www.pwc.com HRS Insight Human Resource Services June 27, 2011 HRS Insight 11/11 Accounting for Pension Buy-In Buy Arrangements Authored by: Ken Stoler, PartnerThe first pension "buy--in" contract was recently explores the advantages and disadvantages, andpurchased by a U.S. pension plan. This buy-in buy the accounting implications, of buy buy-inarrangement is similar to a traditional non non- arrangements.participating annuity (a "buy-out"), where a "buyplan transfers future responsibility for Backgroundpromised employee retirement benefits to an Purchases of buy-in contracts have been ininsurance company. Under the buy buy-in gaining popularity overseas, but until recentlyarrangement, however, the benefit obligation is had not been sold in the U.S. In May 2011, thenot transferred to the insurer. Instead, the plan rred first U.S.-based buy-in arrangement was based buyremains responsible for paying the benefits, but completed. This contract offers the employerpurchases a contract from the insurer which the ability to "lock in" the cash cost of some ofgenerates returns designed to equal all future its pension benefit obligation and virtuallybenefits payments to covered participants. participants eliminate future volatility, while continuing to maintain the plan and offer benefits toWhen accounting for a traditional buy-out employees.annuity, the purchase of the annuity generallytriggers settlement accounting, with often a The buy-in contract is held by the pension plan, insignificant income statement effect. The buy buy-in and essentially reimburses the plan for allcontract, however, typically generates no future benefit payments covered by thesettlement but retains certain other advantages contract. That is, as benefit payments are madeof an annuity purchase. This HRS Insight rchase.
www.pwc.comby the plan, the insurer will make equal mak specific circumstances and the associated circumstances,payments to the plan under the buybuy-in contract. benefits or drawbacks, in evaluating whetherAs a result, the net ongoing cash flow to the to purchase a buy- contract. -inplan for the covered participants is nil, and thecost of providing benefits is entirely funded by Accounting for a Buy-In Buythe buy-in contract. ArrangementThe contract is generally a single-premium singl When a traditional non non-participating buy-outarrangement, where an upfront payment is annuity is purchased, an employer generallymade by the pension plan to the insurer in applies settlement accounting. The pensionexchange for the contract. The buy-in is often buy obligation is removed from the books, as arepriced similar to a buy-out annuity, since the buy the assets used to purchase the anannuity. If theeconomics are nearly the same (insurer taking price of the annuity contract exceeds theon responsibility to make annual payments carrying value of the obligation, as is often thesufficient to cover promised retirement case, the excess is a loss. Any gains or lossesbenefits). Generally, the buy buy-in contract also deferred in accumulated other comprehensiveallows the holder to covert the arrangement to a income are also recognized in the incomebuy-out annuity upon request and for no out statement as part of the settlement gain or loss. rtadditional cost. Special rules apply if only part of the benefit obligation is settled.After acquiring the buy buy-in contract, theemployer has eliminated the risks associated Observation: Since most plans today havewith changes in the benefit obligation due to deferred losses reflected in accumulated otherchanging mortality rates, fluctuating interest comprehensive income, settlement via annuityrates, etc. However, the employer has not purchase generally results in a significant allyeliminated all risk, because the ability of the income statement loss.insurer to make good on the contract (i.e., theinsurers credit risk) remains. To the extent the In order to qualify for a settlement, theinsurer is unable to make payment in full on the accounting literature1 requires that threebuy-in contract; the employer would still be criteria all be met:responsible for all promised benefit payments. 1) The action is irrevocable, 2) The employer is relieved of primaryObservation: The buy contract may cover buy-in responsibility for the obligation, andsome or all of the plans existing benefitobligation, depending on the specific situation.For example, an employer may wish topurchase a contract covering only the benefitscurrently in payment status to retirees but not 1The US GAAP pension accounting literaturecover active employees future benefits. For addressing settlement accounting is in ASC 715- 20-20. International financial reporting 20.frozen plans, some employers may consider a standards (IFRS) related to settlementcontract that covers the entire benefit accounting are generally consistent with USobligation. Each employer should assess its GAAP.
