GASB 45 Background and Implementing the Standards

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GASB 45 Background and Implementing the
Standards

• Joint Middle Management Conference
• April 16, 2007

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Part 1 - Background
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The Hysteria

• You Dropped a Bomb on Me, GASB Uncovering a
  1.5 Trillion in Hidden OPEB Liabilities for
  State and Local Governments Credit Suisse
• Old Promises Emerging Bills - Fitch
• Current Fiscal Policy is Unsustainable health
  expenditures will be 18.3 of GDP in 2013
• David Walker Comptroller General of the US
• 46 of health care financed with public funds
• US HHS report in 2003

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The Hysteria in Private Industry

• General Motors Near Bankruptcy because of
  health care costs
• GMs health care costs - 5.6 Billion
• American workers health care costs 1,500 per
  car
• Ford Forced into Major Layoffs
• Fords costs - 3.2 billion
• The worst part of all this is that these very
  high costs dont necessarily buy the best
  health.
• -- Rick Wagoner
• Chairman and CEO, General Motors

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Statement 45 (for Employers/Sponsors)

• Issued June 2004
• Affects employers that offer retiree healthcare
  and other post employment benefits
• Where applicable, will require accrual-basis
  accounting for expense and measurement and
  disclosure of funded status (UAAL)

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Executive Summary

• Must record expense and liabilities in GAAP
  financial statements if affected (as opposed to
  past practice of pay as you go)
• May have significant impact on sponsors
  financial statements
• Sponsors and funded plans will need actuarial and
  accounting analysis to evaluate impact of new
  standards

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Executive Summary

• Covers a wider range of benefits than may be
  apparent
• Some employers are surprised to learn they have
  an OPEB liability even though they believe they
  are not subsidizing OPEB
• Unless retirees pay 100 of true cost for
  medical benefits, employer is considered to be
  subsidizing and costs for financial reporting to
  be determined under these new rules
• Effective dates

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Annual Required Contribution (ARC)
Amortization Payment (portion of unfunded
liability)
Annual Required Contribution (ARC)
Normal Cost (value of benefits accruing in
current year)


Annual OPEB Cost (expense)
Adjustment to ARC (amort. of Net OPEB Obligation)
Interest on Net OPEB Obligation
Annual OPEB Cost (expense)
Annual Required Contribution (ARC)

-

Net OPEB Obligation (balance sheet)
Net OPEB Obligation (balance sheet)
Accumulated Annual OPEB Cost
Accumulated Employer Contributions

-
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Plan Assets

• To be considered plan assets must be
• irrevocably held in trust (or an equivalent
  arrangement)
• dedicated to providing benefits only to retirees
  and/or their beneficiaries in accordance with
  plan terms
• legally protected from creditors of the employer
  or plan administrator
• Earmarking of employer assets that do not meet
  these requirements will not be considered plan
  assets for GASB 45 purposes

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Plan Assets

• GASB 45 differentiates treatment based on whether
  a plan is advance-funded or not
• Advance-funded typically means consistently
  contributes the ARC
• Will require that money be set aside to pay
  future benefits
• Unfunded means benefits paid out-of-pocket as
  they are due
• Partially funded means a combination of the two

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Part 2 Where are states in implementing OPEB?
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Where are States in Implementing OPEB

• 23 have done either actuarial valuations or
  preliminary valuation (including Massachusetts,)
  remainder are in process
• 12 have either submitted trust legislation or
  have already enacted trusts
• 8 anticipate funding part or all of ARC in FY08

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Where are States in Implementing OPEB

• Funding Mechanisms being considered by states
  include
• of Tobacco Settlement Payments (Massachusetts)
• Appropriations (Many states)
• of payroll (Delaware, Florida, Georgia, Nevada,
  South Carolina)
• of Lottery Net Revenues (North Carolina)
• Other Funds and Predecessor Trusts

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How Large Are These Liabilities?
Estimated Unfunded OPEB Accrued Liabilities
Obtained through publicly available sources.
Billions
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How Large Are These Liabilities?
Estimated Unfunded OPEB Accrued Liabilities as a
of Personal Income
Obtained through publicly available sources.
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How Large Are These Liabilities?
Estimated Unfunded Per Capita OPEB Accrued
Liabilities
Obtained through publicly available sources.
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Overview of OPEB in Massachusetts

• OPEB is retiree health care costs, inclusive of
  dental / vision and a small amount of life
  insurance
• State is responsible for state workers, not
  teachers or other municipal employees for OPEB.
• Municipalities are responsible for them
• State contracts for health insurance through
  Group Insurance Commission (GIC)
• Municipalities contract for health insurance
  individually
• State and municipal employees are unionized

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Strategies Massachusetts is Considering or has
used to deal with OPEB

