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.

Understanding the Leveraging Effect of GASB 45 OPEB Liabilities

As public plan sponsors complete their second (or third) actuarial valuation of GASB 45 liabilities, they may be surprised at the potential volatility of their Actuarial Accrued Liability (AAL). There are various factors that can cause large AAL changes, including adjustments to the plan provisions or switching health insurers. This post focuses on a less obvious (though sometimes more powerful) source: the leveraged nature of OPEB liabilities.

The retiree healthcare promises measured under GASB 45 generally consist of two pieces: a gross health claims component (i.e., the expected cost of retiree health coverage) and a premium offset component (i.e., the amount that retirees pay for their coverage). The net OPEB liability is just the difference between these two elements. The following example illustrates how a small change in either of the input components can have a much larger effect on the net liability result. We call it the “leveraging” effect.

Read more…

Preparing to Apply for the ERRP Subsidy

We’ve had a couple of initial posts on the new Early Retiree Reinsurance Program (ERRP): the first one gave a quick overview of the amount of funds available, while the second post described options for spending the reimbursement. In this post, I’d like to give a quick overview of some actions plan sponsors can take now in order to speed up their initial application to participate in the ERRP.

The ERRP was designed with $5 billion in funding that will be available from June 21, 2010 until January 1, 2014, unless the money runs out first (very likely). So, it’s essentially first-come, first-served for employers who want to claim their share of the funds. In order to participate, however, a plan sponsor must first submit an application for approval by the Secretary of the Department of Health and Human Services.

As the regulations published on May 5, 2010 note, it is of “paramount importance to applicants that they submit complete applications upon their first submission.” Rejected applications will go to the “end of the line” for resubmission, and the regs hint these applications might not get reviewed again until it is too late (i.e., the ERRP funds are all gone). Fortunately, once a sponsor has the application accepted, they do not have to reapply in future years.

The HHS hasn’t released the actual application forms yet, but there are a few important actions that plan sponsors can take now so that they are able to submit their applications as quickly as possible. Plan sponsors should:

  • Figure out who their authorized representative will be. This person will sign the application and certify that it is true and accurate.
  • Draft a summary of how you will use the reimbursement money to reduce plan participant or sponsor costs.
  • Draft a summary of how you will implement programs and procedures to generate savings for plan participants with chronic and high-cost conditions. (This is one of the requirements of the ERRP program, but you should check whether your current plan already satisfies this condition so that you don’t unnecessarily change your plan provisions.)
  • Estimate your projected reimbursement amounts for the first two years of the ERRP. These projected amounts will be required on the application.
  • Identify all benefit options in your plan that are available to early retirees. The HHS will use this information to track where funds are being spent.
  • Make sure you can attest that there are fraud, waste, and abuse policies and procedures in place.

These are just a few of the items that plan sponsors are required to include in their ERRP application, but they are ones that you can proactively address. By preparing ahead of time, you can get an edge on your competitors in applying to receive ERRP funds.