Through the normal operation of a plan, some beneficiaries may be paid in a lump sum at the conclusion of employment. Technically, that “normal” benefit payment is a settlement. However, in accordance with ASC 715-30-35-82, settlement accounting is not required for individual lump sum payouts if the cost (e.g., the lump sum payment or price of the annuity contract) of all settlements in a year is less than or equal to the sum of the service cost and interest cost components of net periodic pension cost for the plan for the year (see PEB 3.2 for elements of pension cost). Notwithstanding that exception, a reporting entity may adopt a policy of recognizing the gain/loss on all settlements when they occur, or a reporting entity may adopt a policy to recognize the gain/loss on all settlements if the cost of the settlements exceeds some other defined threshold less than the sum of service and interest cost. Whichever policy is adopted should be applied consistently from year to year.

If an employer determines that it is probable that during the fiscal year the criteria for settlement accounting will be met, the employer should recognize settlements immediately when they occur, rather than wait for the threshold to be met. In practice, it may be acceptable to perform the settlement calculations as of the end of each quarter in situations when lump sums are paid throughout the year as a “normal” form of benefit payment.

If, at the beginning of the year, an employer determines that it is not probable that the criteria for recognition of settlement accounting will be met during the fiscal year, but then later in the year the cost of settlements exceed the threshold for settlement accounting, then the employer should recognize the gain or loss for all settlements that have occurred (not just those that exceed the threshold) in the period when it becomes probable that the threshold will be met, consistent with the guidance in ASC 715-30-55-168 and the guidance in ASC 250 for a change in an accounting estimate.

For purposes of applying the thresholds described in PEB 4.3.3, the “cost” of settlements is determined in accordance with the guidance in ASC 715-30-35-83.

Because of the nature of OPEB obligations, settlements are unusual in OPEB plans. Typically, settlements of OPEB obligations arise only from the sale of a business when the buyer assumes the OPEB obligation for the employees of the sold component (see Example 3 in ASC 715-60-55-130 through ASC 715-60-55-134). A key characteristic of a settlement is the transfer of cash or plan assets to a third party (e.g., employer pays lump sums to participants in exchange for the participant's right to receive retiree medical benefits). Accordingly, a plan amendment that merely eliminates OPEB benefits for a subset of the plan's population is not a settlement; it would be a negative plan amendment (see PEB 4.6.1).

A full settlement of the entire plan can occur only when the accumulated and projected benefit obligations (PBO) are equal (i.e., a flat-benefit or frozen plan). It is unlikely that an annuity contract could be purchased to settle the entire projected benefit obligation for a pay-related plan when there are still active employees because the insurer would be assuming a liability for benefits based on unknown salary progression. However, the plan may first be frozen, eliminating the salary progression component of the PBO, which generally would result in a curtailment when the freeze is adopted. See PEB 4.4.3.1 for information on hard freezes. Once the salary progression component of the PBO is eliminated, annuity contracts could be purchased to fully settle the PBO.

In a full settlement, the employer recognizes the balance of any unamortized net gain or loss and any unamortized transition asset arising from adoption of ASC 715.

When only a portion of the benefit obligation is settled, the employer should recognize in income a pro rata portion of the aggregate unamortized net gain or loss and a pro rata portion of the unamortized transition asset determined upon adoption of ASC 715. The pro rata factor is based on the percentage reduction in the projected benefit obligation from the settlement. The unamortized gain or loss subject to recognition is for the entire plan (not just the portion being settled) and includes the effect of the remeasurement of the entire plan assets and pension obligation immediately prior to settlement. Note that prior service cost (including any transition obligation) does not enter into the calculated gain or loss on settlement; it continues to be amortized over the estimated future service period of the employees, assuming those employees are expected to provide future service to the employer pursuant to the continuing pension plan.

