Accounting for OPEB

1
Accounting for OPEB

• Labor Update
• February 6, 2006

2

• GASB
• OPEB

3

• Governmental
• Accounting
• Standards
• Board

4

• Other
• Post
• Employment
• Benefits

5
Other Post-Employment Benefits (OPEB)

• GASB Statement No. 43 (plans)
• GASB Statement No. 45 (employers)

6
Effective date for OPEB plans (one year earlier
than for employers)
The Health Service System would need to report as
of June 30, 2007
7
Effective date for employers
The employers (City and County of San Francisco,
Unified School District and Community College
District) would need to report as of June 30, 2008
8
Nature and Character of Post-Employment Benefits

• PART 1

9
Question 1

• What are post-employment benefits and why are
  they important?

10
Question 1 response

• Payments made directly to former employees or
  their beneficiaries, or to third parties on their
  behalf, as compensation for services rendered
  while they were still active employees
• Essential form of compensation
• Payment deferred
• Significant and growing element of cost

11
Related Employment Costs 2005-06City Only (in
Millions of )

• Active Retired Total
• Pension 170.5 170.5
• Health Benefits 205.9 95.9 301.8
• Total 472.3

12
Question 2

• What are the major categories of post-employment
  benefits?

13
Question 2 response

• Pension benefits
• Retirement income
• OPEB
• Healthcare
• All Other Post-Employment Benefits not offered as
  an integral part of a pension plan

14
Question 3

• What is the difference between a defined
  contribution plan and a defined benefit plan?

15
Question 3 response

• Defined contribution plans
• Focus on inputs (contributions)
• Defined benefit plans
• Focus on outputs (future results)
• Hybrid plans
• Elements of both

16
SummaryDefined Benefit Plans v. Defined
Contribution Plans
17
Question 4

• Which type of post-employment benefit plan is
  more commondefined benefit or defined
  contribution?

18
Question 4 response

• Pensions
• Defined benefit plans remain the rule in the
  public sector
• Defined contribution plans tend to supplement
  rather than replace defined benefit plans

19
Financing Post-employment Benefits

• PART 2

20
Question 5

• How do employers in defined contribution plans
  finance post-employment benefits?

21
Question 5 response

• By making regular timely payments of
  contractually required contributions

22
Question 6

• How do employers in defined benefit plans finance
  post-employment benefits?

23
Question 6 response

• Two approaches
• Pay-as-you-go
• Advance funding
• Example (work life 2010-2024)
• Pay-as-you-go
• Start financing in 2025
• Advance funding
• Finance between 2010-2024

24
Question 7

• Which funding approach is more commonpay-as-you-g
  o funding or advance funding?

25
Question 7 response

• Pension benefits
• Typically advance funded in both the public and
  private sectors
• OPEB
• Traditionally pay-as-you-go funding
• Consistent with focus on near-term impact on
  budget
• Risk compare focus on monthly mortgage rates
  without consideration of the length of the
  mortgage

26
Question 7 response (cont.)

• Reasons for difference in funding approach
  between pensions and OPEB
• Possibly disparity in accounting standards
  between pensions and OPEB

27
Question 8

• Does the GASB require employers to advance fund
  OPEB?

28
Question 8 response

• GASB has no authority over budgeting and finance
• Standards may nonetheless provide incentive for
  change

29
Question 9

• Accounting considerations aside, is advance
  funding generally considered preferable to
  pay-as-you go funding?

30
Question 9 response

• Basic rule finance costs in period receiving
  benefit
• Rules on debt financing of capital assets
• Arguments in favor of advance funding
• Intergenerational equity
• Cost reduction through investment earnings

31
Advance Funding Defined Benefits

• PART 3

32
Question 10

• If an employer advance funds post-employment
  benefits, how is the amount to be funded each
  period determined?

33
Question 10 response

• Three-step process (actuarial valuation)
• Project anticipated future benefits
• Discount future benefit payments to their present
  value
• Allocate the total present value of future
  benefit payments to the appropriate period of
  employee service

34
Years of Active Service
Post-employment
1. Project future payments

2. Discount to present value


3. Allocate to periods of employee service
35
Question 11

• How are future obligations of OPEB projected?

36
Question 11 response

• OPEB often less documented than pension benefits
• Projections should be based on substantive plan
• Employers and employees shared understanding of
  promised benefits

37
Question 12

• What are actuarial assumptions and how do they
  affect the projection of defined benefits?

38
Question 12 response

• Basis for projecting anticipated future benefits
• Turnover
• Retirement age
• Mortality
• Inflation rate
• Healthcare cost trend data
• Investment return
• Post-retirement benefit increases

39
Question 13

• Why are actuarial assumptions important?

