GASB 45

GASB 45 is a rule promulgated by the Governmental Accounting Standards Board. It will have potentially serious consequences for all governmental entities that have post-retirement benefit liabilities.

Lexington is aware that GASB 45 is coming. This is from the report of the Ad Hoc Financial Policy Committee dated 3/15/06. The entire report can be found here.

The town commissioned a report from an actuarial firm. Their report, dated March 9, 2007, shows liabilities of $518 million, and assets of 0! This massive unfunded liability will be a burden to taxpayers for years to come.

TOWN OF LEXINGTON AD HOC FINANCIAL POLICY COMMITTEE REPORT TO BOARD OF SELECTMEN FINANCIAL POLICY RECOMMENDATIONS

POST-EMPLOYMENT BENEFIT POLICIES

A. Objectives Define and adequately fund the Town’s pension and health benefit responsibilities and obligations to its retired employees.

B. Financial Policies for Pension Obligations The Board of Selectmen and Town Meeting should continue to support the Retirement Board’s track record of prudent judgment and actions.

1.
Continue the current practice of bi-annual actuarial valuations of the Contributory Retirement System.

2. Contribute to the Retirement System annually so as to amortize the unfunded accrued pension liability no later than 2015.

3. Ensure that annual contributions thereafter are sufficient to fully fund 100% of the actuarial liabilities.

4. Conduct an actuarial study of any early retirement incentive program, retirement contribution "holiday," or other proposal affecting either retirement benefits or contributions – prior to accepting such programs - to determine the actuarial liability to the retirement system and impact on the Town’s annual retirement contribution.

C. Financial Policies for Health Benefit Obligations The Committee understands that in the near future the Governmental Accounting Standards Board will require full disclosure of this liability in the Town’s financial statements. The Board of Selectmen should take timely action to determine the magnitude of this liability and to develop a funding strategy for this obligation.

1.
Engage a firm to conduct an actuarial valuation of the health benefit obligations to retirees and current employees, quantify this liability, and generate funding options.

2. To the extent possible, consult the Retirement Board in developing a strategy to fund the actuarial liability for such health benefit obligations. The Town should take advantage of the Board’s exemplary track record and expertise in managing the Town’s contributory retirement system.

We will be hearing much more about GASB 45 in the not-too-distant future. In the meantime, here is a little primer on the topic.

Introduction

Employees of state and local governments, including public school districts, public universities

and other governmental entities, may be compensated in a variety of forms in exchange for

their services. In addition to a salary, many employees earn benefits over their years of

service that will not be received until after their employment with the government ends

through retirement or other reason for separation. The most common type of these

postemployment benefits is a pension. As the name suggests, other postemployment benefits

(OPEBs) are postemployment benefits other than pensions. OPEB generally takes the form of

defined benefit health insurance, dental, vision, prescription drug, or other health care

benefits. It may also include some types of life insurance, legal services, and other benefits.

Private sector and non-profit employers have been subject to OPEB reporting since the early

1990s under the FASB 106 rules. Governmental employers were exempt from this reporting

obligation until the issuance of GASB Statement 45 in August of 2004.

What is the GASB requiring?

The value of the promise made to provide retiree benefits must now be actuarially calculated

and accrued during the working years of employees and recognized as a financial obligation of

the employer as the OPEB Cost. This amount needs to be reported on the financial statements

of all public sector employers beginning in the first financial reporting period after December

15, 2006 for the largest employers while small employers have until 2008 to begin reporting.

OPEB Cost is derived from an actuarial calculation

1 that must be done every two or three years

depending on employer size. Actuarial valuations take several assumptions into account:

Turnover rate and retiree rate
Medical care inflation
Mortality
Discount rate
Benefit design
Health care cost factors such as age, gender, family size, geographic area, industry
The promise to retirees
Salary scale assumption
Expected long-term (or short-term) rate of return on plan assets

The determination of the costs and obligations for postemployment benefits other than

pensions is based on the calculation of the actuarial present value of the postemployment

benefits that are expected to be paid to or on behalf of the employee under the terms of the

plan and the attribution of such present value to periods of service. Generally, the attribution

period is from the date of hire to the date the employee gains full eligibility for benefits (e.g.,

retirement).

