managing opeb liability june 2007 presented by david boomershine senior consulting actuary managing...

Managing OPEB Liability

June 2007

Presented by

David BoomershineSenior Consulting Actuary

Managing OPEB Liability

The Actuarial View:GASB Statements 43 and 45

2Managing OPEB Liability

Agenda

Introduction

Overview

Baseline Valuation /Process

Actuarial Basis

Major Cost Drivers

Funding

Plan Design

Bond Rating Agency Views

Conclusions/Questions


Introduction

GASB OPEB Exposure Draft – February 2003

Revised Exposure Draft – January 2004

Statement 43 – May 2004

Statement 45 – July 2004 www.gasb.org

Change “Pay-As-You-Go” to accrual accounting for post employment medical, dental, and life insurance Shifts costs between taxpaying generations

Similar to FAS 106 for private sector


Overview of GASB Rules

Effective dates for Statement 45:

Annual Revenue Effective for FY > FYE Phase I >$100m 12/15/2006 6/30/2008 Phase II >$10m & <$100m 12/15/2007 6/30/2009 Phase III <$10m 12/15/2008 6/30/2010

Effective dates for Statement 43 (if funded): 1 year earlier:

FYE Phase I 6/30/2007 Phase II 6/30/2008 Phase III 6/30/2009


Statement 43

Disclosures for Plan include:(If Plan is funded – i.e., trust fund established)

Plan description

Significant accounting policies

Actuarial methods and assumptions

Contributions and reserves

Funded status: assets vs. actuarial liabilities

Statement of funding progress


Statement 45

Primary Features/Disclosures – for Plan Sponsor:

Book actuarial cost as an expense on financial statements

Accrue liability on finance statements – actual contributions vs. expense (Not Actuarial Accrued Liability)



Why is GASB proposing a new accounting standard?

Current accounting standards ignore cost while employee renders service and recognizes cost only after an employee retires

GASB argues this delayed recognition shifts “costs” from one taxpaying generation to another.



GASB #43 and #45 standards are structured like GASB’s Pension accounting & reporting standards

GASB #25 – Plan’s accounting/disclosures GASB #27 – Plan Sponsor’s accounting/disclosures

Primary similarities between Pension and OPEB disclosures Valuation process Annual Actuarial Cost Net Liability: Cumulative differences between contributions and

costs

Primary Differences Benefit types Healthcare trends, assumptions Funding



If the employer does not otherwise contribute to the cost of retirees’ benefits, an OPEB liability is not required

However, final Statements require OPEB liability if implicit rate subsidy exists



Key financial statement components – GASB #45 Annual Required Contribution (annual expense) – ARC Annual OPEB Cost (annual expense) – AOC Net OPEB Obligation (balance sheet liability) – NOO

Advance funding is not required; however there are some advantages The Net OPEB Obligation will be close to zero The actuary can use a more favorable discount rate to

value the plan


Case Study Example

GASB vs. Pay-As-You-Go (PAYG)Annual Cost/contributions

$0

$40

$80

$120

$160

$200

$240

$280

2007 2012 2017 2022 2027 2032

An

nu

al A

mo

un

t M

illi

on

s

GASB Pay As you go


Actuarial Valuation Process

Primary InputsInformation Needed From Plan Sponsor

Plan Provisions – Substantive Plan Documents/summaries/Employee Communications

Participant census data Active Retiree

Full Listing of basic demographic data and coverage

Fund Assets, if any Financial Statement for Trust Fund, if any

Cost experience/premiums 2 or 3 years of claims/premium experience, usually from carriers

Actuarial methods and assumptions

Pension valuation report, input on discount rate



Key steps in Actuarial Valuation Process Identify the “Substantive Plan”

The plan as understood by the employer and plan members May include oral and/or written commitment by employer

Data collection and review Employee/Retiree Claims/Premiums

Determine actuarial basis Project future benefit cash flows Discount projected cash flows back to measurement date to

determine present value of all future benefits (PVB)



Key Steps in Actuarial Valuation Process (continued)

Determine Accrued Liability (AL) (i.e.portion of PVB earned through service-to-date)

Determine Normal Cost (i.e., the value of benefits “earned” during a year)

Determine Annual Required Contribution (ARC)

Produce Valuation Report



Actuarial Basis Allowable Cost Methods – 6

Projected Unit Credit Entry Age Normal

Primary Actuarial Assumptions Discount Rate Healthcare Trend Rates Retirement Mortality Termination Disability Salary increases Coverage election Married Rate


Baseline GASB Results

Baseline Valuation Results (about 10,000 participants) – Case Study

Fiscal Year Ending June 30, 2007($ millions)

Normal Cost $ 30

Unfunded Actuarial Accrued Liability- Amortization (30 years)

$ 800

60

Annual Required Contribution (ARC) (also Annual OPEB Cost (AOC) for first year)

$ 90

Expected Benefit Payments $ 15

Expected Net OPEB Obligation (NOO) at June 30, 2007

$ 75

Note: 6% Discount Rate for BaselineNo pre-funding



Major Cost Drivers

Assumptions Discount rate assumption Healthcare trend rate assumption Retirement

Plan Design Retiree cost sharing Eligibility (Retirement) Spousal coverage


To Fund or Not To Fund?