www.pwc.com 3) The transaction eliminates significant the insurer corresponding to the benefits due to risks related to the obligation and the covered participants, but ultimately the assets used to effect the settlement primary responsibility has not been transferred. responsibil Thus, in the event the insurer was unable to make payment under the buy-in (for example, buyIn the case of a buy-in contract, these three in due to bankruptcy), the employer would still becriteria are typically not met. First, the buy-in y buy obligated for the promised retirement benefits.contract is often not irrevocable, as it mayinclude a provision under which thearrangement can be terminated. A pre-defined pre Ongoing Pension Accountingcash surrender value or termination formula for the Buy- Asset -Inmay be negotiated up front, and while a Since settlement accounting is not applied andsignificant termination penalty may exist, it mination the contract is not considered an annuity, thenonetheless affords the employer the ability to buy-in contract represents an investment asset inunwind the transaction if desired. Based on of the plan. Typically, the pension trust (andthis, the arrangement would not qualify for not the employer) would acquire the buybuy-insettlement accounting. contract, and thus it would be accounted for as us a plan asset. Plan assets are recorded at fairIn addition, settlement accounting is not value as of each measurement date, and areappropriate because the employer is not therefore generally remeasured annuallyrelieved of primary responsibility for the (unless an interim remeasurement is required ifobligation. Under the terms of the contract the a significant event occurs). In presentation oninsurer is not assuming the retirement benefit the balance sheet the fair value of plan assets isobligation, and the employer remains netted against the related pension obligation.responsible for the plan and making benefit In determining the appropriate value at whichpayments to the plan participants. The an to present these buy buy-in assets, the accountingemployer continues to be considered the plan literature is not clear. Accordingly, we believesponsor under ERISA. Unlike an annuity that the following two approaches are llowingcontract, where participants are notified that acceptable.responsibility for payment of their benefits hasbeen transferred to the insurer and the Under the first approach, the fair value of theemployer is no longer involved, participants are buy-in contract is directly measured at each innot notified of the buy- arrangement and -in plan measurement date. Initially, this faircannot look to the insurer for payments value would be based on the purchase price ofdirectly. Furthermore, the employer/plan the contract. In subsequent measurements, fairtrustees could decide to use the money received value would be estimated based on theunder the buy-in contract for other purposes in contracts exit price2, or the amount at whichunder the plan (i.e. to purchase other er the contract could be sold to a willing third third-investments).The buy-in contract effectively is an investment in 2As defined in ASC 820, Fair Valueby which the plan can receive payments from Measurements and Disclosures
www.pwc.comparty buyer. Estimating this value would likely Ongoing Accounting for theinclude similar considerations as were used bythe insurer when originally pricing the buy rer buy-in Pension Benefit Obligationcontract, including factors based on When a buy-in contract is acquired, there is a inassumptions about the plan participants question as to whether any adjustment in thecovered under the contract, such as changes in measurement of the associated benefitexpected mortality. It would also be based on obligation is necessary. Again, the accountingthe current discount rate inherent in the literature is not clear and therefore we believecontract. This rate would likely be the same ract. that two approaches are acceptable.rate used by an insurer in the current price of abuy-out annuity, often using the PBGC out Under the first alternative, the benefitpublished rate for single single-employer pension obligation covered by the buy-in contract would buyannuities3. continue to be measured with the traditional discount rate and mortality assumptions used mortThe second approach is based on the guidance by the employer. The discount rate is generallyin the accounting literatu addressing literature based on yields of high-quality corporate bonds highvaluation of insurance contracts that are not at each measurement date. We would expectannuities4. This guidance notes that such the value of the buy-in contract asset to exceed buycontracts should be reflected at fair value, but the value of the benefit obligation under thisindicates that if the contract has a stated cash approach; while both would