The largest component of OPEB Cost is retiree health care benefits. According to The Kaiser

Family Foundation’s

Employer Health Benefits 2005 Annual Survey, 84% of public sector

employers employing more than 200 workers offer some form of retiree health care benefits.

Continuing with a “pay-as-you-go” philosophy will create a significant new financial liability for

these employers to deal with. This may be increasingly difficult in a time when most public

sector employers are experiencing double-digit health care cost increases, reduced and

restricted budgets, and reduced federal and state subsidies. In addition, many states have

laws that mandate a provision allowing early retirees to remain on the active health care plan

until they become eligible for Medicare. The cost difference between the blended plan cost

(including actives and retirees) and the actual cost for the retirees must be recognized as an

implicit rate subsidy by the employer. This amount adds additional liability for the employer,

even if the employer is not contributing financially toward the retiree health care plan.

Does the GASB require funding of the OPEB Cost?

Although there is no requirement that the employer actually fund the OPEB Cost, not doing so

could have a significant impact on the employer’s overall credit rating, consequently, affecting

the cost of issuing debt financing for the public sector employer. Any Net OPEB Obligation

needs to be reported as an unfunded liability on financial statements. Several of the Nation's

rating agencies have indicated that they will now consider GASB 45 obligations in financial

analyses.

Standard & Poor’s
, the Nation’s largest rating agency, issued a report stating2: “The new

[GASB 45] reporting may reveal cases in which the actuarial funding of postemployment health

benefits would seriously strain operations, or, further, may uncover conditions under which

employers are unable or unwilling to fulfill these obligations. In such cases, these liabilities may

adversely affect the employer's creditworthiness. All Standard & Poor's rated employers will be

monitored closely in terms of their reporting under GASB 45. Upon implementation of these

new standards, we will include the new information as part of our ongoing analytical

surveillance of ratings."

FitchRatings
issued a report stating3: “Initially, Fitch's credit focus will be on understanding

each issuer's [GASB 45] liability and its plans for addressing it. Fitch also will review an entity's

reasoning for developing its plan. An absence of action taken to fund OPEB liabilities or

otherwise manage them will be viewed as a negative rating factor. Steady progress toward

reaching the actuarially determined annual contribution level will be critical to sound credit

quality."

Simplified alternative measurement method for employers with fewer than 100 members - Valuation required every three years

Standard & Poor's - Reporting & Credit Implications of GASB 45 Statement on Other Postemployment Benefits - 12/2004 were >>

FitchRatings - The Not So Golden Years - Credit Implications of GASB 45 - 6/2005

Here's an op-ed piece by Robert Pozen that appeared in the Boston Globe. He doesn't mention GASB 45 by name but that is what he's talking about when he mentions "new accounting rules."

Paying for public retiree healthcare

By Robert C. Pozen | January 25, 2007

WHILE THE BURDENS of retiree healthcare benefits on General Motors are well known, Massachusetts residents will be surprised by the large unfunded obligations of the public sector to pay similar benefits.

Starting this year, state and local governments will be required by new accounting rules to disclose estimates of their unfunded obligations for retiree healthcare benefits. This estimate for the Commonwealth of Massachusetts will exceed $13 billion -- which does not include any estimates for cities, towns, and other public entities. Although most of these estimates have not yet been published, they are likely to be startling -- for example, the unfunded obligations for retiree healthcare will be as high as $650 million for the city of Newton.

Healthcare costs are higher in the public sector than the private sector in Massachusetts. In 2003, the total healthcare costs in the government sector were $3,844 for a single person and $8,755 for a family, as compared to $3,529 and $8,429 respectively in the private sector.

Moreover, employees of state government typically pay 15 percent of their healthcare costs, in contrast to an average of 20 to 30 percent in the private sector. In the past, this differential has been justified by lower salaries in the public sector. Unlike pension payouts, retiree healthcare benefits are almost always paid out of current tax revenues by state and local governmental units. These units have not provided advance funding for such benefits by making regular contributions to separate trusts, which would generate investment returns to help pay for future benefits. Nor will these units be required to establish such trusts under the new accounting rules. However, these rules do allow more favorable assumptions in estimating unfunded obligations for retiree healthcare if a state or city provides some advance funding for this purpose.

