Data Used to Estimate U.S. Companies'
Retiree Health Liabilities

small impact because early retirees have only a few years of eligibility for this benefit. Once the retirees reach age 65, we assumed, companies pay the same for them as they do for those who retire at 65.

First-year contributions could range from a low of $26 billion to a high
of $42 billion, according to our analysis. The lower contribution level
would fund our low-expense estimate of employers' accrued liabilities
($187 billion); the higher level, our high-expense estimate ($290 billion).
We amortized accrued liabilities over 25 years for our baseline estimate
of $32 billion for first-year contributions and for the sensitivity
analysis.

Changing only the length of the amortization period in the unit credit method caused our estimate of first-year contributions to vary by $7 billion (in 1988 dollars) around the baseline value of $32.4 billion. The shorter period-15 years—would raise annual contributions by 15.7 percent (to $37.5 billion), while the longer period-35 years—would reduce annual contributions by 5.6 percent (to $30.6 billion).

Table IV.1: Sensitivity of Estimated Total Liabilities of $402 Billion to Different Values for Selected Variables (1988)
Dollars in billions

Appendix V

GAO's Method for Estimating 1988 Retiree

Health Liabilities and Annual Contributions to Begin Advance Funding

Our estimates of employers' 1988 total and accrued liabilities for retiree health benefits were based on a model of companies' projected benefit payments. The data sources and assumptions underlying the model are set forth in appendix IV.

We calculated retiree health liabilities by

1. projecting annual benefit payouts for active workers and retirees, using assumptions about mortality and future increases in medical care costs;

2. converting these benefit payouts to present values at an assumed discount rate; and

3. selecting a pension-funding method to estimate the accrued portion of total liabilities and the contribution that would be needed as of 1988 to begin advance-funding the benefits.

Projecting Numbers of Using data on pensioners and active workers with employer-sponsored

Retirees and Costs for
Health Benefits

Table V.1: Distribution of the Initial
Population in Companies With Retiree
Health Plans in 1988

group health coverage, we constructed populations of retirees and work-
ers receiving retiree health benefits in 1988. We grouped these popula-
tions into 5-year age cohorts of workers and retirees age 40 and above
(see table V.1).

We then projected each cohort into the future, using age-specific probabilities of death or mortality rates. For example, of the 2 million retirees age 65-69 receiving health benefits in 1988, we estimated that about 45,000 would die within a year. This left about 1.95 million alive in 1989. The number of expected deaths was based on mortality rates from a table commonly used by actuaries in pension valuations (see app. IV for a discussion of this table). We continued the process into future years until there were no more survivors from the cohort.

GAO's Method for Estimating 1988 Retiree
Health Liabilities and Annual Contributions
to Begin Advance Funding

Table V.2: Projected Employer Health
Payments for the Cohort of Retirees
Ages 65-69 in 1988, in 5-Year Increments
(1988-2023)

As an example, table V.2 shows every fifth year of the projection for the 65-69 cohort.

Benefit Payouts for
Retirees

Present Value of
Future Benefits

Calculated

Employers' average annual cost to provide health benefits for a retiree
65 or older (including the cost for any dependents) was $777 in 1988, we
estimated. We projected this average cost into the future using assumed
future medical inflation rates. (Our cost estimates and inflation assump-
tion are discussed in appendix IV.) Then, by multiplying the number of
expected retirees by the projected average annual health cost per
retiree, we estimated retiree health care costs in future years. For exam-
ple, table II.2 shows every fifth year of the projected payout for the
cohort of retirees ages 65-69 in 1988.

Employers' total liabilities for retiree health benefits are presented in
terms of present values of future benefits (PVFB). Present values are
sums of money that, if invested now at a given rate of compound inter-
est, will accumulate exactly to specified amounts at specified future
dates. To convert future benefit payments to PVFBS we used discount
"factors"-amounts that grow at the assumed interest rate to $1 in
specified numbers of years. We chose a 7-percent annual interest rate to
arrive at PVFBS for our cohorts.

For example, table V.3 shows the results of this conversion for every fifth year of the 65-to-69 cohort projection. We totaled the payments for each year (the last column of the table) and all intermediate years to arrive at the present value in 1988 of $28 billion for the health benefits expected to be paid to this cohort.

Table V.3: 1988 Present Value of Future Benefit Payments for Retirees Ages 6569 in 1988 (1988-2023)

GAO's Method for Estimating 1988 Retiree
Health Liabilities and Annual Contributions
to Begin Advance Funding

The average employer annual health cost for cohorts of retirees younger
than 65 is higher until they reach age 65 than for other retirees, as the
younger retirees are not yet eligible for Medicare. Thus, we estimated,
the average employer health cost per pre-65 retiree in 1988 was $2,602
(see app. IV). Using our medical inflation rate assumptions, we projected
this cost into the future.

To reach the present value of $99.5 billion for future health benefits for the 6.6 million persons already retired in 1988, we estimated the initial per capita early and normal retiree health costs, and the initial numbers of retirees. Also, we used certain mortality, medical inflation, and interest rate assumptions. Were alternate values of health costs, numbers of retirees, or assumptions used, a different present value would result.

Age of Retirement
Calculated for Active
Workers

All of the $99.5 billion would be accrued as of 1988, under the projected unit credit funding method that we used. Accrued liabilities represent amounts attributed by this method to the past service of workers. Because retirees' service is all in the past, the present value of their future health benefits is 100-percent accrued, by definition.

Calculating employers' liabilities for future retiree health benefits of active workers required us to make assumptions about the ages at which workers would retire. In pension plans, actuaries often assume one or two ages of retirement, even though they know that workers retire at several ages. These ages—often the plan's early and normal retirement ages-produce present values reasonably close to those that would result from several retirement ages.

GAO's Method for Estimating 1988 Retiree
Health Liabilities and Annual Contributions
to Begin Advance Funding

Benefits Projected for
Each 5-Year Cohort

Table V.4: Projected Benefits of the
Cohort Ages 45-49 in 1988 (1988-2043)

Because retiree health costs differ before and after age 65, we selected two retirement ages for use in our model: 60 and 65. Using CPS data on the age at retirement of private pensioners, we assumed for our baseline estimates that 60 percent of workers would retire early at age 60 and 40 percent at the normal age of 65.

For each 5-year cohort of active workers in the U.S. in 1988, we estimated that 60.5 percent of those retiring at age 60 and 58.7 percent of those retiring at age 65 would be covered. According to our estimates, the cohort ages 45-49 of 3.3 million workers was divided into 1.3 million workers expected to retire at age 65 and 2.0 million expected to retire early. As with the retiree cohorts, we applied mortality rates to estimate the future survivors from these subgroups. We then multiplied the number of future retirees by our projected average health costs to determine the benefit payouts for each of these groups. Finally, we calculated the present value of the projected benefit payouts. As an example, table V.4 shows every fifth year of this projection for the 45-49 age cohort.

Accrued Liabilities
Calculated for Workers
Over 40 and Retirees

To determine what portion of the total 1988 liabilities for active workers age 40 and over was accrued, we prorated the liabilities for each cohort by the ratio of average service since age 40 to expected service at retirement. (This proration is commonly employed in the actuarial funding method we used, the projected unit credit method.)