Post employment benefits: Meaning, Criticisms & Real-World Uses

Post employment benefits are a form of employee benefits provided by an employer to workers after they have concluded their period of employment. These benefits typically include items such as pension plans, post-employment life insurance, and post-employment medical care.¹³ They represent a significant area within Accounting & Corporate Finance because companies must recognize the future financial obligations associated with these promises in their financial statements, even though the actual payments occur later. Post employment benefits differ from short-term benefits, like wages or annual leave, which are usually settled within 12 months of the employee rendering service.¹²

History and Origin

The concept of providing for workers in their old age has roots in various forms, from early mutual aid societies to formalized company benefits. In the United States, formalized pension plans began emerging in the private sector in the late 19th century, with American Express adopting one of the first private plans in 1875.¹¹ However, broad-based provisions for post-employment security gained significant traction with the passage of the Social Security Act in 1935.¹⁰ This landmark legislation created a federally administered system of social insurance aimed at providing retirement benefits, financed through payroll taxes.⁹ While Social Security established a baseline for many, private sector and public sector pension schemes continued to evolve, often complementing these governmental programs.⁸ The development of detailed accounting standards, such as those from the International Accounting Standards Board (IASB) or the Financial Accounting Standards Board (FASB), later formalized how companies must account for these complex future obligations, ensuring greater transparency in financial reporting.⁷

Key Takeaways

Post employment benefits represent future financial obligations owed by employers to former employees.
These benefits commonly include pensions, retiree healthcare, and life insurance.
Companies must recognize these obligations as accrued liabilities on their balance sheet and related expenses on their income statement.
The calculation of these obligations relies heavily on actuarial assumptions about future events like employee turnover, salary increases, and mortality rates.
Accounting standards aim to ensure that the cost of providing these benefits is recognized in the period the employee earns them, rather than when paid.⁶

Formula and Calculation

The calculation of post employment benefits, particularly for defined benefit plan obligations, involves complex actuarial valuations. A core component is the present value of the defined benefit obligation (PVDBO), which estimates the total future benefit payments to employees for service rendered to date, discounted back to the present.

The formula generally involves:

PVDBO = \sum_{t=1}^{N} (E_t \times P_t \times (1+g)^{t-1} \times (1+i)^{-t})

Where:

(PVDBO) = Present Value of Defined Benefit Obligation
(E_t) = Estimated annual benefit payment in year (t)
(P_t) = Probability of employee being alive and eligible in year (t) (based on mortality and turnover assumptions)
(g) = Assumed annual salary increase rate (if benefits are salary-related)
(i) = Discount rate used to bring future payments to their present value
(N) = Expected remaining service period or benefit payment period for all relevant employees

Actuarial models consider factors such as employee demographics, expected salary increases, and expected healthcare costs for retiree medical plans. The net liability or asset recognized by the company is typically the difference between the PVDBO and the fair value of any plan assets held in a dedicated fund.

Interpreting Post Employment Benefits

Interpreting post employment benefits involves understanding their impact on a company's financial health and future obligations. A significant liability for these benefits on a company's balance sheet indicates substantial future cash outflows. This can affect liquidity and solvency, especially if the underlying assumptions, such as the discount rate or expected return on plan assets, prove overly optimistic.

Analysts often scrutinize these liabilities to assess a company's true financial position, as underfunded obligations can pose a considerable risk. Companies with substantial post employment benefit obligations, particularly those with defined benefit plans, face ongoing management of actuarial risks and investment risks associated with their plan assets.⁵ Transparency in reporting these figures, including the assumptions used, allows stakeholders to gauge the potential volatility and future funding requirements.

Hypothetical Example

Consider "Company Alpha," which offers a defined benefit pension plan to its employees. In this defined benefit plan, employees are promised a fixed annual pension amount upon retirement, based on their final salary and years of service.

As of December 31, 2024, Company Alpha's actuaries calculate that the present value of its total future pension obligations to current and former employees is $100 million. This calculation accounts for expected employee retirements, future salary increases, and mortality rates. The company holds $80 million in a dedicated pension fund to meet these future obligations.

On its balance sheet for 2024, Company Alpha would report a net post employment benefit liability of $20 million ($100 million obligation - $80 million in plan assets). This $20 million represents the underfunded portion of its pension plan and is a liability that the company will need to fund in the future. Each year, the company will also recognize an expense on its income statement related to the current service cost (benefits earned by employees in the current year) and interest cost on the obligation, offset by the expected return on plan assets.