In other parts of the country, a few governmental units have issued bonds to finance their pension or healthcare benefits. The bonds do allow these government units to spread the costs of these benefits over the life of the bonds. However, the bonds do not reduce these costs at all, and they create an additional risk -- that the investment returns on the bond proceeds will be less than the interest and principal payments on the bonds.

So what can fruitfully be done?

First, Massachusetts residents should press all cities, towns, and other governmental units to publish estimates of their retiree healthcare obligations as soon as practical -- and not wait until the end of 2007 as allowed by the new accounting rules. We cannot develop strategies to cope with these obligations unless we have a much more precise understanding of the amounts involved. For some governmental units, these amounts may be small enough to be easily financed out of current tax revenues. For other cities and towns, these amounts may be large enough to jeopardize their bond ratings and provoke a debate on raising local taxes above the Proposition 2 1/2 limit.

Second, we should explicitly integrate retirement healthcare benefits into the new state plan for universal access. For example, after retirement but before Medicare, some former employees of governmental units may be eligible for premium subsidies from the state -- which extend to families of four with annual incomes up to $60,000. These premium subsidies should be credited against any retiree healthcare benefits to avoid double dipping.

Third, we should encourage all governmental units in Massachusetts to establish and fund separate trusts for retiree healthcare obligations, as they have done for pension benefits. The state already provides a good investment vehicle for pension plans of many governmental units, so it could create a common trust fund to provide these units with an option for financing their retiree healthcare obligations. Such advance funding would not only lower the accounting entries for their unfunded obligations, but also would help defray the cost of such obligations through investment returns.

Finally, and most important, we should have a public dialogue about possible constraints on future growth of retiree healthcare benefits in the public sector.

While it would not be politically feasible to change already accrued benefits, we could substantially reduce such benefits for new public employees and set a ceiling on future accruals by current employees below a certain age. Moreover, we should analyze whether 15 percent continues to be the appropriate level for sharing retiree healthcare costs by former public employees in light of their total compensation and the overall budget picture.

Robert C. Pozen is chairman of MFS Investment Management.

Here's an excellent article by the Mass DLS on this issue:

Other Post-Employment Benefits

Joe Markarian

In the December 2005 issue, City & Town presented a cover story on health insurance for municipal employees.

Five months earlier, The Massachusetts

Taxpayers Foundation issued a report entitled, “A Mounting Crisis for Local Budgets: The Crippling Effects of Soaring Municipal Health Costs.” In each case, historical trends were referenced or analyzed, and future cost escalations to provide health insurance for municipal employees were forewarned.

To further advance the discussion, this article focuses on the emerging need for cities and towns to address the cost of non-pension benefits and compensations due municipal employees on their retirement, as opposed to during their employment.

“Other post-employment benefits” (OPEB) generally take the form of health insurance and dental, vision, prescription, or other healthcare benefits provided to eligible retirees, including in some cases their beneficiaries.

They may also involve some type of life insurance, but as noted do not include pensions.

The Government Accounting Standards Board (GASB) recently determined that OPEB is a part of the compensation that employees earn each year, and as such, should be accounted for as a liability on a municipality’s year-end financial statements.

In practice, however, most governments report only their cash outlays for OPEB in the year of actual distribution, rather than in the year benefits are earned (these two amounts may be vastly different).

Furthermore, most governments do not report information about the nature and size of their long-term financial obligations and commitments related to OPEB. Consequently, the readers of financial statements, including the public, have incomplete information with which to assess the cost of public services or to analyze the financial position and longrun financial health of a government.

The response from GASB was to address these shortcomings in the form of GASB Statement No. 45, Accounting and Financial Reporting by Employers for Post-employment Benefits Other Than Pensions. (A companion Statement 43 deals with related plans.)

The purpose of the new standard is to compel municipalities, through actuarial analysis, to assign an aggregate cost to the OPEB earned by employees and projected over their estimated years of service. Similar to the implementation of GASB 34, municipalities across the Commonwealth will have to be in compliance with GASB 45 according to the following schedule:

Tier 1 (FY1999 revenues larger than $100 million): FY2008 Tier 2 (FY1999 revenues between $10 million and $100 million): FY2009 Tier 3 (FY1999 revenues less than $10 million): FY2010 To identify OBEB cost, an actuarial valuation is required biennially for retiree health plans with a total membership of 200 or more. Triennial actuarial valuations are required for plans with less than 200 plan members. GASB also allows for an “Alternative Measurement Method” for employers with fewer than 100 plan members. Included in the count are active employees, terminated employees not yet receiving benefits and retired employees or beneficiaries who are currently receiving benefits. The implementation of GASB 45 and a new reporting standard could force noticeable changes in government practice.

