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Basic Information about

GASB Statement 45

Karl JohnsonProject Manager

Governmental Accounting Standards BoardNorwalk, CT

National Governors AssociationGASB Live Meeting Conference Call

April 19, 2007

The views expressed are those of the speaker and are not official representations of the Governmental Accounting Standards Board,

which expresses itself through written pronouncements issued after extensive due process.

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What Is the GASB?

An independent, professional standard-setting Board

Operates as a function of the Financial Accounting Foundation—a private, NFP foundation created to ensure continuity, support, and independence to the FASB and the GASB

Establishes generally accepting accounting principles (GAAP) for accounting and financial reporting by state and local governmental entities

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Why the Board’s SuddenInterest in Accounting for Retiree Healthcare Benefits? Actually, the subject of “other postemployment benefits” (OPEB)

was first placed on the Board’s technical agenda for research and development of standards in 1987

GASB issued interim guidance in 1989, 1990, and 1994, but even then contemplated a more comprehensive look at the subject (i.e., the OPEB Project that produced Statements 43 and 45 in 2004)

The subject of OPEB was considered major for several reasons: The potential materiality of retiree healthcare The inadequacy of pay-as-you-go accounting practice to

provide relevant, decision useful information about OPEB costs, obligations, and potential demands on future cash flows

The complexity of issues related to measurement and recognition of costs and obligations

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The OPEB Project

Nov. 1994—GASB issued Statements 25, 26, and 27 on pension accounting

1995-1996—GASB Board and staff attempted a quick adaptation of Statements 25 and 27 to OPEB but ran out of time because of competing project priorities, including Statement 34

1999-2004—Board and staff worked steadily on OPEB issues: Settled on an overall accounting approach (same as for pensions) Adapted pension requirements to OPEB Addressed issues unique to OPEB (including alternative

measurement method for very small plans and implicit rate subsidies) Conducted extensive due process—utilized an expert Task Force to

advise and assist, issued three Exposure Drafts (two for Statement 45), analyzed respondents’ comments on issues, and held two public hearings and a focus group meeting of financial analysts

Issued Statements 43 and 45 in April and June 2004, respectively

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In a Nutshell:GASB Statement 45 (for Employers)

Subject: accounting and reporting by employers for their OPEB expenses and obligations—most notably, for retiree healthcare benefits

Applies to all employers that pay all or part of the cost of the benefits, including “implicit rate subsidies”

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In a Nutshell:GASB Statement 45 (for Employers)(continued)

Requires a change: From pay-as-you-go

accounting—in which expense is not recognized until OPEB obligations are finally paid in years after retirement

To accrual-basis accounting–in which expense is recognized during years of active service (for which OPEB is part of the total compensation package)

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In a Nutshell:GASB Statement 45 (for Employers)(continued)

Requires measurement and disclosure of the total actuarial accrued liabilities for past service costs, the net unfunded actuarial accrued liabilities after subtracting plan assets, if any, that have been set aside to pay accrued benefits as they come due, and the plan’s funded ratio

Requires actuarial valuations every 2 or 3 years for accounting and financial reporting purposes (sooner if something major changes)

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Objective of Statement 45 To faithfully represent (reflect like a good, non-distorting mirror)

the financial effects of the underlying financial transaction that creates OPEB

The Board concluded that OPEB arises from an exchange transaction between an employer and employees in which an employer: Acquires employee services, for which it Pays or provides salaries, active-employee healthcare,

etc., and promises to pay or provide after employment a pension and OPEB such as retiree healthcare—all as components of a total compensation package

That exchange, rather than the annual payments of premiums or claims costs for retired people that follow from it, is the basic transaction to be accounted for (the substance of OPEB)*

* The Board considered but rejected the view that OPEB is a serial gift or gratuity (a series of non-exchange transactions in which the employer gives benefits for which it receives no value in return)

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Measurement Approach for OPEB:Broad Steps of Process to Develop Information for Accrual Accounting and Financial Reporting

1. Project cash outflows for benefits

2. Discount projected benefits to present value (PV)

3. Allocate the PV of projected benefits to financial reporting periods using an acceptable actuarial cost method and amortization method

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25 40 62 80

Employee Age Timeline

Age when hired

Present ageAssumed age at

retirement Life Expectancy

Service Period

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25 40 62 80

1) Project Benefits

2) Discount

A.P.V.