Practical Applications

Post employment benefits are central to financial accounting and corporate reporting, notably under accounting standards like IAS 19 (International Accounting Standard 19) or ASC 715 in the United States.⁴ These standards dictate how companies measure, recognize, and disclose the financial impact of employee benefits, ensuring that investors and other stakeholders receive comprehensive information.³

For instance, publicly traded companies must provide detailed disclosures about their post employment benefit plans in their financial statements and accompanying notes, as guided by regulatory bodies. The U.S. Securities and Exchange Commission (SEC) provides specific SEC financial reporting guidance on employee compensation and benefits, emphasizing transparency for investors. This allows for rigorous financial analysis, as the magnitude and funding status of these obligations can significantly influence a company's valuation, risk profile, and long-term financial stability. These benefits are also crucial in compensation planning and negotiation, as they form a substantial part of an employee's total remuneration package and affect workforce retention strategies.

Limitations and Criticisms

One of the primary limitations of accounting for post employment benefits, particularly defined benefit plans, lies in the reliance on actuarial assumptions. These assumptions—such as discount rates, expected rates of return on plan assets, future salary increases, and demographic changes like mortality rates—are inherently estimates and can introduce significant volatility and subjectivity into the reported figures. A slight change in a key assumption can lead to a material change in the reported liability or expense, potentially obscuring the true financial position if assumptions are consistently optimistic or pessimistic.

Critics also point to the potential for underfunding, especially in public sector schemes. Many state and local government pension plans in the U.S. have faced significant funding gaps, raising concerns about their long-term sustainability and the burden on taxpayers. The² Pew Charitable Trusts has extensively documented the challenges associated with state pension plan funding, highlighting the trillions of dollars in shortfalls that can emerge when assets don't keep pace with promised benefits. Thi¹s can constrain future budgets, diverting funds from other public services. The complexity of these calculations and the long-term nature of the obligations make them difficult for external stakeholders to fully grasp and evaluate, sometimes leading to a lack of accountability or a delay in addressing funding deficiencies.

Post Employment Benefits vs. Retirement Plans

The terms "post employment benefits" and "retirement savings" are often used interchangeably, but they represent different financial concepts. Post employment benefits is a broad accounting term that encompasses all benefits provided to employees after they cease active employment, including pensions, post-retirement healthcare, and other similar arrangements. It focuses on the employer's financial obligation and how it's reported.

In contrast, "retirement plans" is a more general term that refers to savings vehicles or programs designed to provide income during retirement. This category includes a wider array of structures, such as employer-sponsored defined contribution plans (e.g., 401(k)s, 403(b)s) where the employee often bears the investment risk, and individual retirement accounts (IRAs). While many post employment benefits are indeed retirement plans (like defined benefit plans), not all retirement plans fall under the strict accounting definition of post employment benefits (e.g., a pure defined contribution plan where the employer's obligation ends once contributions are made).

FAQs

What types of benefits are considered post employment benefits?

Post employment benefits typically include long-term benefits provided to employees after they leave the company, such as pension plans, post-employment medical care (retiree healthcare), and post-employment life insurance. They are distinct from short-term benefits like regular salaries or vacation pay.

How do companies account for post employment benefits?

Companies account for post employment benefits as liabilities on their balance sheet and expenses on their income statement. This involves estimating the future cost of these benefits using actuarial assumptions and recognizing the cost over the employee's service period, rather than waiting until the benefits are actually paid out.

What is the difference between a defined benefit plan and a defined contribution plan in the context of post employment benefits?

In a defined benefit plan, the employer promises a specific benefit amount to the employee upon retirement, and the employer bears the investment and actuarial risk. For example, a pension that pays a set percentage of an employee's final salary. In contrast, a defined contribution plan (like a 401(k)) involves the employer making regular contributions to an employee's individual account, but the ultimate benefit depends on the investment performance of that account, with the employee bearing the investment risk. Once contributions are made, the employer's obligation is typically fulfilled.

Why are post employment benefits important for investors?

For investors, post employment benefits represent significant future obligations that can impact a company's financial health, cash flow, and overall valuation. Underfunded accrued liabilities for these benefits can signal potential financial strain or require substantial future cash injections from the company, affecting profitability and shareholder returns.

What is vesting, and how does it relate to post employment benefits?

Vesting refers to the point at which an employee gains a non-forfeitable right to their employee benefits. For post employment benefits, vesting means that even if an employee leaves the company before retirement, they are entitled to receive a portion or all of the benefits they have earned up to that point. Vesting schedules vary but are critical in determining when an employer's obligation to a departing employee becomes absolute.