Initially, the disclosure of a city or town’s total obligation to future retirees, and particularly the unfunded portion of that liability, will gain the attention of taxpayers, municipal employees and decision makers. Whether or not a community chooses to fund its OPEB liability in advance, which is not presently required, will be of interest to municipal credit rating agencies. In either case, the total OPEB cost to a community is an issue.

Because the largest component of OPEB is health insurance, governments nationwide are exploring cost reduction options.

In Massachusetts, some communities have focused on part-time positions and whether persons in those positions contribute to the pension system. After a compensated employee becomes “vested” in the local retirement system, that employee becomes eligible for health coverage, upon retirement, at a cost to the municipality. An appointed person vests after contributing to the pension system for 10 years, while elected officials vest after 6 years. (See PERAC Vesting Regulations.) As a potential area of future savings, a community can decide to eliminate compensation (salary or stipend) for elected or appointed, part-time persons — usually board or committee members — who would then serve as volunteers.

Also, once the OPEB liability is known, a community can adopt a funding plan (as presently exists for pensions) to pay future retiree benefits, rather than continue with a pay-as-you-go approach.

Since no general statewide authority exists to create a post-employment health insurance liability fund, it would have to be approved through special legislation. Several communities have set up such funds by special legislation, including Bedford, Waltham, Hingham, Winchester, Lexington, Wellesley, Arlington and Sudbury. The enabling acts for those funds stipulate that they are to be locally managed in a way similar to a pension or other trust fund. Since the amounts set aside in these funds are from general municipal appropriations, they should be subject to the same investment limitations as other municipal trusts under M.G.L. c. 44, 54, which are more flexible than for other town funds, but more restrictive and protective than private trusts. Because interest can accrue in those accounts, the fund balance builds and retiree health coverage costs a municipality less in the long run.

In other actions, communities can adopt M.G.L. c. 32B, 18. The local acceptance of M.G.L. c. 32B, 18 will require all eligible retirees to enroll in Medicare Part B. In its simplest terms, this section allows a community to shift a meaningful portion of its retiree health care costs to the federal Medicare program. The retiree sees no loss in benefits received. However, as this is a very specialized area of the law, we suggest that counsel be consulted prior to moving forward. Please see the Best Practices on the subject.

Nationally, discussion has been directed to drug benefits because it is an area of significant cost under health care coverage plans. Measures under consideration include increased cost sharing through the imposition of higher co-pays and deductibles, adoption of incentives to encourage the use of generic drugs, and requirements for prior authorization to purchase certain drugs.

Although more apt to be seen in the private sector, a dramatic action for a municipality would be to convert from a defined-benefit to a defined-contribution health plan. Commonly referred to as consumer driven or self-directed health care plans, defined-contribution plans place responsibility for making health care choices on the employees. The employer continues to contribute, but the benefits expense is a more fixed and predictable cost.

In one form, the employer offers multiple health plans to choose from, and then contributes directly to the health care provider selected by the employee. If the premium is higher, the employee makes up the difference. If it is lower, then the employee receives the difference.

Defined contribution plans can also work in tandem with health savings accounts. Under some models, employers contribute a fixed dollar amount to a health savings account to which an employee may also contribute. Once the employee expends the account balance, he pays a deductible for further care, after which employer coverage continues, often in the form of catastrophic insurance. The accumulated savings over the employees work years is intended to cover health insurance costs during retirement.

The defined contribution alternative can be shaped and reshaped into multiple configurations. It also gives rise to major collective bargaining implications. Only one municipality in the country is reported to have implemented the switch.

The release of GASB 45 further accelerated debate on health care cost containment. As actuarial analyses are completed across the country and begin to produce what are likely to be enormous OPEB liabilities, pressure to address costs at all levels of government will only intensify.

