OPEB Funding Policy Opportunities

New Governmental Accounting Standards Board (GASB) statements 74 and 75 are intended to make accounting for OPEB (Other Postemployment Benefits, usually retiree medical) more transparent by moving the entire unfunded liability to the face of the financial statements. This post discusses some of the OPEB funding policy opportunities that employers should consider as they prepare to implement GASB 74/75 over the next two years.

Opportunity #1: The potential for funded status improvement. Unlike pension plans which are generally pre-funded, most public sector OPEB liabilities are unfunded and benefits are pay-as-you-go. But employers should consider that ANY funding policy is better than nothing – and even a modest level of pre-funding will improve the plan’s funded status and balance sheet impact.

Opportunity #2: A funding policy can help lower the calculated liability. The ultimate cost of retiree medical benefits can never be known exactly until benefits are actually paid in the future. However, the best estimate of those costs in today’s dollars is impacted by how (and if) funds are invested. To the extent that investment returns can help fund future benefit costs, an OPEB trust with higher expected returns can help reduce your calculated OPEB liability.

Opportunity #3: Attention can drive action. OPEB liabilities are becoming front-page headlines – particularly because of their unfunded nature. Employers should harness this increased scrutiny to compel stakeholders (e.g., employers, employees, and taxpayers) to collaboratively review OPEB terms and create a strategy to prudently prefund these promises.

There will be pitfalls along the way. It may be difficult to secure additional funding sources when employers and employees are already trying to eliminate existing pension debt. Plus, OPEB costs are usually more volatile than pensions, so an OPEB funding policy will need to consider strategies to deal with this “moving target”.

There may also be situations where an employer does not want to prefund OPEB. Perhaps they fear that “committing” money towards OPEB will reduce their ability to reduce benefit levels in the future. However, this rationale just skirts the larger issue of knowingly promising benefit levels which are unaffordable.

GASB 74/75 is a catalyst for public employers to revisit their OPEB funding policies. There is a limited timeframe for stakeholders to develop a meaningful funding strategy before the entire unfunded liability goes “on the books”.

First pensions, now OPEB – New GASB 74 & 75 will transform OPEB reporting

Public sector employers, get ready! The Governmental Accounting Standards Board (GASB) has officially approved new accounting statements for Other Post-Employment Benefit plans (OPEB; retiree medical). Here’s what the recent GASB announcement confirms:

  • Final provisions will closely mirror GASB 67/68 pension accounting. The official statements won’t be released until late June, but last summer’s OPEB exposure draft included similar provisions such as:
    • The unfunded liability will now go on the balance sheet.
    • The liability discount rate will be based on a projection of how long dedicated assets (plus future contributions) will cover current plan members’ future benefit payments.
    • OPEB expense will recognize asset and liability changes over a shorter time period.
    • Goodbye ARC! Funding and accounting are officially separated, so plans and employers should consider developing a new OPEB funding policy.
  • Expanded note disclosures and RSI are required, including sensitivity of results to a +/-1% change in the discount rate and medical trend assumptions.
  • Effective dates:
    • GASB 74 Plan accounting is first effective for reporting periods beginning after June 15, 2016 (e.g., fiscal years beginning July 1, 2016 or January 1, 2017).
    • GASB 75 Employer accounting is first effective for reporting periods beginning after June 15, 2017 (e.g., fiscal years beginning July 1, 2017 or January 1, 2018).

Although the implementation dates are almost 3 years away, employers should take action now to prepare. Some questions to ask include:

  1. How can I develop and implement an OPEB funding policy over the next few years? Prefunding OPEB can help reduce the unfunded balance sheet liability.
  2. What plan benefit adjustments and investment policy changes are available to lower my long-term OPEB liability? Now is the time to review your OPEB management strategies.
  3. What is my strategy to educate stakeholders about OPEB promises and their potential financial impact under the new GASB 74/75 requirements? OPEB is a complex topic that may be unfamiliar to plan members, government decision-makers, and taxpayers.

The new GASB 74/75 statements should help make OPEB promises more understandable and transparent. While there’s still sufficient lead-up time, employers should view this as an opportunity to proactively address an employee benefit which is often unfunded but must be managed prudently.