be based on similar ;surrender value, this can be used as a proxy for participant demographics, the discount ratefair value. For many insurance contracts held used in valuing the obligation would likely bein a pension trust, the cash surrender value (if higher than the rate inherent in the buy buy-inany) is considered to be reflective of fair value contract (which, as discussed above, is likelyand thus is used for reporting purposes. In the based on lower PBGC annuity rates). In annuicase of buy-in arrangements, however, while a in addition, the value of the buy buy-in contract maycash-out formula may exist, this value generally be based on different mortality assumptions.incorporates a fairly sizeable terminationpenalty. Based on this, while use of the Under the second alternative, the value of thesurrender value would be acceptable, we believe benefit obligation associated with theit is not required since the surrender value participants covered by the contract would begenerally would not represent a good proxy for set equal to the fair value of the buy buy-in contractfair value due to the penalty provision. ir at each measurement date. This approach is considered supportable because the guidance on establishing discount rates5 calls for the rate at which the obligation could be effectively settled. While purchase of the buy-in contract buy3 The Pension Benefit Guarantee Corporation(PBGC) publishes monthly rates used in valuing hes does not result in an actual settlement, it can besingle-employer annuity benefits on its website employer viewed to result in an effective settlement sinceat www.pbgc.gov.4 ASC 715-30-35-60 discusses valuation of 60insurance contracts that are not annuities 5 43 ASC 715-30-35-43
www.pwc.comthe majority of the risks and rewards associated remeasurement, the fair value of the buy-inwith the benefit obligation and related assets asset and the associated benefit obligationhas been eliminated. As a result, the discount should be equal, other than potential breakagerate used in pricing the buy-in contract also buy due to changes in credit quality of the insurer.represents the rate at which the obligation can Going forward, we would generally expect thebe effectively settled. Under this approach, it is asset and obligation to continue to move inalso considered acceptable to change the tandem. Likewise, the expected return on planmortality assumption to that reflected in the assets related to the buy buy-in contract and thevalue of the buy-in contract. ntract. related interest cost on the associated benefit obligation recognized as components of netIf this second alternative is followed, an periodic benefit cost should be equal andactuarial loss will need to be recognized at the offsetting.next plan measurement date, since the benefitobligation will be increased to match the Observation: If the buybuy-in contract covers(generally higher) purchase price of the buy-in buy only a portion of the plan obligation andcontract. For example, if the benefit obligation le, participants, determination of the appropriatewas $100 before purchasing a buy buy-in contract discount rate and expected return on assets tofor $105, the obligation would be reset to $105, use may be more complex. ayand a $5 actuarial loss would be reflected inother comprehensive income. After this initialSummary of Reporting ImpactThe following table provides a high-level summary of the financial reporting impact of a decision to lowing high levelpurchase a buy-in contract, a buy in buy-out annuity, or maintaining current status quo.
www.pwc.com Balance Sheet Current Income Future Income Statement Impact Statement Impact ImpactBuy-in No change. No settlement gain/loss Continued amortization ofcontract Pension gain/loss deferred in AOCI. obligation Expense could increase if expected remains. Buy-in Buy return on buy buy-in asset is less than contract is plan previous assumed return, but asset. expense will be less volatile.Buy-out Remove pension Recognize settlement No future amortization of futurannuity obligation and gain/loss on recognition of gain/loss deferred in AOCI. No related plan amounts deferred in AOCI, expense volatility going forward assets including the gain/loss arising on purchase of annuityStatus No change in No settlement gain/loss Continued amortization ofquo pension gain/loss deferred in AOCI and obligation and continued application of expected plan assets return assumption to plan assetsHow PwC Can HelpPwC has considerable expertise with respect to the accounting and disclosure for pension and OPEBplans. In addition, we can help you better understand the complex issues related to pensioninvestment strategies, actuarial measurements, taxation and funding. Please contact one of the stmentindividuals listed below, or your local engagement partner, to further discuss how PwC can help.