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The Monthly Blend
March 2006
Accounting for Death Benefits in Deferred Compensation Agreements 
Submitted by: Jodie Perez, CPA
Companies have set up many different types of deferred compensation arrangements for their key executives and other employees. These deferred compensation arrangements may also include some type of death benefit. Therefore, companies will often purchase life insurance in order to provide this benefit. As each deferred compensation agreement and related death benefit is unique to that agreement, it is important to obtain, read and understand every part of the arrangement. Differences between agreements can greatly impact the accounting. This article will specifically cover the accounting for the existence of a death benefit in deferred compensation agreements, including when the death benefit is the only deferred compensation.
The general principle is that the promise to the employee is accounted for as a liability and any asset represented by the life insurance contract is accounted for as an asset. Accounting Principles Board Opinion No. 12, Omnibus Opinion 1967 (ABS 12), provides guidance on the accounting for deferred compensation contracts with individual employees of those contracts, taken together, do not constitute a plan. FASB Statement No. 106, Employers ' Accounting for Postretirement Benefits Other Than Pensions (FAS 106), provides guidance on the accounting for postretirement benefits that are part of a plan for retirees, but are not part of a pension plan. In addition, FASB Technical Bulletin 85-4, Accounting for Purchases of Life Insurance , as the name suggests provides guidance on how to account for life insurance policies.
In understanding the agreements, there are certain key features you should be aware of that the following questions illustrate:
- Who owns and controls the life insurance policy - the company or the executive?
- What party does the life insurance company pay the death benefits directly - the company or the executive's beneficiary?
- Who is responsible for paying the premiums - the company or the executive?
- Does the death benefit expire at any time? A common expiration term is that the death benefit expires once the executive has been paid in full for any other deferred compensation.
- Is the death benefit a pre-retirement, post-retirement or both type of benefit?
- Is there a split dollar arrangement?
The answers to these questions dictate the accounting for the death benefits components of life insurance arrangements. Many common agreements have a split dollar arrangement. A split dollar life insurance policy is an arrangement in which the employer and employee share the cash surrender value and/or death benefits of the insurance policy and sometimes split the premiums. There are two common types of split dollar life insurance arrangements:
- Endorsement Split Dollar Policies. In endorsement policies, the employer purchases a life insurance policy to insure the life of an employee. The employer enters into a separate agreement with the employee that splits the policy's premium and/or policy benefits between the employer and the employee. The employer owns the policy, controls all rights of ownership, and may terminate the benefits promised to the employee if the employee departs the company prior to retirement. The employer may endorse a portion of the death benefit to the employee whereby the employee designates a beneficiary for this portion of the death benefit by executing an agreement that is binding on the life insurance company to pay the death benefit directly to the designated beneficiary. Upon the death of the employee, the employee's beneficiary receives the designated portion of the death benefits directly from the insurance company and the employer receives the remainder of the death benefits.
- Collateral Assignment Split Dollar Policies. In collateral assignment polices, the employer purchases a life insurance policy to insure the life of an employee and transfers ownership of the policy to the employee or a trust they establish. The employee or trust owns the insurance policy and controls all of the rights of ownership. The employer usually pays all of a substantial part of the premium. The employee irrevocably assigns a portion of the death benefits to the employer as collateral for the employer's interest in the policy. This is done so the employer receives back all or most of the amounts they pay to maintain the policy. Amounts due to the employer vary, but, typically, the employer is entitled to receive a portion of the death benefit equal to the premiums paid by the employer, premiums paid plus an additional fixed or variable return on those premiums, the cash value of the policy, or some combination of the higher of these amounts. Upon retirement, the employee may have an option to buy the employer's interest in the insurance policy.
Although split dollar arrangements are the most common, if the death benefit agreement is not covered by a split dollar arrangement, the guidance for the accounting is the same. The accounting for post-retirement death benefits, whether covered by a life insurance arrangement or not, is governed by APB 12, as amended by FAS 106. Deferred compensation arrangements are usually accounted for as an individual contract. In limited circumstances a group of individual contracts may be the equivalent of a plan. Paragraph 13 of FAS 106 states that any post-retirement benefit payable to an employee should be accrued over the service period to the date of full eligibility (normally retirement date). An exception to this is when an insurance company unconditionally undertakes a legal obligation to provide specified benefits to specific individuals and the company and, therefore, the company has transferred its significant risk of this benefit to the insurance company. Therefore, the existence of a split dollar arrangement can change the "normal" accounting for a post-retirement benefit. However, since no split dollar arrangements are the same even between the two types described above it is again reiterated that one must understand all of the terms of the agreements in order to determine if the risk has truly been transferred to the insurance company. Assuming the risk has been transferred, instead of accruing the post-retirement death benefit over the service period, there would be no liability recorded on the company's financial statements. See the examples following for some specific situations encountered in our client base.