Top 5 Take-Aways from the GASB OPEB Accounting Exposure Draft

Last week the Governmental Accounting Standards Board (GASB) released its long-awaited exposure draft of proposed Other Post-Employment Benefits (OPEB) accounting changes. Although there may be modifications before the rules are finalized, public employers should be aware of the potential consequences. Here’s our list of the top 5 items from the exposure draft:

1. Most of the proposed GASB 67/68 pension changes are carrying over to OPEB – which is not surprising. These include:

– The Net OPEB Liability (NOL; essentially the entire unfunded liability) goes on the face of the financial statements. This will be a major change from the incremental Net OPEB Obligation currently used as the balance sheet liability.

– The discount rate will be based on a projection of whether the employer’s current assets plus projected contributions are expected to cover current plan members’ future benefit payments.

– Enhanced disclosures of historical contributions, funded status, and the basis for selecting actuarial assumptions.

– Accelerated recognition of liability changes in OPEB expense; no more 30 year open amortizations.

– Funding and accounting are officially separated; this means no more ARC.

2. Goodbye community-rating exception to the implicit subsidy liability. Now everyone with blended premiums must calculate an implicit subsidy liability.

3. All plans will now use the Entry Age Normal (level percent of pay) actuarial method to allocate liabilities between past and future service periods. Although OPEB benefits are not usually pay-related, this new requirement is intended to make liabilities more comparable than the 6 different methods currently allowed under GASB 45.

4. Disclosure of the Net OPEB Liability’s sensitivity to changes in medical trend (+/- 1%), discount rate (+/- 1%), and combinations thereof. This means a total of 9 different NOL measurements.

5. Calculation of an Actuarially Determined Contribution (ADC) and development of a funding policy. Although not technically required, employers will need these two important items if they are prefunding their OPEB and not simply using pay-as-you-go funding.

And, as an added bonus, the exposure draft requires actuarial valuations at least biennially and has eliminated the triennial option for employers with fewer than 200 members. Given the volatility of OPEB liabilities, this is probably a better policy.

What do all of these changes mean for public employers? We’re still sorting through all of the details, but the primary outcome is that more effort will be required to prepare OPEB actuarial valuations and the results will have a greater impact on employers’ financial statements.

Although these changes aren’t scheduled to be effective until the fiscal year beginning after December 15, 2016, public employers will want to start thinking about the potential financial impact and whether they will prompt updated OPEB funding and investment policies. Comments regarding the exposure draft are due no later than August 29, 2014.

Pension Discount Rates – September 2013 Preview

After several years of painfully-low pension discount rates, we’ve seen a modest rebound in 2013. Using the Citigroup Pension Liability Index (CPLI) and Citigroup Pension Discount Curve (CPDC) as proxies, pension accounting discount rates are up by about 80 basis points so far this year.

This is great news for pension plan sponsors, especially if rates continue their upward trend. Add in strong year-to-date equity returns, and we may finally see a reduction in unfunded pension balance sheet liability for fiscal year-end 2013.

Analysis
In the chart below we compare the CPDC at four different measurement dates (12/31 2010 to 2012, and 8/31/2013). We also highlight the CPLI at each measurement date. The CPLI can be thought of as the average discount rate produced by the curve for an average pension plan.

Citigroup comparison 08312013

Rates have increased at all points along the spectrum since 12/31/2012. The orange arrows highlight the trend in yield curve movement. The increase in rates all along the yield curve means that all types of plans (e.g., frozen and open) should benefit if interest rates continue to increase through year-end.

Net Effect on Balance Sheet Liability
Many plans had strong investment returns during the first half of the year, with some fluctuations over the past couple of months. If those early investment gains can be preserved (or increased) until year-end, then this will further improve the pension funded status (assets minus liabilities). Depending on the starting funded status, the change in pension liabilities and assets can have a leveraging effect on the reported balance sheet liability.

Conclusions
So, what should plan sponsors be considering over the next few months as we approach year-end? Here are a few ideas.

  • Don’t count your chickens before they hatch. We’re still several months away from year-end for most plans and a lot can change between now and then. However, there’s reason to be cautiously optimistic.
  • Now maybe a good time to consider strategies that lock-in some of this year’s investment gains. These could include exploring an LDI strategy to more closely align plan assets and liabilities. Or, offering a lump sum payout window for terminated vested participants early in 2014.
  • Even though increased discount rates tend to lower the present value of pension liabilities, your plan may still have an overall liability increase. This could result from active participants continuing to accrue new benefits in the plan, or from the fact that benefits will have one fewer year of interest discount at 12/31/2013 compared to 12/31/2012.