3) Actuarial cost method

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How Allocated Portions of the PV of Projected Benefits Affect Financial Reporting

Amounts allocated to past periods ~ actuarial accrued liabilities• Disclosed in notes to financial statements• Also, an amount that would amortize the total AAL within an

acceptable period of years if paid as part of a regular funding policy is included in the measurement of annual OPEB cost, or expense

Amount allocated to current period ~ normal cost (service cost)• The other principal component of annual OPEB cost

Amounts allocated to future periods ~ future normal cost• Not reported—pertains to services that haven’t occurred yet

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Annual OPEB Cost and Net OPEB Obligation: Illustration (Employer in Year 2 of Applying Statement 45)

Normal cost (current service cost) $ 350,000Amortization of the UAAL (for past services) 600,000

Annual required contribution (ARC)* 950,000Interest on beginning net OPEB obligation* 50,000ARC adjustment* (58,500)

Annual OPEB cost* = expense 941,500Actual employer contribution* (PAYGO method of financing) (250,000)

Increase in net OPEB obligation* 691,500Net OPEB obligation—beginning* 650,000Net OPEB obligation—ending* 1,341,500

* The ARC, the annual OPEB cost and its components, actual employer contributions, and changes in the net OPEB obligation are required to be disclosed in the employer’s notes to the financial statements.

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What Do the ARC and the Net OPEB Obligation Tell Me as a Reader of the Financial Report?

The ARC expressed as a % of covered payroll represents the level of employer contribution effort that would be needed on a sustained, consistent basis to cover normal cost and amortize the UAAL over not more than 30 years: An indicator of the “size” of the employer’s commitment,

expressed in terms of the ongoing contribution effort required to sustain it

An indicator of potential long-term demands on future cash flows

The net OPEB obligation indicates whether since implementation of Statement 45 an employer has contributed less (more) than the ARC

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Funded Status Information: Illustration (Two Employers)Information Disclosed in Notes to Financial Statements and Presented in RSI

Govt. A Govt. BUnfunded Partially(PAYGO) Funded

Actuarial accrued liabilities (AAL) (a) $13,500,000 $13,500,000Actuarial value of plan assets (b) -0-- 9,000,000

Unfunded actuarial accrued liabilities (UAAL) (a-b) 13,500,000 4,500,000

Funded ratio (b/a) 0.0% 66.7%

Covered payroll (c) $7,600,000 $7,600,000

UAAL as a % of covered payroll (a-b/c) 177.6% 59.2%

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What Does the UAAL Tell Me as a Reader of the Financial Report?

The UAAL is the portion of the present value of projected benefits attributed to past periods

It can be thought of as a measure of the value of employee services that were received by the employer and tax/rate payers or constituents in past periods but not paid or funded

Other things being equal, the higher the UAAL, the higher will be the following going forward: Amortization component of the ARC The ARC Annual OPEB cost, or expense Demands on future cash flows, or budgets

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Disclosure of Actual Employer Contributions as a Percentage of Annual OPEB Cost

A key factor affecting the funded status of the benefits is the level of employer contributions

Accordingly, employers also should disclose for each of the past three years the annual OPEB cost, the percentage of annual OPEB cost actually contributed, and the ending net OPEB obligation

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Effective Dates and Transition

Staggered implementation of Statement 45 based on a government’s phase for implementing GASB 34: Phase 1 ($100M+ revenue)—first fiscal year beginning after Dec.

15, 2006 Phase 2 ($10M to < $100M revenue)—one year setback Phase 3 (< $10M revenue)—two year setback

Earlier implementation is encouragedEmployers may apply Statement 45 prospectively—that is,

may report zero beginning net OPEB obligation as of the beginning of the year of implementation

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Concluding Comments

Implementation planning tasks may include, for example: Analyzing and classifying employee benefits offered Gathering information about plan terms and covered group Obtaining an initial actuarial valuation and absorbing the new

information it provides (a watershed event) Considering how OPEB will be managed and accounted for going

forward: Initiating discussions and decision processes regarding variables

that can be managed to make or keep benefits sustainable If planning to fund, establishing a qualifying OPEB plan trust Separating active-employee and retiring healthcare benefits for

accounting purposes, if combined Working out issues related to fund structure, funds flows, and

accounting and financial report preparation

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Concluding Comments(continued)

In the end, the information that Statement 45 requires to be developed and reported is intended to provide the diverse users of governments’ financial reports: A more transparent accounting for employers’ costs and

obligations associated with OPEB More decision-useful financial information to better inform

discussion and decision-making about important matters such as: Benefits and plan design Cost sharing between the employer and plan members The method of financing benefits

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Additional Resources

GASB website, www.gasb.org:

• OPEB fact sheet• Plain language summary• Summaries of standards• Order information (Statements, Implementation Guides, Technical Bulletins, etc.)• A system for submitting technical accounting and financial reporting questions to GASB’s professional staff

Telephone (203) 847-0700