Employer Alert: Avoiding Repercussions of FASB 112
Disability Insurance Gaps and Employer Balance Sheet Liability
CFOs and HR Benefit Managers might ask what a disability has to do with accounting and balance sheet liabilities.
Most Employers provide Group Long Term Disability (LTD) insurance as an Employee Benefit. Group LTD plans target 60% income replacement for the disabled employee. These plans most often do not adequately protect highly compensated employees or Executives due to plan design limits, such as benefit maximums, uncovered forms of compensation, and taxation of benefits.
The Employer has several options to help improve the income replacement levels of their highly compensated employees while disabled. The option the Employer chooses may create a significant balance sheet liability due to their legal obligations to the Financial Accounting Standards Board’s statement 112, also known as FASB 112.
FASB 112 requires Employers to hold any post-employment benefits, such as self-funded disability benefit payments or salary continuation, as a liability on the balance sheet. The liability on the balance sheet is not limited to the current benefit paid, but on the total estimated amount to be paid on the liability for the duration of the disability “claim”. Essentially, the Employer’s liability includes the amount of future benefits to be paid (or reserves) for the disability “claim”.
What are the Employer’s options, and when does FASB 112 come into play?
1. Do nothing. This means that the Employer will only provide protection under the Group LTD plan – even if it means their highly valued employee will face significant hardship while disabled. The Employer is not subject to FASB 112. An income replacement “gap analysis” commonly shows Group LTD plans replacing as little as 10 – 25% of a highly compensated employees income. This is a tough message to deliver to your valued employees, Executives, and even Officers. Seeing a colleague face unnecessary financial hardship during a difficult time, isn’t good for employee moral; never mind attracting and retaining top talent.
2. Self-fund income replacement amounts not protected by the Group LTD plan, via a written qualified sick or salary continuation plan. Self-funded amounts are subject to accounting under FASB 112. We’ll look at some examples of FASB 112s impact on the balance sheet further below. A written plan identifies the amount, and the duration for which benefit payments will be guaranteed for. By doing so, the written plan could potentially limit the number of years that payments need to be accounted for under FASB 112. However, if the Employer limits the amount and duration of self-funded benefit payments, the Employer still leaves highly compensated employees financially exposed during a disability.
The Employer’s liability on the balance sheet decreases each year, as the benefits are paid. The liability from the balance sheet is removed the sooner of once the Executive has returned to work full-time, or when the benefits cease.
3. Offer an additional fully insured disability insurance protection, such as a Supplemental Disability Insurance (IDI) or Supplemental LTD plan. The insurance company assumes the liability. Since the Employer is no longer self-funding benefit payments, the Employer avoids the obligations and impact of FASB 112. Highly compensated employees can be fully insured with a supplemental and/or excess risk disability insurance plan, often at a very modest cost. This is the best option for attracting and retaining top talent, while protecting the Employer’s balance sheet.
Assuming the Employer selected Option 2 - Let’s look at some numbers:
An Executive earns $500,000 of base salary annually, or $41,666/month. We will leave bonus compensation out of the conversation for mathematical simplicity. However, keep in mind that 78% of Group LTD plans do not cover bonus compensation – and most Executives earn bonus income!
Let’s imagine this Executive becomes disabled due to sickness and can’t work. Based on the type of sickness, the Executive is expected to miss work for 5 years (60 months).
The Employer’s Group LTD protects up to 60% of base salary, to a monthly benefit maximum of $10,000/month. This Executive is only receiving 24% income replacement of BASE salary ($10,000 /$41,666). Keep in mind that the under-insurance situation is much worse than 24%, since we are ignoring bonus, which isn’t normally covered by LTD). Since 60% of this Executives base salary in $25,000 month ($41,666 x .6), this Executive requires a supplement of $15,000 month to achieve 60% replacement.
Example A: The Employer choses to “self-fund” the additional $15,000 monthly benefit the Executive needs to achieve 60% replacement.
FASB 112 requires the Employer to hold as a liability on the balance sheet, the total estimated amount to be paid on the liability for the duration of the “claim”. To put numbers to this, the Employer would need to hold $15,000/month for 5 years (60 months), or $900,000, as the liability on the balance sheet.
Example B: The Employer choses to protect 100% of base salary ($41,666/month). Since the Group LTD provides $15,000/month, the Employer would self-fund $26,666/month to achieve 100% protection. FASB 112 requires the Employer to hold $1,599,960 (60 months of disability) as a total estimated liability on the balance sheet.
Remember, the Employer’s liability on the balance sheet decreases each year, as the benefits are paid. The liability from the balance sheet is removed the sooner of once the Executive has returned to work full-time, or when the benefits cease.
The Final Word:
The Employer has several options to help improve the income replacement levels of their highly compensated employees while disabled. The option the Employer chooses may create a significant balance sheet liability due to their legal obligations to FASB 112. A Supplemental Disability Insurance (IDI) Plan, also known as Supplemental LTD, can eliminate the Employer’s obligation to FASB 112 and liability to the balance sheet, reduces the Employer’s financial exposure, improves income protection levels, helps attract and retain top talent, and is very affordable.
Navis Benefits Group, LLC is a “specialty benefits” Firm, and works with Employee Benefit Firms and their Employer clients to provide state-of-the-art Supplemental Disability Benefit Plans, Executive Benefit Plans, Long-Term Care Plans, and Voluntary Worksite Benefit Solutions.
