Speaking Out

Response to Dr. Pring

The issues raised by Dr. Pring on the magnitude and implications of the University's post-retirement medical benefits obligation reflect many of the concerns deliberated by the FAS 106 Work Group. The initial valuation of the retiree medical liability was calculated in June of 1990 by Coopers & Lybrand and amounted to $127 million. Realizing that the measurement of the University's liability would be highly dependent on many variables, each of the assumptions underlying the calculation was closely scrutinized.

Coopers & Lybrand carried out an extensive analysis of health care costs from data supplied by our health carriers. A series of discussions took place in which baseline costs were verified, checks were made of the eligible population, and actuarial assumptions were reviewed, with the University supplying additional data where available. Several assumptions based upon national patterns were refined using University experiential data. These included retirement ages of faculty and staff and termination patterns for both faculty and staff. The most critical assumption for the projection involved medical cost inflation rates. These rates were reduced based upon recent University cost patterns.

The net result of all of these revisions reduced the estimated liability to $96 million. Subsequently, modeling was done in-house as plan design modifications were considered. At the later stages of modeling, the University again turned to Coopers & Lybrand. This was done because as the University's auditors, Coopers & Lybrand will have to concur with the calculated liability when they render an opinion on the University's financial statements.

The calculated liability is not a worst-case scenario. As discussed, the amount was reduced by using actual University experience rather than national norms. The model did not assume that all individuals retire early. Such an assumption would have resulted in overstatement of the liability. Rather, the model used historical University retirement patterns in calculating the cost of the program. However, FAS 106 requires the University to accrue the cost of retiree medical benefits over the active work life of employees. The accrual period ends when employees become fully eligible for the benefit, i.e., at age 55 with 15 years of service or at age 62 with 10 years of service.

The University and Coopers & Lybrand's actuarial experts worked together to assure that the calculated numbers are in compliance with the requirements of the Financial Accounting Standards Board. It is important to note that the University's obligation will be reviewed annually. Appropriate adjustments will be made in light of actual experience and consistent with FAS 106 requirements.

As indicated in Almanac articles, the University must choose to recognize the entire liability in one year or alternatively, amortize the obligation over a twenty-year period. The University will likely choose the latter approach since Penn does not have sufficient fund balances to absorb its full liability all at once. Funding is not an "all-or-nothing" choice. However, to the extent that the University does fund the obligation, interest earnings will partially offset our post-retirement medical benefit costs on an ongoing basis. Additionally, the Work Group concluded that segregating assets for this purpose would give greater assurance to faculty and staff that these commitments could be honored in the future.

The proposed plan modifications were developed through a consultative process in which cost considerations were balanced with expectations of both present and future retirees. Dr. Pring is correct, there are other alternatives. The University has had an early retirement program for tenured faculty for many years. Although this program has been helpful in transitioning faculty into retirement, its budgetary impact is not of the same order of magnitude as the FAS 106 annual expense. The cost savings from this program are contingent on utilization in any given year and the savings are not recaptured to offset the overall University benefits costs.

Any alternative must result in real savings in the short-term since FAS 106 must be adopted in the next budget year. Any increase in the employee benefits rate is taken very seriously since it affeacts our competitiveness and puts pressure on both restricted and unrestricted budgets. The recommendations of the Work Group permit the University to determine with certainty the near term budgetary impact and strike an appropriate balance between cost containment and the University's commitment to provide retirement health benefits.

-- Michael Aiken, Provost
-- John Wells Gould, Acting Executive Vice President


January 12, 1993
Volume 39 Number 17

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