Your plan’s specific cash flows could have an enormous impact on how much the drop in discount rates affects your pension liability. If you’ve just used the CPLI in the past, it’s worth looking at modeling your own projected cash flows with the CPDC or an alternative index or yield curve to see how it stacks up.

OPEB Investments – The Danger of Playing It Safe

CautionUnder GASB 43 and 45, public sector employers are required to account for retiree medical benefits under special rules for Other Post-Employment Benefits (OPEB).  Many have chosen to pre-fund these liabilities in a trust similar to a retirement plan trust.  At the recent Minnesota School Board Association convention, Van Iwaarden Associates teamed up with an investment advisor to emphasize how actuaries and investment advisors should work together to develop a prudent investment policy based on projected benefit payments.

Most policy makers at public sector employers are not investment experts nor are they experienced with pre-funding long term liabilities.  Too often, the decision is made to invest trust assets in “safe” investments just as they do with operating funds.  This is potentially a major mistake, especially now with short term interest rates near zero!

The best practice is to pre-fund retiree medical liabilities and to invest the trust assets in a way that is consistent with the projected cash flow.  Certainly, a substantial portion of the assets should be invested for the short term to meet short term cash flow.  However, the balance of the assets should be invested for the long term to meet projected cash flows twenty to thirty years away.

The recommended action plan for decision makers includes:

1.    Estimate the projected life of the OPEB Trust
2.    Review investment policy and its handling of OPEB
3.    Amend policy and investment strategy appropriately

A detailed actuarial report is the start of the process to manage OPEB liabilities and assets.  The actuarial report can and should be much more than just a perfunctory exercise to meet GASB accounting requirements.
The full presentation can be found through this link.

“Measure It Before You Promise It” for GASB 45 OPEB

Over the past several years, GASB 45 has required public employers to recognize the cost of Other Postemployment Benefits (OPEB: e.g., retiree health insurance, life insurance) while employees are accruing the benefits, not after they retire. For many public entities, the true cost of their healthcare promises has been an eye opener.

However, public employers (especially local entities) should remember that GASB-type calculations are valuable in the “off-season” too. This post discusses one of the biggest missed opportunities for cost-saving: Measuring the cost impact of changes to retiree OPEB before contracts are signed.

In the corporate world, it is almost unheard of for employers to adjust their retiree benefit promises without first measuring the cost impact. This is especially true of collectively-bargained pension and retiree health plans. Both sides hire an actuary to estimate the cost of these benefits and bring their numbers to the table.

However, many local public entities may not be used to this process yet. During the biennial GASB 45 valuation process, we still encounter contractual changes to retiree benefits that occurred after the prior actuarial study but were not reported to us in the interim. There are two main problems with this approach:

  1. It’s not prudent to make or change benefit promises without estimating the cost impact. Suppose an employer is renegotiating a contract and there is a proposal to change the retiree health benefit from “fully-paid single premiums until age 65” to “fully-paid family premiums for up to 5 years”. Is this a cost increase or decrease? There’s no way to know unless you measure the cost beforehand.
  1. GASB 45 requires a full actuarial valuation if there is a significant change in benefit promises.  As we discussed in a previous post, public employers shouldn’t wait until the next scheduled actuarial study (2 or 3 years, depending on plan size) to reflect significant plan changes in their financial statements.

As public employers get acquainted with valuing the actuarial cost of their OPEB benefits for GASB 45 financials, they should embrace the philosophy of “measure it before you promise it” for any changes to these benefits. Public sector OPEB are becoming front page news and administrators must proceed cautiously when adjusting benefits or making new promises.

Top Reasons to Change Your GASB 45 Valuation Schedule

GASB 45 requires a complete actuarial valuation of public retiree health plans to be completed every 2 to 3 years (depending on number of plan members), and sponsors usually don’t look forward to the administrative hassles of their next study. However, there are several situations where a new valuation could be advantageous and, likely, mandatory.

In addition to the standard 2 or 3-year cycle, GASB 45 rules also state that:

“A new valuation should be performed if, since the previous valuation, significant changes have occurred that affect the results of the valuation, including significant changes in benefit provisions, the size or composition of the population, … or other factors that impact long-term assumptions.”

Below are some factors which can compel a new valuation sooner than the standard 2 or 3- year cycle:

  • Establishing an OPEB trust.
    • If a revocable trust is established, then this won’t change the unfunded liability for accounting purposes, but it can affect the liability discount rate. See our previous post on the effect of OPEB trusts on GASB 45 discount rates.
    • If an irrevocable trust is established, the discount rate may be impacted and the assets will decrease the plan’s unfunded liability. This will likely reduce the GASB 45 annual accounting expense (Annual OPEB Cost).
  • Large change in retiree health benefits. This includes changes to plan coverage levels (e.g., deductibles and co-pays), premiums, or eligibility for benefits.

