Discussion of how a pension plan sponsor may account for a buy-in annuity contract held as a pension investment. Comparison of buy-in vs. buy-out accounting.

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HRS Insight
Human Resource Services
June 27, 2011
HRS Insight 11/11
Accounting for Pension Buy-In
Buy
Arrangements
Authored by: Ken Stoler, Partner
The first pension "buy--in" contract was recently explores the advantages and disadvantages, and
purchased by a U.S. pension plan. This buy-in
buy the accounting implications, of buy
buy-in
arrangement is similar to a traditional non
non- arrangements.
participating annuity (a "buy-out"), where a
"buy
plan transfers future responsibility for Background
promised employee retirement benefits to an Purchases of buy-in contracts have been
in
insurance company. Under the buy buy-in gaining popularity overseas, but until recently
arrangement, however, the benefit obligation is had not been sold in the U.S. In May 2011, the
not transferred to the insurer. Instead, the plan
rred first U.S.-based buy-in arrangement was
based buy
remains responsible for paying the benefits, but completed. This contract offers the employer
purchases a contract from the insurer which the ability to "lock in" the cash cost of some of
generates returns designed to equal all future its pension benefit obligation and virtually
benefits payments to covered participants.
participants eliminate future volatility, while continuing to
maintain the plan and offer benefits to
When accounting for a traditional buy-out
employees.
annuity, the purchase of the annuity generally
triggers settlement accounting, with often a The buy-in contract is held by the pension plan,
in
significant income statement effect. The buy
buy-in and essentially reimburses the plan for all
contract, however, typically generates no future benefit payments covered by the
settlement but retains certain other advantages contract. That is, as benefit payments are made
of an annuity purchase. This HRS Insight
rchase.

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by 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 whether
As a result, the net ongoing cash flow to the to purchase a buy- contract.
-in
plan for the covered participants is nil, and the
cost of providing benefits is entirely funded by Accounting for a Buy-In
Buy
the buy-in contract.
Arrangement
The contract is generally a single-premium
singl When a traditional non
non-participating buy-out
arrangement, where an upfront payment is annuity is purchased, an employer generally
made by the pension plan to the insurer in applies settlement accounting. The pension
exchange for the contract. The buy-in is often
buy obligation is removed from the books, as are
priced similar to a buy-out annuity, since the
buy the assets used to purchase the anannuity. If the
economics are nearly the same (insurer taking price of the annuity contract exceeds the
on responsibility to make annual payments carrying value of the obligation, as is often the
sufficient to cover promised retirement case, the excess is a loss. Any gains or losses
benefits). Generally, the buy
buy-in contract also deferred in accumulated other comprehensive
allows the holder to covert the arrangement to a income are also recognized in the income
buy-out annuity upon request and for no
out statement as part of the settlement gain or loss.
rt
additional cost. Special rules apply if only part of the benefit
obligation is settled.
After acquiring the buy
buy-in contract, the
employer has eliminated the risks associated Observation: Since most plans today have
with changes in the benefit obligation due to deferred losses reflected in accumulated other
changing mortality rates, fluctuating interest comprehensive income, settlement via annuity
rates, etc. However, the employer has not purchase generally results in a significant
ally
eliminated all risk, because the ability of the income statement loss.
insurer to make good on the contract (i.e., the
insurer's credit risk) remains. To the extent the In order to qualify for a settlement, the
insurer is unable to make payment in full on the accounting literature1 requires that three
buy-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 primary
Observation: The buy contract may cover
buy-in
responsibility for the obligation, and
some or all of the plan's existing benefit
obligation, depending on the specific situation.
For example, an employer may wish to
purchase a contract covering only the benefits
currently in payment status to retirees but not
1The US GAAP pension accounting literature
cover active employee's 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 settlement
contract that covers the entire benefit accounting are generally consistent with US
obligation. Each employer should assess its GAAP.

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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,
buy
In the case of a buy-in contract, these three
in
due to bankruptcy), the employer would still be
criteria are typically not met. First, the buy-in
y buy
obligated for the promised retirement benefits.
contract is often not irrevocable, as it may
include a provision under which the
arrangement can be terminated. A pre-defined
pre
Ongoing Pension Accounting
cash surrender value or termination formula for the Buy- Asset
-In
may be negotiated up front, and while a Since settlement accounting is not applied and
significant termination penalty may exist, it
mination the contract is not considered an annuity, the
nonetheless affords the employer the ability to buy-in contract represents an investment asset
in
unwind the transaction if desired. Based on of the plan. Typically, the pension trust (and
this, the arrangement would not qualify for not the employer) would acquire the buybuy-in
settlement accounting. contract, and thus it would be accounted for as
us
a plan asset. Plan assets are recorded at fair
In addition, settlement accounting is not
value as of each measurement date, and are
appropriate because the employer is not
therefore generally remeasured annually
relieved of primary responsibility for the
(unless an interim remeasurement is required if
obligation. Under the terms of the contract the
a significant event occurs). In presentation on
insurer is not assuming the retirement benefit
the balance sheet the fair value of plan assets is
obligation, and the employer remains
netted against the related pension obligation.
responsible for the plan and making benefit
In determining the appropriate value at which
payments to the plan participants. The
an
to present these buy
buy-in assets, the accounting
employer continues to be considered the plan
literature is not clear. Accordingly, we believe
sponsor under ERISA. Unlike an annuity
that the following two approaches are
llowing
contract, where participants are notified that
acceptable.
responsibility for payment of their benefits has
been transferred to the insurer and the Under the first approach, the fair value of the
employer is no longer involved, participants are buy-in contract is directly measured at each
in
not notified of the buy- arrangement and
-in plan measurement date. Initially, this fair
cannot look to the insurer for payments value would be based on the purchase price of
directly. Furthermore, the employer/plan the contract. In subsequent measurements, fair
trustees could decide to use the money received value would be estimated based on the
under the buy-in contract for other purposes
in contract's 'exit price'2, or the amount at which
under 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 Value
by which the plan can receive payments from Measurements and Disclosures