• Measured the Liability
• Without information, there can be no strategy
• Updated for FY2008 budget
• Amortizing Unfunded OPEB obligations over a long
  time up to 30 years
• Considering OPEB costs in any long term
  personnel decision making
• Governor has proposed legislation for a Trust
• Allows lower cost of funds due to higher return
  if funded

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How we are Using Results to Decide Strategy
DOES NOT INCLUDE TEACHERS
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How we are Using Results to Decide Strategy
DOES NOT INCLUDE TEACHERS
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How we are Using Results to Decide Strategy
Current PAYGO cost is about 330 MM OPEB is
2-3x Private industry is 6-10x
DOES NOT INCLUDE TEACHERS note numbers
unofficially updated to FY08 to 763.1M and
1,206M
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Sensitivity Analysis 1 ? in Health Care Trend
Rate no prefunding
? in UAAL 19.5 / - 15.1
? in ARC 24.4 / - 18.3
DOES NOT INCLUDE TEACHERS
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Sensitivity Analysis 1 ? in Health Care Trend
Rate Prefunding
? in UAAL 14.0 / - 11.4
? in ARC 17.0 / - 13.4
DOES NOT INCLUDE TEACHERS
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Sensitivity Analysis Change in Retiree
Contribution Rates to 25
? in UAAL - 11.8
? in ARC -11.7
DOES NOT INCLUDE TEACHERS
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Sensitivity Analysis Change in Retiree
Contribution Rates to 25
? in UAAL - 11.8
? in ARC -11.8
DOES NOT INCLUDE TEACHERS
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Funding Strategies Pros and Cons

• Create an Irrevocable Trust
• Pros
• If funded, affords most rate of return, cutting
  costs dramatically biggest bang for the buck
• May be a similar structure to current pension
  system, but separate legal entity
• Cons
• Inflexible the only way funds can be removed is
  for benefits, unless all future costs are paid
• Needs to be separate account from pensions for
  tax purposes

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Funding Strategies Pros and Cons

• Do Nothing
• Pros
• No budgetary effect
• Cons
• Debt ratings may be changed if peers are funding
  OPEB
• Ratios will be downgraded due to increased
  liabilities

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Funding Strategies Pros and Cons

• Partially Fund
• Pros
• Follows the spirit of GASB 45
• Shows management is taking action
• Massachusetts has proposed taking this approach
  using up to 90 of MSA payments
• Cons
• Cannot use highest interest rates, thereby
  lowering liability considerably
• Cash flow drain, though not as much as full
  funding

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Funding Strategies Pros and Cons Partial
Funding
Millions Pensions Only
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Funding Strategies Pros and Cons Partial
Funding
Governors proposal for funding up to 90 of
expected MSA Payments
Millions Pensions and OPEB
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Other Strategies for Dealing with OPEB that
Governments have Done or are Considering

• Change the health benefit structure
• Increase cost sharing
• Think outside the box
• Employee actions
• OPEB Bonds
• Insurance vehicles

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Funding Strategies Pros and Cons

• Increase Employee Contributions
• Pros
• Directly lowers employer obligations
• Employees have more of a stake in governments
  health care decisions
• Cons
• May trigger contractual issues with unions
• May not have an immediate affect as current
  employees and retirees may not be effected

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Funding Strategies Pros and Cons

• Allow greater employee options
• VEBA trusts, IRC 401(h) after tax contribution
  accounts, HSAs, Defined Contribution (DC),
  Retirement Medical Benefit Accounts
• Pros
• Employees have more of a stake in governments
  health care decisions
• Potential Tax Benefits for employees depending on
  vehicle
• Cons
• Need to be careful with DC accounts as it creates
  classes of employees

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Funding Strategies Pros and Cons

• Using one-time revenues, surpluses, MSA payments
• Pros
• Gives a quick jolt of funding with minimal pain
  on taxpayers
• Cons
• May be one time only true funding needs to be
  sustained

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Funding Strategies Pros and Cons

• Using bonds and insurance vehicles
• Pros
• Gives a quick jolt of funding with minimal
  immediate pain on taxpayers
• Cons
• Bonds trades a variable liability to a fixed
  liability
• Insurance products need to defease the liability
  to be effective

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Funding Strategies Pros and Cons

• The elephant in the room
• Control health care costs through consolidation
  and aggressive management
• Pros
• Combined with other strategies has the greatest
  effect
• Cons
• May require legislation and breaking down age-old
  barriers

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Quick Comparison of Funding Vehicles
Source TIAA CREF The Retiree Health Care
Challenge Page 16 November 2006
1 IRS PLR 200610025
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Quick Comparison of Funding Vehicles
Source TIAA CREF The Retiree Health Care
Challenge Page 16 November 2006
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Massachusetts Next Steps in GASB 45
Implementation

• Legislation needs to be passed on trust and
  initial funding model
• If funding is similar to Commonwealths pension
  model, get Federal approval
• Work with 60 separate auditees to get
  implemented
• Commission to explore future funding

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Questions