Financial Statements of Defined Benefit Plans

The objective of a financial statement made regarding a defined benefit health and welfare plan, or a defined contribution plan, is to provide relevant financial information to evaluate a plan’s present and future ability to pay benefit obligations when due. To achieve this goal, the plan resources, benefit obligations, transactions, and events related to the plan must be provided in the financial statement. Supported information that helps to understand this financial information may also be included in the statement.
Defined benefit plans should be prepared on an accrual basis of accounting. Several items are required for the financial statement related to this plan. First is a statement of net assets available for the year’s benefits, which contains information related to investments, insurance contracts, and investment contacts. Second, a statement of changes for these assets is necessary. These changes must be significant and have occurred during the established year.
These changes include the following:

  • Contributions
  • Changes to the value of investments and income
  • Changes of income taxes either paid or payable
  • Changes of payments to claims and to premiums
  • Changes of operating and administrative expenses
    If any changes are made to contributions made from employers, both cash and noncash components must be addressed separately. The nature of noncash contributions must be described in a note. Other issues regarding changes to contributions, as well as contributions from other identified sources (for instance, sate subsidies or federal grants), can be related to employees, collected or remitted.
    Regarding changes of investment value, regardless of whether the investments result in net depreciation or appreciation: they must be addressed separately based on the measurements of the investment’s fair value. Fair value measurements refer to whether value is measured by a quoted price in an active market or by another method.
    The changes of a payment for a claim do not include changes to the contacts by the insurance company, which are not included in plan assets.
    The third item included in the financial statement of a defined benefit plan is information about the plan’s obligations throughout the year.
    The final inclusion item for a defined benefit plan is information regarding the impact made by changes in the plan’s obligations. All factors resulting in these changes throughout the plan’s period must be identified: Amendments, changes in the nature of the plan, and changes in actuarial assumption are the minimum disclosures about changes in benefit obligation.
    Certain defined contribution plans have balance limitations in the participant’s accounts (for example, vacation plans, holiday plans, and legal plans) (FASB ASC 965-205-10-1-2). The required financial information includes plan resources, how these resources are working and are managed, and the result of transactions and events that influence these resources (in addition to other factors that may help to understand the provided information). A statement of net assets available for the plan benefits throughout the year is required information, as is the statement of changes in net assets.
    Self-Funding of Healthcare Benefits
    A major financial consideration for benefit programs deals with self-funding. In such a plan, instead of buying a product, an employer funds an employee’s plan from the company’s general resources.
    Healthcare costs have been rising steadily over the past many years. Due to this, employers seek out ways to bring these costs down. Self-insuring health plans provide just such an opportunity. Companies are permitted to pay submitted claims in such plans utilizing a pay-as-you-go process. Self-funding will be discussed in detail in Chapter 3.
    Tax Dimensions of Healthcare Plans
    As described previously in this chapter, IRS tax codes have introduced certain healthcare initiatives. This section covers these initiatives.
    Health Savings Accounts
    Health savings accounts, also known as HSAs, were created in 2003 so that individuals covered by high-deductible health plans (HDHP) could receive tax-preferred treatment for funds used for medical expenses. Generally, any adult who is covered by such a HDHP (and has no other coverage) may establish an HSA.
    A high-deductible health plan is so named because it has a higher deductible (but also with lower premiums) than a traditional health plan. These are usually meant for specific, catastrophic illnesses. HSAs were established as a part of the Medicare Prescription Drug Improvement and Modernization Act, which was signed into law on December 8, 2003, by President George W. Bush.
    In a survey conducted by the Kaiser Family Foundation in September 2008, it was found that 8% of covered workers were enrolled in a CDHP (including both HSAs and HRAs), up from 4% in 2006. The study also found that roughly 10% of firms offered such plans. There is evidence that the majority of HSA plans were employer sponsored and that about 25% of them were individually set up. Another survey, by America’s Health Insurance Plans (AHIP), provides evidence that confirms this. This study reported that the number of Americans covered by HSA plans had grown to a total of 6.1 million as of January 2008; 4.6 million of these were employer sponsored, and 1.5 million were individually purchased.