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party buyer. Estimating this value would likely Ongoing Accounting for the
include similar considerations as were used by
the insurer when originally pricing the buy
rer buy-in Pension Benefit Obligation
contract, including factors based on When a buy-in contract is acquired, there is a
in
assumptions about the plan participants question as to whether any adjustment in the
covered under the contract, such as changes in measurement of the associated benefit
expected mortality. It would also be based on obligation is necessary. Again, the accounting
the current discount rate inherent in the literature is not clear and therefore we believe
contract. This rate would likely be the same
ract. that two approaches are acceptable.
rate used by an insurer in the current price of a
buy-out annuity, often using the PBGC
out Under the first alternative, the benefit
published rate for single
single-employer pension obligation covered by the buy-in contract would
buy
annuities3. continue to be measured with the traditional
discount rate and mortality assumptions used
mort
The second approach is based on the guidance by the employer. The discount rate is generally
in the accounting literatu addressing
literature based on yields of high-quality corporate bonds
high
valuation of insurance contracts that are not at each measurement date. We would expect
annuities4. This guidance notes that such the value of the buy-in contract asset to exceed
buy
contracts should be reflected at fair value, but the value of the benefit obligation under this
indicates 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 rate
fair value. For many insurance contracts held used in valuing the obligation would likely be
in a pension trust, the cash surrender value (if higher than the rate inherent in the buy
buy-in
any) is considered to be reflective of fair value contract (which, as discussed above, is likely
and thus is used for reporting purposes. In the based on lower PBGC annuity rates). In
annui
case of buy-in arrangements, however, while a
in addition, the value of the buy
buy-in contract may
cash-out formula may exist, this value generally be based on different mortality assumptions.
incorporates a fairly sizeable termination
penalty. Based on this, while use of the Under the second alternative, the value of the
surrender value would be acceptable, we believe benefit obligation associated with the
it is not required since the surrender value participants covered by the contract would be
generally would not represent a good proxy for set equal to the fair value of the buy
buy-in contract
fair 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
buy
3 The Pension Benefit Guarantee Corporation
(PBGC) publishes monthly rates used in valuing
hes does not result in an actual settlement, it can be
single-employer annuity benefits on its website
employer viewed to result in an effective settlement since
at www.pbgc.gov.
4 ASC 715-30-35-60 discusses valuation of
60
insurance contracts that are not annuities 5 43
ASC 715-30-35-43

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the majority of the risks and rewards associated remeasurement, the fair value of the buy-in
with the benefit obligation and related assets asset and the associated benefit obligation
has been eliminated. As a result, the discount should be equal, other than potential breakage
rate 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 the
be effectively settled. Under this approach, it is asset and obligation to continue to move in
also considered acceptable to change the tandem. Likewise, the expected return on plan
mortality assumption to that reflected in the assets related to the buy
buy-in contract and the
value of the buy-in contract.
ntract. related interest cost on the associated benefit
obligation recognized as components of net
If this second alternative is followed, an periodic benefit cost should be equal and
actuarial loss will need to be recognized at the offsetting.
next plan measurement date, since the benefit
obligation 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 and
contract. For example, if the benefit obligation
le, participants, determination of the appropriate
was $100 before purchasing a buy buy-in contract discount rate and expected return on assets to
for $105, the obligation would be reset to $105, use may be more complex.
ay
and a $5 actuarial loss would be reflected in
other comprehensive income. After this initial
Summary of Reporting Impact
The following table provides a high-level summary of the financial reporting impact of a decision to
lowing high level
purchase a buy-in contract, a buy
in buy-out annuity, or maintaining current status quo.

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Balance Sheet Current Income Future Income Statement
Impact Statement Impact Impact
Buy-in No change. No settlement gain/loss Continued amortization of
contract 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
futur
annuity 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
annuity
Status No change in No settlement gain/loss Continued amortization of
quo pension gain/loss deferred in AOCI and
obligation and continued application of expected
plan assets return assumption to plan assets
How PwC Can Help
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plans. In addition, we can help you better understand the complex issues related to pension
investment strategies, actuarial measurements, taxation and funding. Please contact one of the
stment
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