40
Question 13 response

• Projections only as reliable as underlying
  assumptions
• Even small changes in assumptions can have a
  major impact on cost
• Overly optimistic assumptions may mask a portion
  of cost

41
Question 14

• What is the annual required contribution (ARC)?

42
Question 14 responseElements of annual
required contribution (ARC)

• Normal cost
• Amortization of the Unfunded Actuarial Liability
• 30 year maximum amortization period
• Level dollar or level percentage of payroll
• Minimum 10 year amortization period

43
Question 15

• What is the actuarial accrued liability (AAL)?

44
Question 15 response

• Value in todays dollars (i.e., present value) of
  vested and vesting benefits for services already
  rendered
• Actuarial rather than accounting liability and
  therefore not reported on the face of financial
  statements
• It is the unfunded portion of this obligation
  that should be the primary focus of attention

45
Question 16

• What is the unfunded actuarial accrued liability
  (UAAL)?

46
Question 16 response

• Difference between accumulated resources and
  actuarial accrued liability
• Use actuarial value of assets (AVA)
• Average over 3 to 5 years
• Not displayed on the face of the financial
  statements
• Of paramount importance as the measure of the
  cost of benefits that have been earned to date
  but not yet paid for

47
Question 17

• How often are actuarial valuations required for
  accounting purposes?

48
Question 17 response

• Pension plans
• At least every two years
• OPEB
• 200 or more participants
• At least every two years
• Less than 200 participants
• At least every three years
• New valuations always required in any year with
  substantial changes

49
Employer Accounting forPost-employment Benefits

• PART 4

50
Question 18

• When employers participate in a cost-sharing
  multiple-employer defined benefit plan, what
  amount do they recognize as benefit cost each
  period?

51
Question 18 response

• Normally the Annual Required Contribution

52
Question 19

• What are the accounting consequences if an
  employer in a single-employer or agent
  multiple-employer plan fails to contribute the
  full amount of the annual required contribution?

53
Question 19 response

• If ARC wholly or partially unfunded
• Accounting liability
• Net pension/OPEB obligation

54
Assume, for example, that an employers annual
required contribution for pension benefits is
12,000, but that the employer contributed only
10,000 of this amount. In that case, the effect
in the government-wide financial statements would
be as follows
55
Question 20

• For purposes of determining whether an employer
  has contributed the full amount of the annual
  required contribution, what qualifies as a
  contribution?

56
Question 20 response

• Contributions
• Outside parties
• Placed in trust or an equivalent arrangement
• Earmarked resources do not constitute
  contributions

57
Question 21

• When is it proper to treat an arrangement that is
  not actually a trust as equivalent to a trust
  for accounting purposes?

58
Question 21 response

• Requirements for an arrangement to be equivalent
  to a trust
• Once an employer contribution has been made, it
  cannot be recovered by the employer
• Resources are sheltered from the claims of
  creditors, both of the employer and of the entity
  administering the arrangement

59
Question 22

• Government-wide financial statements report
  expenses, while governmental funds report
  expenditures. Is there any practical
  difference between the two in the case of
  post-employment benefits?

60
Question 22 response

• General fund example (fund statements)
• Expenditures when payments made
• No accounting liability
• Government-wide example
• Expense when incurred
• Liability if not funded to the extent required
  each year

61
Net OPEB obligation (NOPEBO)

• Cumulative result of under funding ARC
• Reported in accrual-based statement
• Government-wide statement of net assets
• Proprietary fund statement of net assets
• Not reported in governmental fund balance sheet

62
Evaluating the Financial Health of Pension and
OPEB Plans

• PART 5

63
Question 23

• What are the key indicators of financial health
  for a defined benefit plan?

64
Question 23 response

• Two types of information crucial
• Funding progress
• Employer contributions

65
Question 24

• What kind of information do financial reports
  provide regarding funding progress?

66
Question 24 response

• Typically required supplementary information
• Actuarial valuation date
• Actuarial value of assets
• Actuarial accrued liability
• Unfunded actuarial accrued liability (UAAL)
• Funded ratio
• Covered payroll
• UAAL as percentage of covered payroll

67
Question 25

• What kind of information do financial reports
  provide regarding employer contributions?

68
Question 25 response

• Typically required supplementary information
• Annual required contribution compared to actual
  employer contributions
• Latter expressed as a of the former
• Employer contributions are a key indicator of a
  governments ability and willingness to meet its
  commitment to fund post-employment benefits

69
Question 26

• Why do analysts focus on trend data when
  evaluating the financial health of defined
  benefit plans?

70
Question 26 response

• Both actuarial numbers subject to considerable
  volatility
• Focus in funding progress on trends over time
• Direction
• Speed
• Focus in employer contributions on 100
  contribution rate

71
Next Steps

• PART 6

72
What are the next steps?

• Actuarial analysis next 60 days
• Policy decision on funding 2007-08 budget