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.
In Scenario 1, we see that if claims increase by 5% more than expected then the net liability increases by 25%. Similarly, Scenario 2 shows a net liability decrease of 20% if premiums increase by 5% more than expected. Although the variance in gross liability and premium is relatively mild, in both cases the net liability change is leveraged specifically because it is a “net” amount.
The point is that a leveraged change can occur whenever we are dealing with a net difference between two larger pieces. OPEB liabilities often fit this description. Moreover, the leveraging is compounded as the gross claims and premium offset components get closer in value. This is why the GASB 45 Implicit Subsidy liability has the potential to be quite volatile.
Public plan sponsors who are used to dealing with pension liabilities under GASB 27 may be accustomed to relatively stable liabilities from year to year. However, the retiree healthcare promises measured under GASB 45 will likely be more volatile. This is especially true as plan sponsors fine-tune details like health claims and premiums during the first few GASB 45 actuarial studies.
[…] 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. […]