De-Mystifying GASB 45 & Pragmatic Implementation of OPEB GFOAT – April 14, 2014 Don Paschal
Blessing & Curse • City Staff Generally: - those who do not have retiree health care or implicit subsidy feel fortunate - those with a retiree health care want to preserve it • City Employees: - want and like retiree health care • Staff Challenge: - how to preserve, sustain, and fund 2
What is OPEB? • Retirement health care benefits, including: – Medical, Dental, Vision – Life-Insurance, Long-term Care, etc. • Medical is most common and expensive • Widely divergent practices • For some cities, fastest growing expense 3
Technical Knowledge has Improved • Unfunded Actuarially Accrued Liability (UAAL) Amount of liability over the next 30 years (like a mortgage) • Annual Required (Recommended) Contribution Amount required to fully fund over amortization period • “Pay -As-You- Go” Costs Amount actually paid out each year • Pre-Funding Costs Same as pension – Periodic contributions to trust • And many more… 4
Pragmatic Knowledge/Actions Lacking • Be open and very transparent with both City Council and City Staff. • Document; remind; get them comfortable with reality. • If policy “too rich”, talk about the need for funding with employees at every opportunity – failure to get employee support can put entire benefit in jeopardy. • Initiate a plan of attack… START NOW! 5
Be Intentional - Communicate City Manager/Finance Director may have significant fiduciary liability for failure to fully inform and educate Council about: • Size of OPEB liabilities • Need to curtail/limit liabilities • Setting up trust • Much more than a financial statement footnote! 6
What Are Cities Doing? • Ignoring, hoping it will go away (would never do same with pension) • Assuming/hoping they can absorb annual cost in budget (totally different approach for pension) • Many are funding trusts • Reducing Retiree Health Benefits (in a few cases, OPEB has been eliminated) • What Are You Doing? 7
Why Should Your City Care? • Many cities facing huge unfunded liabilities • Increasing challenge of balancing total compensation costs with public services • Pensions are only the tip of the GASB iceberg – will get tougher; GASB 68 (2015 implementation) • Emerging public issue will be exacerbated by revised GASB 45 • Proposed OPEB version of GASB 68 not far after; will be line item on balance sheet 8
How BIG is the Problem? • Prior Studies: • PEW Study – OPEB liability GREATER than Pensions 62 largest cities in U.S. - $118B unfunded liability • 2008 CA City Survey (covering 75% of total budgets) 85% of cities have some unfunded OPEB liability - Combined Unfunded Liability over $10B - But only 20% had pre-funded at that time - End Result – 2/3rds of CA Cities on Pay-As-You-Go • Texas – not any better than above! 9
The 6 Big Misconceptions 1. Agency is OK because it set aside a reserve in general fund to lower and cover a portion of OPEB liabilities 2. Establishing a trust means that Agency MUST continue to provide retiree health care benefits in the future 3. If Agency pre-funds, I am obligated to make regular contributions into the trust 4. If Agency pre-funds and later decides to eliminate retiree health care, the money will be stuck in the trust because it’s irrevocable 5. Funds in the trust can only be used to pay future retiree health care premiums 6. Agency doesn’t have the full ARC, therefore can’t get started pre - funding 10
Irrevocable Trusts – GASB 45 For a contribution to be considered an asset and offset a liability, it must: • Be in an irrevocable trust • Be for retiree health care benefits only such as medical, dental, vision, etc. • Not be accessible by creditors OPEB Assets may be accessed at ANY TIME for OPEB expenses with these options: • Retiree health care provider can be paid directly • Agency can be reimbursed for benefit payments • Payments can be sent directly to retirees (if OPEB policy allows) • Agency can be reimbursed for cost of OPEB Actuarial Valuation 11
Why Should You Pre-fund? • Pre-funding results in a greater rate of return which in turn lowers liabilities • Rule of Thumb: For every 1% increase in discount rate, you lower your liability costs about 10-12% • Contributions into the trust are “assets” which offsets liabilities on financial statements • GASB 68 will require agencies to report pension liabilities on their balance sheet in 2015 with OPEB following in the near future (probable 2017?) 12