    Evidence gleaned from other sources regarding HSAs shows that, since their inception, contributions to these plans outstrip withdrawals by a considerable amount, usually nearly double.
    Contributions to an HSA may be made by any individual member of an HSA-eligible HDHP, by an employer, or by any other person. If an employer makes a contribution to such a plan, the plan in question is considered the same as any other ERISA-qualified plan, and nondiscrimination rules become effective. However, if contributions are made through a Section 125 plan, nondiscrimination rules do not apply. Employers have some flexibility in the distribution of these plans, in that they have the option of treating full-time and part-time employees differently; they may also treat individual and family participants differently.
    Contributions from an employer or employee may be made on a pretax basis. In the absence of employer contributions, they may be made on a post-tax basis and used to decrease gross taxable income the following year. The main advantage of pretax contributions is avoiding the FICA and Medicare tax deduction, which amounts to a savings of 7.65%. This percentage applies to both employer and employee (subject to limits of the Social Security wage base). Regardless of the method or savings associated with them, deposits may only be made for those covered under an HSA-eligible HDHP.
    Initially, the annual maximum deposit to an HSA was less than the actual deductible or specified IRS limits. Congress later abolished this limit based on the deductible and set limits for maximum contributions. All contributions to an HSA, regardless of the source, count toward an annual maximum. A catch-up provision also applies for plan participants aged 55 of over, allowing the IRS limit to be increased.
    All deposits to an HSA become the property of the policyholder, regardless of its source. Funds that are deposited, but not withdrawn, carry over each year into the next. If the policyholder ends her HSA-eligible insurance coverage, she is no longer permitted to deposit further funds; however, funds already in the HSA remain available for use.
    The Tax Relief and Health Care Act, signed into law on December 20, 2006, added a provision that allowed a one-time rollover of Individual Retirement Account (IRA) assets to be used to fund up to a year’s worth of a maximum HSA contribution. State tax treatment of HSAs varies.
    According to IRS Publication 969: Health Savings and Other Tax-Favored Health Plans, an individual can generally make contributions to an HSA for a given tax year until the deadline for filing returns for that year, which is typically April 15.
    The IRS stipulated contributions for the years 2012 and 2013, respectively, as follows:

Funds in an HSA can be invested similarly to the method used for IRAs. Investment earnings are sheltered from taxation until money is withdrawn.
HSA funds can be rolled over to other HSAs, but not into an IRA or a 401(k); further, funds from IRAs and other investments cannot be rolled into an HSA, barring the one-time IRA transfer mentioned previously.
Unlike some employer contributions to, for example, a 401(k) plan, all HSA contributions belong to the participant as soon as they are given, regardless of the source. HSA participants are not required to obtain advance approval from their trustee, or their medical insurer, to withdraw funds. These funds are not subject to income tax if made for qualified expenses. These include services and items covered by the health plan, but they are subject to cost sharing, such as a deductible and co-insurance or copayments. Funds can be withdrawn for expenses not covered under medical plans, such as dental, vision, and chiropractic care; medical equipment such as eyeglasses and hearing aids; and transportation expenses (as long as they are related to medical care). Through December 31, 2010, nonprescription over-the-counter medications were also eligible.
Beginning on January 1, 2011, the Patient Protection and Affordable Care Act, also known as Healthcare Reform, stipulates that HSA funds cannot be used to buy over-the-counter drugs without a doctor’s prescription.