Massachusetts municipalities must recognize that the issues related to health care cost containment for retirees are a complicated, evolving area of law and financial management practice. The Division of Local Services strongly recommends that competent legal counsel be engaged throughout any process of evaluating options available to your community. ■

GASB STATEMENT 45 ON OPEB ACCOUNTING BY GOVERNMENTS

A FEW BASIC QUESTIONS AND ANSWERS

1. Why was Statement 45 on OPEB accounting by governments necessary?

Statement 45 was issued to provide more complete, reliable, and decision-useful financial reporting regarding the costs and financial obligations that governments incur when they provide postemployment benefits other than pensions (OPEB) as part of the compensation for services rendered by their employees.
Postemployment healthcare benefits, the most common form of OPEB, are a very significant financial commitment for many governments.
2. How was OPEB accounting and financial reporting done prior to Statement 45?

Prior to Statement 45, governments typically followed a "pay-as-you-go" accounting approach in which the cost of benefits is not reported until after employees retire. However, this approach is not comprehensive—only revealing a limited amount of data and failing to account for costs and obligations incurred as governments receive employee services each year for which they have promised future benefit payments in exchange.

3. What does Statement 45 accomplish?

• • • • • When they implement Statement 45, many governments will report, for the first time, annual OPEB cost and their unfunded actuarial accrued liabilities for past service costs. This will foster improved accountability and a better foundation for informed policy decisions about, for example, the level and types of benefits provided and potential methods of financing those benefits.

The Standard also:

Results in reporting the estimated cost of the benefits as expense each year
during the years that employees are providing services to the government and its constituents in exchange for those benefits.

Provides, to the diverse users of a government’s financial reports, more accurate information about the total cost of the services that a government provides to its constituents.

Clarifies whether the amount a government has paid or contributed for OPEB during the report year has covered its annual OPEB cost. Generally, the more of its annual OPEB cost that a government chooses to defer, the higher will be (a) its unfunded actuarial accrued liability and (b) the cash flow demands on the government and its tax or rate payers in future years.

Provides better information to report users about a government’s unfunded actuarial accrued liabilities (the difference between a government’s total obligation for OPEB and any assets it has set aside for financing the benefits) and changes in the funded status of the benefits over time.

4. What are the most common misconceptions about Statement 45?

a. That it requires governments to fund OPEB. Statement 45 establishes standards for
accounting and financial reporting. How a government actually finances benefits is a policy decision made by government officials. The objective of Statement 45 is to more accurately reflect the financial effects of OPEB transactions, including the amounts paid or contributed by the government, whatever those amounts may be.

b. That it requires immediate reporting of a financial-statement liability for the entire unfunded actuarial accrued liability. Statement 45 does not require immediate recognition of the unfunded actuarial accrued liability (UAAL) as a financial-statement liability. The requirements regarding the reporting of an OPEB liability on the face of the financial statements work as follows:

Governments may apply Statement 45 prospectively. At the beginning of the year of implementation, nearly all governments will start with zero financial-statement liability.

From that point forward, a government will accumulate a liability called the net OPEB obligation, if and to the extent its actual OPEB contributions are less than its annual OPEB cost, or expense.

The net OPEB obligation (not the same as the UAAL) will increase rapidly over time if, for example, a government’s OPEB financing policy is pay-as-you-go, and the amounts paid for current premiums are much less than the annual OPEB cost.

Statement 45 does, however, also require the disclosure of information about the funded status of the plan, including the UAAL, in the notes to the financial statements—and the presentation of multi-year funding progress trend information as a required supplementary schedule.

c. That it requires governments to report "future costs" for OPEB. It is misleading and incorrect to describe accrual accounting for OPEB as requiring the expensing of "future costs." From an accrual accounting standpoint (the basis of accounting required for all transactions in the government-wide financial statements), the reported expenses relate entirely to transactions (exchanges of employee services for the promised future benefits) that already have occurred. Statement 45 requires governments to report costs and obligations incurred as a consequence of receiving employee services, for which benefits are owed in exchange. The normal cost component of annual expense is the portion of the present value of estimated total benefits that is attributed to services received in the current year. The annual expense also includes an amortization component representing a portion of the UAAL, which relates to past service costs. Estimated benefit costs associated with projected future years of service are not reported.

If you're still interested in this topic, here's a so-called "plain language" summary from the GASB.

Lexopengov.com

An Open Government Initiative

Paying for public retiree healthcare

Other Post-Employment Benefits

Joe Markarian

Five months earlier, The Massachusetts