Discount Rate BasisPer GASB 45: Basis for setting Discount Rate is determined by the source of funds used for paying benefits

Assuming the Plan is pre-funded: Benefits paid through Trust Fund Investment portfolio similar to pension plans Use Discount Rate – about 8%

Assuming the Plan is not pre-funded: Benefits paid through General Fund Low fixed interest return Use Discount Rate – about 4%


Alternative Valuation Results Using Level Dollar amortization approach

Discount Rate 6.00% 4.00% 8.00%

($ millions) ($ millions) ($ millions)

Normal cost $ 30 $ 40 $ 20

Unfunded Actuarial Accrued Liability- Amortization (30 Years)

80060

1,10065

56050

Annual Required Contribution (ARC) 90 105 70

Expected Benefit Payments/Contributions 15 15 70

Expected Net OPEB Obligation 75 90 0



Projection of Net OPEB Obligation


$0

$300

$600

$900

$1,200

$1,500

$1,800

$2,100

2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023

Fiscal Year Beginning July 1

Net

OP

EB

Ob

ligat

ion

Bal

ance

($ m

illio

ns)

Pay-as-you-go Pre-Fund OPEB Cost



Alternative Valuation Results Using Level % of Pay amortization approach

Discount Rate 6.00% 4.00% 8.00%

($ millions) ($ millions) ($ millions)

Normal cost $ 30 $ 40 $ 20

Unfunded Actuarial Accrued Liability- Amortization (30 Years)

80040

1,10045

56035

Annual Required Contribution (ARC) 70 85 55

Expected Benefit Payments/Contributions 15 15 55

Expected Net OPEB Obligation 55 70 0



Projection of Net OPEB Obligation

$0

$250

$500

$750

$1,000

$1,250

$1,500

$1,750

2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023

Fiscal Year Beginning July 1

Net

OP

EB

Ob

ligat

ion

Bal

ance

($ m

illio

ns)

Pay-as-you-go Pre-Fund OPEB Cost



Partial Pre-funding?

GASB Implementation Guidelines: Partial Pre-Funding indicates a pro-ration of the Discount Rate

Example: ½ Pre-Funding indicates a 6% Discount Rate

Phase-in Pre-Funding

Confirmed verbally with GASB officials

Typical phase in period is 5 years

Base on “present value” approach

Example: 5 year phase in utilizes 7.5% Discount Rate


Pre-Funding is cheaper over time

Discount Rate advantage

Builds up fund to reduce Unfunded Actuarial Accrued Liability and amortization costs

Reduces AOC in future years, which will include Interest on NOO Amortization of NOO

Also, reduces NOO liability on balance sheet

Impact on bond ratings



Pre-funding – Several Vehicles

VEBA

Section 115 governmental trust

401(h) qualified medical sub-account

Health Reimbursement Arrangements

Health Savings Accounts

Leave conversion plans

OPEB Obligation Bonds


Retiree Healthcare Landscape

Public Sector employers may start to feel significant pressure in several areas: Cost pressure in general GASB putting large liabilities on financial statements Need to “remove” implicit rate subsidies Key personnel loss on demographic front “Graying of America”; post-65 group growing rapidly


Retiree Healthcare Landscape

Social “Need” diminished for Medicare-eligible retirees Prescription drugs now available in individual marketplace Diminished “need” for employers to continue plans

New and revitalized Medicare-eligible marketplace Many Part D vendors (PDPs) Revitalized and expanded Medicare Advantage (MA),

including PPOs and Private Fee for Service (PFFS) plans

Social “Need” still exists for early retirees No viable market for individual coverage


Retiree medical Plans: A Perspective

Movement away from traditional “defined benefit”

From …..Benefit Delivery Package of benefits provided to claimants, defined by cost

sharing amounts, by claim or by year

To…..Financial commitment Type and amount of dollar cost promised to the

postretirement medical program, and what is valued for FASB 106/GASB 45

Plan sponsors can set desired link between the two Depends on promises to employees and retirees and

financial perspective


Spectrum of Design Changes

Benefit Delivery Financial Commitment

Medicare Coordination

Increase Cost Sharing

Increase RetireePremiums

TightenEligibility

Cap EmployerSubsidy

PensionTrade-off

TrueDC

DiscontinueCoverage

DefinedDollar

Subsidy

AggregateAccount Access

Only


Benefit Delivery

Aggregate Account

Defined Dollar Benefit

Defined Benefit

True Defined Contribution

Access OnlyGASB 43/45Stops Here

Retiree Risk andResponsibility

More

More

Employer Risk and

Responsibility

FinancialCommitment

Retiree Medical Financial Models


Benefit Delivery – the role of the Employer can change from …

Plan-Sponsor (current): Designs/communicates/enrolls Negotiates with vendors Funds (and bears financial risk) AdministersTO

Facilitator: Locates external plans Communicates/enrolls Funds (possibly through insured plans)TO

Disengaged: Provides fixed financial subsidy directly to retirees


Bond Rating Agency views

Looking for “funding plan”; may include: Funding annual costs

Full Partial Phase In

Plan design revisions Impact may take several years to sort out

Potential Impact of Accounting


Identify OPEB Plans in force

Determine data needs

Develop census information

Preliminary cost and liability assessment

Determine best options to meet objectives Funding Plan Design

Disclosure

Action Steps


Thank you!Thank you!

Questions?