HSA funds can be withdrawn in numerous ways—debit cards, personal checks, and so on. These withdrawals can be made for any reason, but withdrawals that are not for documented and qualified medical expenses are subject to income tax alongside a 20% penalty. This tax penalty is waived for anyone who has reached the age of 65, or has become disabled, at the time of the withdrawal. Then, only income tax is paid on the withdrawal, and, in effect, the account has become tax deferred (similar to an IRA). Medical expenses continue to be tax-free. As of January 1, 2011, rules governing HSAs in the Patient Protection and Affordable Care Act went into effect, and the penalty for nonqualified withdrawals was 10%.
Account holders are required to retain proper documentation for their medical expenses. Failure to do this may cause the IRS to rule their expenses as unqualified, and thus subject the taxpayer to additional penalties.
An HSA plan is an innovation created primarily to contain healthcare costs for employers, and thus increase the efficiency of the healthcare system. The guiding principle at work is that when individuals spend their own money, it makes them more responsible when purchasing healthcare benefits, because they will pursue cost-effective choices. It is further believed that individuals required to pay for their own expenses will consume less medical care, be more studious in gathering information, specifically seek out lower-cost options, and be more vigilant against excess and fraud. For these reasons, the HSA program has great value as a cost-containment measure.
Two other plans fall within the purview of CDHPs: HRAs and FSAs. They have similar objectives but different structures.
Health Reimbursement Accounts
Health reimbursement accounts, also known as health reimbursement arrangements or HRAs, are IRS-approved programs that permit employers to set aside funds to reimburse medical expenses paid by employees. These programs have tax advantages for both employees and employers.
An account such as this is offered both to employees and retirees. The participant can use the money to pay for deductible and co-insurance accounts or covered medical expenses. Like an HSA, leftover funds can be used from year to year, as long as the employee is a member of the plan. The money is contributed by the employer and therefore doesn’t count as income, thus saving valuable tax dollars.
HRA programs are set up by employers, which are then managed by a third-party administrator. A possible feature of this plan would allow participants to roll over plan balances from one year to the next. However, the employee must decide how to decide how much can be rolled over. This can be stipulated as a percentage or as a flat amount. According to the IRS, an HRA program “must be funded solely by an employer,” and contributions cannot be paid through a voluntary salary reduction agreement. There is no limit on an employer’s contributions, as they are excluded from an employee’s income.
As per IRS regulations documented in IRS Publication 96, “employees are reimbursed tax free for qualified medical expenses up to a maximum dollar amount for a coverage period.” HRAs reimburse only those items agreed to by the employer—copays, co-insurance, deductibles, and services—that are not covered by the company’s standard insurance plan. With an HRA, employers fund individual reimbursement accounts for their employees and define how these funds can be used.
Before a plan can be implemented, qualified claims must be laid out in a plan document. Approved reimbursements may be medical services, dental services, copays, co-insurance, and deductibles. However, these guidelines can vary from plan to plan. The employer is not required to prepay into a fund for reimbursements and can choose instead to reimburse employee claims as they come.
Reimbursements under an HRA plan can be made for the following:

  • Current and former employees
  • Spouses
  • Any person the employee may have claimed as a dependent on his or her tax return (with stipulated exceptions)
    The biggest cost-containment advantage in a plan like this is that employers will have predictability for their expenses when providing healthcare benefits to their employees.
    Flexible Spending Accounts
    As indicated previously, flexible spending accounts (FSAs) cannot be classified as a cost-containment device to be used by the employer. Instead, an FSA is more useful as a program to facilitate an employee’s usage of his own money to spend on healthcare and dependent care expenses. In a program such as this, an individual can set aside a certain percentage of his earnings to pay for these expenses; these funds are not subject to payroll taxes. A major disadvantage of an FSA, however, is that these funds are lost at the end of the year, unlike the funds in an HSA account.
    The most common type of FSA is one for medical expenses. HSAs and FSAs are similar in nature, with the primary difference being that an HSA is a component of a consumer-driven plan, whereas an FSA can be offered alongside a traditional healthcare benefit plan. An FSA can have two components: one for qualified medical expenses and the other for dependent care expenses.