If employment contracts are amended to scale back (or increase) the amount of retiree health benefits paid by the employer, then this can have a big impact on plan liabilities as costs are shifted to retirees. See our previous post on the leveraging effect of OPEB liabilities.

Plan changes will affect the per-member costs and will likely affect future assumptions about retiree participation in the plan. A new valuation should be performed to capture this liability increase (or decrease) as soon as possible for the year of change.

  • Large change in number of employees or retirees. If there are significant employee layoffs/retirements or if many retirees drop coverage due to increasing costs, then a new valuation may be needed to accurately capture the effect on the plan’s GASB 45 liabilities.

There are likely many other scenarios which would require a new GASB 45 study. This is especially true in the case of a plan on the 3-year cycle where there is an increased likelihood of a significant change in the “off-cycle” periods.

Public Safety Benefits Can Significantly Affect OPEB Liabilities

Federal, state and local regulations often include mandated health benefits for officers disabled in the line of duty. These benefits are a way to reward officers for protecting and serving the public at great risk of bodily harm. The value of these benefits must be accounted for under GASB accounting rules, and there are a few important considerations when doing so.

Important considerations for OPEB plans:

– Determining the implicit rate subsidy (health cost in excess of the average premium). This may include expected health care costs for disabled officers that are significantly higher than for non-disabled individuals.  Another factor to consider is whether or not disabled officers are Medicare-eligible. If so, how does that reduce the expected health care costs?

– Determining the direct subsidy (portion of the premium paid by the employer).  This is the premium cost not only for disabled officers, but also for dependents.

– Length of benefit coverage. Unlike regular retiree health care which can begin around age 50 to 55 for officers, disability health care begins much earlier.  Often officers disabled in the line of duty are in their 30’s and 40’s.

The earlier start creates significant additional costs.  For example, the direct subsidy for a disabled officer age 40 could exceed $150,000 ($6,000 in premium per year for 25 years) – and this does not include any costs for dependent coverage or the implicit subsidy. Read more…

OPEB Participation Rates – “Kind of a Grey Area” Under Healthcare Reform

One of the highest impact assumptions in OPEB actuarial valuations is the participation rate.  This rate represents the percent of future retirees assumed to participate in the employer’s health plan during retirement.

The participation assumption has a direct and leveraged effect on OPEB liabilities.  For example, if the assumption is that 60% of employees are assumed to elect coverage at retirement, but the actual “crystal ball” rate is 40%, then the plan’s liability is 1½ times what it should be.  As a result of healthcare reform, similar examples may become a reality that employers and actuaries should address proactively. 

How will healthcare reform affect participation rates?  That’s kind of a grey area.  How grey?  “Charcoal” as Fletch would say.

Participation rates will be different in the future due to anticipated cost-saving changes to retiree plans by employers.  Recently, 61% of the companies included in an Aon Hewitt survey were either already evaluating or expected to evaluate their long-term retiree medical strategy by the end of 2011.

Read more…

How will the “Cadillac Tax” impact your OPEB plan?

 Although the effect of healthcare reform on retiree health plans is difficult to gauge at this point, there are several provisions that could impact the long-term costs   and strategies for employer plans. Let’s start with the so-called “Cadillac Tax” on high-cost insurance plans effective in 2018.

 What it is:

 A non-deductible 40% excise tax paid by the coverage provider (employer and/or insurer) on the value of health plan cost in excess of certain thresholds. Currently, most plans are well below the thresholds, but are likely to exceed them in the next decade. This is because the thresholds will be indexed at CPI-U which is significantly lower than medical inflation rates affecting plans.

Purpose of the provision:

One of the goals of the Patient Protection Affordable Care Act (PPACA) was to lower long-term healthcare costs. By their nature, plans with generous benefits implicitly encourage participants to maximize their usage and thus cause higher medical costs. This provision seeks to discourage high-cost plans by leveling a tax on “excessive” benefits and possibly help fund healthcare reform.

Important considerations for retiree health plans:

Health plan costs for early retirees, which are often significantly higher than employee costs, may exceed their thresholds sooner, even though thresholds for early retirees are slightly higher than thresholds for employees. Read more…