As described in PEB 4.3.3, the gain or loss on a partial settlement of the projected benefit obligation need not be recognized when the cost of all settlements in the year equals or is less than the sum of the current year’s service and interest cost for that particular plan. Accordingly, the employer may view the action (e.g., the payment of lump-sum benefits) as a normal part of operating the plan, and may elect not to recognize a portion of the gains and losses in connection with each lump-sum payment. Other employers who purchase annuity contracts for employees upon retirement may view the action as a settlement and elect to recognize a portion of the gains and losses in connection with each transaction. The approach taken by the employer is an accounting policy election and should be consistently followed.

In general, a partial settlement refers to a transaction where the employer settles the full amount of its obligation for vested benefits with respect to a portion of the plan's participants so that significant risks related to the obligation for those participants is eliminated. On the other hand, a settlement of only a portion of the obligation for a given participant or group of participants' vested benefits where the employer remains liable for the balance of the benefit obligation for those same participants' vested benefits may not constitute a settlement because it does not eliminate significant risks related to the pension benefit obligation for the participants as described in ASC 715-30-55-149.

The critical factor in determining whether settlement has occurred is the transfer of risk. Transfer of risk within a controlled group does not constitute settlement; risk transferred outside the group does. Risk has also not been transferred if there is reasonable doubt that the insurer will meet its obligations under an annuity contract. Therefore, the purchase of the contract from such an insurer does not constitute settlement (see PEB 2.6.4.4).

Annuities purchased from an insurance company controlled by the employer do not constitute a settlement since the risk has not been eliminated, but merely transferred within the group. When annuities are purchased from an affiliated insurance company not controlled by the employer (e.g., subsidiary A purchases an annuity from subsidiary B), settlement accounting should be reflected in the separate reporting entity financial statements of the employer; however, for consolidated financial statement purposes, no settlement is deemed to have occurred.

If a nonparticipating annuity contract is purchased from an insurance company that is an investee not controlled by the employer, the entire settlement gain or loss should be recognized by the employer if all settlement criteria are met.

ASC 715-30-35-89 through ASC 715-30-35-91 address the accounting for pension benefits paid by an employer after an insurance company fails to meet its obligation to pay annuity benefits. The employer should recognize a loss at the time the deficiency was assumed if any gain was recognized on the original settlement. The loss recognized would be the lesser of (a) any gain recognized on the original settlement and (b) the amount of the benefit obligation assumed by the employer. Any excess of the obligation assumed by the employer over the loss recognized should be accounted for as a plan amendment or plan initiation (i.e., prior service cost).

A pension buy-in arrangement is similar to a traditional nonparticipating annuity (also known as a buy-out, see PEB 4.3.2), when a plan transfers future responsibility for some portion of promised employee retirement benefits to an insurance company. Under the buy-in arrangement, however, the benefit obligation is not transferred to the insurer. Instead, the plan remains responsible for paying the benefits, but purchases a contract from the insurer that generates returns designed to equal all future designated contractual benefits payments to covered participants.

While the purchase of a traditional buy-out annuity contract generally triggers settlement accounting, the purchase of a buy-in contract typically results in no settlement accounting because the employer has not been relieved of primary responsibility for the benefit obligation. The buy-in contract is effectively an investment by which the plan can receive payments from the insurer corresponding to the benefits due to the covered participants, but ultimately the primary obligation to pay benefits has not been transferred. In the event the insurer is unable to make payment under the buy-in (for example, due to bankruptcy), the employer would still be obligated to provide the promised retirement benefits.

ERISA generally precludes an employer from withdrawing excess plan assets from a pension plan without first settling the obligation. Limited exceptions exist for the transfer of excess plan assets to an ESOP or a postretirement medical benefit plan. However, in some jurisdictions (e.g., Canada and the United Kingdom), employers may withdraw excess funds from a defined benefit pension trust when certain conditions are met. As noted in ASC 715-30-55-6, if an employer merely withdraws excess plan assets (cash) from a pension plan but is not required to settle the pension obligation as part of the asset reversion, no gain or loss should be recognized. The withdrawal would be recorded as a negative contribution.