    Medical Expense FSA
    The most common type of FSA is utilized for medical expenses not paid by insurance, such as deductibles, copayments, and co-insurance amounts. As of January 1, 2011, over-the-counter medications are permissible only when purchased with a doctor’s prescription; a sole exception is made for insulin. However, over-the-counter medical devices such as bandages, crutches, and eyeglass repair kits are allowed.
    Prior to the enactment of the Patient Protection and Affordable Care Act, the IRS permitted employers to set any maximum for their employees. This act amended Section 125, such that FSAs cannot allow employees to choose an annual election in excess of a limit, determined by the IRS, of $2,500 for the first plan year, beginning after December 31, 2012. Subsequent plan years’ limits will be indexed based on cost-of-living adjustments. Employers are permitted to limit their employees’ annual elections further. This limit is applied to each employee without regard to whether that employee has a spouse or children. Nonelective contributions not deducted from the employee’s wages are not counted against this limit. A worker employed by multiple, unrelated employers is permitted to choose an amount up to the limit under each employer’s separate plan. This limit does not apply to HSAs, reimbursement arrangements, or the employee’s share of the cost of employer-sponsored coverage.
    Dependent Care FSA
    FSAs can also be established to pay for expenses for an employee’s dependents. This dependent care FSA is capped federally at $5,000 per year, per household. Married spouses can each elect a separate FSA, but their combined elections cannot exceed $3,000. All withdrawals in excess of $5,000 are taxed.
    In recent years, the FSA debit card was developed to allow employees to access the account directly. It also simplified the substantiation requirement, which initially called for labor-intensive claims processing.
    A drawback to this system is that money set aside must be paid “within the coverage period,” as defined by the coverage’s definition. This period, or plan year, is typically defined as the calendar year. Funds left unspent at the end of this coverage period are forfeited.
    These funds can be used for administrative costs or can be equally distributed as taxable income among all participants. The coverage period ceases with the termination of employment, regardless of who initiated this termination. The sole exception is when the employee continues coverage with the company under COBRA or some other arrangement.
    International Financial Reporting Standards and Employee Health and Welfare Plans
    Under the International Financial Reporting Standards (IFRS), accounting for employee benefits is addressed in IAS 19. Here we cover only the provisions that affect benefit items only. Note that IAS 19 also covers items that are termed employee compensation for the purposes of this book. The main provisions of IAS 19 that fall under this purview include the following:
  • Short term: Benefits payable within 1 year. The employee will have to provide the services for which required compensation has been earned. These items cover medical benefits provided to regular employees, vacation, and sick pay, as it relates to the employee benefits categorization. IAS 19 requires that the undiscounted amount of these benefits are expected to be paid after service has been rendered.
  • Post-employment: Benefits payable after the employment term is completed. These benefits include pensions, retiree health benefits, life insurance, and the continuation of medical and life benefits after employment has concluded. No termination benefits are included here. In this category, IAS 19 states that if the benefit program is a defined contribution plan, the costs recognized in the period are contributions made in exchange for employee services during said period. For defined benefit plans, the amount recognized in the balance sheet must equal the present value of the defined benefit obligation, as adjusted for unrecognized actuarial gains or losses. Also included are unrecognized past service costs for pension plans (see Chapter 5, “Retirement Plans”). The balance needs to be reduced by the fair value of plan assets at the date of the balance sheet’s creation.
  • Termination: Benefits paid upon involuntary termination, or a voluntary termination, where compensation has been paid for a temporary period. For these benefits, IAS 19 specifies that the payable amounts should be recognized after the company has made a decision to either terminate an employee (or group of employees) before retirement or to provide termination benefits as a result of an offer made to encourage voluntary terminations.
    Under IAS 19, a company is required to show that planned termination is being done within the terms and provisions of a formal, written plan, and that the company does not intend to cancel this plan after termination has taken place. IAS also allows the discounting of action costs (from the balance sheet) as a result of termination after 12 months have expired and if benefits are currently being paid.

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