Pre-retirement death benefits are not covered by FAS 106, but are covered by FASB Statement No. 112 Employers' Accounting for Postemployment Benefits (FAS 112) as FAS 112 covers any benefits to former or inactive employees after employment but before retirement. FAS 112 states that obligations for such benefits should be accrued if the benefit is attributable to employees' services already rendered, employees' rights to those benefits accumulate or vest, payment is probable and the amount can be reasonably estimated. The amount of the death benefit is only accrued once the "triggering event" is probable (i.e. it is probable the executive will die before retirement).
The following examples should be helpful in applying the guidance in FAS 106 but should not be assumed to have the exact fact pattern found in your situation. One difference in the fact pattern could affect the outcome of the guidance provided.
Example 1 Company Owned Policy with No Transfer of Risk to Insurance Company
ABC Company has a company owned life insurance policy on an executive officer. ABC Company is the beneficiary of the life insurance policy and pays all premiums. ABC Company has a deferred compensation agreement and a death benefit agreement with the executive officer. The death benefit agreement provides that the Company will pay one of the following benefits:
- Pre-retirement Death Benefit of $150,000 (it is not probable the executive will die before retirement)
- Post-retirement Death Benefit of $150,000
The agreement also states that the Company will pay the benefits from its general assets, but only so long as one of the Company's general assets is a life insurance policy on the executive's life.
The post-retirement death benefit should be accrued in accordance with FAS 106 in this example. However, the pre-retirement death benefit is not accrued until it is probable the death of the executive will occur prior to retirement.
The post-retirement death benefit needs to be accrued over the service period as the Company has not transferred its risk to the Insurance Company. The evidence is that 1) the Company owns the policy, 2) when the death occurs, the proceeds from the policy are paid to the Company who then must pay the executive's beneficiaries and 3) in order to keep the policy in place, the Company must continue to make premium payments as specified in the policy. The Insurance Company has no legal liability to the executive's beneficiaries. The fact that the Company could choose to cancel this policy and no longer provide the benefit to the executive does not change the fact that the risk has not been transferred to the Insurance Company. The decision to terminate the policy and therefore also the death benefit would be accounted for at the time that decision is made.
The policy is accounted for as directed under FASB Technical Bulletin 85-4, Accounting for Purchase of Life Insurance and is just the way ABC Company has chosen to fund this benefit. Instead of a policy, the Company could have either set aside the money in an account or chosen to just use cash available at time of death to pay the benefit.
Example 2 Company Owned Policy with Transfer of Risk to Insurance Company
XYZ Company has company owned life insurance policy on an executive officer. XYZ Company paid an upfront single premium on the life insurance policy. In addition, XYZ Company has a salary continuation agreement which includes a post-retirement death benefit and an endorsement split dollar agreement with the executive officer.
The Company has ownership of the life insurance policy and provides right of refusal to the executive to purchase the policy in the event the Company decides to terminate the policy. Upon the death of the executive, the Insurance Company is contractually required to pay the designated proceeds directly to the executive's beneficiary with any remainder to be paid to the Company. The Insurance Company relies upon a statement from the Company as to the amount of proceeds it is entitled to receive under the agreement. The amount is governed by the terms of the salary continuation agreement.
In this situation, the Company would not accrue for the post-retirement death benefits contained in the salary continuation agreement (although this is not true for any other post-retirement benefits in the agreement). This company owned life insurance policy would be accounted for as directed under FASB Technical Bulletin 85-4, Accounting for Purchase of Life Insurance.
For more information on the above topic, please contact Jodie Perez at Beason & Nalley, Inc. at 256-533-1720 or email at jperez@beasonnalley.com. Reducing the Burden for Employers
Written by: Wendy Bustios
On January 3, 2006, the Internal Revenue Service proposed regulations concerning Form 941. Employers, who have an annual federal tax liability of $1,000 or less, would be eligible to file a new form. Form 944 would be filed annually and payment would be made at the same time. This would reduce the burden of employers filing Form 941 quarterly.
Employers should receive notification, as to eligibility, February 1 thru February 15, 2006. Those who have not received a letter and feel they are eligible should contact the Internal Revenue Service (1-800-829-0115). Employers should do this by April 1, 2006.
For more information on the above topic, please contact Wendy Bustios at Beason & Nalley, Inc. at 256-533-1720 or email at wbustios@beasonnalley.com. Coffee Talk
Don Nalley has been asked to serve on the Huntsville Chamber's Budget and Finance Committee.
Darryl Walker presented "Understanding TINA and the Consequences of Defective Pricing" to NCMA members in Fort Walton Beach, Florida.
Beason & Nalley will sponsor lunch for the Huntsville Leadership class in Montgomery, Alabama on March 8th. The Huntsville Leadership Course is sponsored by the Huntsville Chamber of Commerce.
Welcome to Matthew McCauley who has joined our Audit and Assurance group as a Consultant.
Beason & Nalley hosted the Accounting & Audit Seminar on February 21. Dr. Ratcliffe, guest speaker, is Director of Accounting and Auditing at Wilson Price and Director Emeritus of the School of Accountancy at Troy University. Related Information:
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