STRATEGIES
But until that tax-efficient day comes, companies, if they choose, can find only “indirect” ways to prefund. One such way is implementing a group RRSP for employees in which an employer may add an extra $2,000 a year, which the retiree can use for health benefits. “The employer gets the writeoff for the contributions to the RRSP,” Ricciuti says.
Or there’s the life insurance route. An employer can buy life insurance on behalf of its employees. “The premiums that are paid are taxable to the employee, but the cash values that grow are the employee’s. Typically, the cash values that grow are tax-free,” says Ricciuti. When the employee retires, she cashes in the insurance. The employer (which owns the life insurance) will get the sum assured, less the cash values the retiree has withdrawn, when the retiree dies.
But these “indirect” ways may not always appeal to employers. EnCana, a natural gas company in Calgary, currently offers a postretirement benefits package. Though the company has explored prefunding, it feels there is not a mature market for it. “There may be some indirect ways to do it in terms of insurance products,” says Jeff Vathje, lead of corporate total compensation with EnCana, “[but] it’s hard as a major organization to come up with these ‘schemes’ so to speak. You want to be reasonably mainstream. You obviously want to have very competitive benefits, but you don’t want to end up caught with something that’s kind of a fringe in terms of how it’s set up.”
Another strategy, which Aon Consulting is delving into, is alternative funding. “We are looking at alternatives where the financial liabilities can be transferred to more competitive capital markets versus traditional markets,” says Laura Mensch, senior vicepresident with Aon Consulting in Toronto. For example, if the total liabilities are $25 million, she says, we’d take that to the capital markets, to Wall Street, and invest it. “We’ll get a higher return than what they’re being charged from the insurance side to immunize against those fluctuations so that they can fund that retirement.” Although Mensch can’t say if companies are actually going forth with alternative ways to fund, she says Aon is currently exploring with employers on either reducing benefits or looking at alternative funding means.
THE REALITY
But in a perfect world, if the government opted to change the ITA to allow prefunding, would all companies do it? Linda Byron, an actuary with Hewitt Associates in Toronto, is not convinced. It would vary from company to company, she says, depending on such factors as the maturity of the company and the number of active versus retired employees. For actual numbers, the industry has only to look to the Kaiser/Hewitt 2006 Survey on Retiree Health Benefits: of the U.S. companies that offer postretirement benefits, only 25% actually prefund. “We’d probably see some companies prefund, but it’s likely not the majority,” says Byron. And the main issue for companies to prefund or not would be return on investment. “Can they get a greater return investing in their own business? If they can, then that’s where they’re going to put their funds.”
THE INDIVIDUAL APPROACH
There’s nothing to say that prefunded postretirement benefits have to be only employer-sponsored. Under the right set-up, individuals could contribute. Ricciuti, however, is skeptical. Even if an employer sent out a communication to say it was contributing another $1,000 to the group RRSP, he’s not sure it would be used for health. “When people cash in their retirement plans, they just see it to pay rent, put food on the table and that’s it. They see healthcare as being provided by the government or their employer.”
Laberge agrees, but would be curious to see if people would contribute to a health benefits plan. “You can put money aside during your working years, tax-deductible, if the government is willing to have some more tax deduction. But people are not even contributing to their maximum of their RRSPs.”
Whether the government will ever alter the ITA is simply one barrier to prefunding postretirement health benefits. If that barrier is lifted, further troubles could ensue such as government requirements and administration costs. Furthermore, unless prefunding is legislated for healthcare as it is for pensions, companies will have to decide for themselves whether or not it is a worthwhile investment.
Brooke Smith is assistant editor of BENEFITS CANADA. brooke.smith@rci.rogers.com
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