Why You Pre-fund? continued • Credit raters look more favorably on agencies who adopt and pre-fund a Trust. Several city clients have received higher credit rating after pre-funding equating to lower borrowing costs • Agencies with lower liabilities have a better chance to retain some level of retiree health care • GFOA views OPEB pre-funding as a best practice , stating “ the financing of post-employment benefits as they are earned (i.e., pre-funding v. pay-as-you-go funding) offers significant advantages…” (Approved by GFOA – 2012) 13
Impact of Pre-funding Actual Texas City Data Pay-as-you-go Pre-Funding Valuation Date: December 31, 2010 Discount Rate Discount Rate 4.50% 7.50% Present Value of Future Benefits $56,081,109 38.11% $34,705,894 Unfunded Actuarial Accrued Liability (UAAL) $36,241,223 33.12% $24,237,902 Annual Required Contribution (ARC) $3,715,512 24.98% $2,787,238 Pay-As-You-Go $1,155,605 --- $1,155,605 14
OPEB Funding Scenarios (7.50% Discount Rate) $2,787,238 1. Put in Full ARC 2. Put in Full ARC, then reimburse PAYGO at the End of Year $2,787,238 - $1,155,605 3. Put in difference between ARC and PAYGO $1,631,633 4. Put in something ??? Remember: Something is always better than nothing! 15
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Funding Strategies • ARC – best to fund full amount • Partial ARC – such as significant % (35%, 50%, etc.) • Add step % each year (5% or 10% step increases) – thus, start at 30% and by year 5 city would be funding 50% • Start with significant reserve infusion such as $ X million staff has been setting aside or major infusion from health care reserve fund or share of cost from each separate fund with OPEB related expense • Add end of year excess or sweep funds, unanticipated sales tax windfall, etc. 17
Typical Methods for Controlling OPEB Costs 1. Increase number of years employed before vesting 2. Pay health care for maximum of X years – encourage retirement within X years of Medicare eligibility (ex: pay max of 5 or 10 years) 3. Mandate using Medicare and supplements upon eligibility 4. Set maximum % of premium or health care City will pay 5. Set maximum $ / retiree City will pay for health care or premium 6. Raise age of OPEB eligibility 18
Elements to a Good Trust Program • Adjust retiree health care policy to a sustainable level or entire program will be in jeopardy • Set up or join trust • Identify/use experienced trustee bank / depository • Must be in trust that has IRS private letter ruling • Must have experienced public funds Registered Investment Advisor (RIA) for investment advice • Be sure program has access to broad array of investment choices, avoid proprietary funds (hidden costs) • Establish long-term return goals with periodic reporting and measurement of objectives • Must keep trust documents up-to-date and in compliance with IRS rules 19
Asset Allocation – Investment Options • Establishing an OPEB Trust does not have to be risky • Agency should choose different risk tolerance level to fit expectations; should be consistent with actuarial discount rate • Most common asset allocation: 50% Stocks/50% Bonds or 60%/40% • Active (using mutual funds to hopefully outperform market) or Passive (using Index/ETF) options • Can change strategy at any time • Requires separate OPEB Investment Policy 20
Actual Client Experience OPEB rescued budget in faltering economy Total Assets, Contributions & Reimbursements Plan Year Contributions Reimbursements Total Assets End $8,000,000 Jun – 08* $3,700,000.00 $0.00 $3,653,284.37 $7,000,000 Contributions $6,000,000 Reimbursements Jun – 09 $3,700,000.00 $0.00 $6,813,311.23 Total Assets $5,000,000 Jun – 10 $0.00 $4,026,122.88 $3,300,644.74 $4,000,000 $3,000,000 Jun – 11 $1,165.00 $1,884,543.44 $1,804,136.27 $2,000,000 $1,000,000 Jun – 12 $0.00 $1,700,000.00 $119,958.88 $0 Jun – 13 $849,022.04 $0.00 $985,632.88 Plan Year Ending Jun – 14† $0 $0 $1,072,386.97 * Plan Year Ending June 2008 is based on 1 month of activity. †Plan Year Ending June 2014 is based on 5 months of activity through 11/30/2013 . 21
Budget Balancing Strategy - 2 nd example YEAR Beginning Balance Contributions Distributions Earnings Ending Balance 1 $0 $1,000,000 $0 $65,000 $1,065,000 2 $1,065,000 $100,000 $0 $75,725 $1,240,725 3 $1,240,725 $100,000 $0 $87,147 $1,427,872 4 $1,427,872 $100,000 $200,000 $86,312 $1,414,184 5 $1,414,184 $100,000 $200,000 $85,422 $1,399,606 Assumptions: • 6.5% rate of return • No fees • Initial Contribution of $1M • Annual contribution of $100,000 in years 2-5 • Distributions (reimbursements) of $200,000 in years 4 and 5 22
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