Copyright © 2007 by The Segal Group, Inc., the parent of The Segal Company. All rights reserved. How Consultants Determine Local Government Liability for.

Copyright © 2007 by The Segal Group, Inc., the parent of The Segal Company. All rights reserved.

How Consultants Determine Local Government Liability for OPEB

Public Employee Forum on GASB Statement #45

February 7, 2007

J. Richard JohnsonSenior Vice PresidentPublic Sector Health Practice Leader The Segal Company

2Copyright © 2007 by The Segal Group, Inc., the parent of The Segal Company. All rights reserved.

What’s Different in GASB Financial Statement Disclosure?

In the past… Annual outlay for retiree health premiums or benefit costs Only took current retirees into account Usually handled as a footnote

Going forward… Actuarial valuation of retiree health liabilities Reporting incorporated into financial statements

– Annual Required Contribution (ARC)– Net OPEB Obligation (NOO)– Required Supplementary Information

Takes into account both active employees and retirees


Financial Statement Disclosure

Income Statement Annual Required Contribution (ARC)

– The Actuarial Accrued Liability (AAL) is the portion of the actuarial present value of total projected benefits allocated to years of employment prior to the measurement date

– The Normal Cost is the portion of the actuarial present value of total projected benefits allocated to the year following the measurement date

– The ARC is equal to the normal cost and the amortization of the unfunded accrued liability.

– There is no requirement that the ARC is funded

Balance Sheet Net OPEB Obligation (NOO)

– The NOO is the cumulative difference between the ARC and the actual contributions made (if any).

– At transition the NOO may be set at zero

Notes to Financial Statements Generally similar to Retirement Supplement Information


What Benefits Are Included in OPEB Valuations?

Medical benefits

Dental

Vision

Prescription drugs

Life insurance

Legal services


What Goes Into the GASB OPEB Valuation?

Employee and Retiree Data

Actuarial Cost Method

Funding and Financial Data

PlanProvisions

Actuarial AssumptionsActuarial

Valuation

Results

Claims and Premium Cost


Calculation Begins with Starting Costs

Monthly claims and enrollment information for recent period of time (one to three years)

Includes active employees and retirees

Consider plan changes during the claim/enrollment period

Determine initial average cost – actives and retirees

True cost increases with age. Project starting costs to reflect “cost curve”

“Starting costs” are the true costs at age 65 for the following: Male, pre-65

Female, pre-65

Male, post-65(post-Medicare)

Female, post-65 (post-Medicare)


What’s Different in Rate Calculations?

Traditional Rate Setting

GASB Rate Determination

POOL:ActivesRetirees

Medicare Retirees

$500/mo

RATES: Total

Active $500Pre-65 Retiree $500Medicare Retiree $300

Active Employees

Pre-65 Retirees

Medicare Retirees

Actual IMPLICITRATES: Total SUBSIDY

Active $375 $125

Pre-65 Retiree $675 ($175)

Medicare Retiree $325 ($25)


Establish Methods and Assumptions

Funding methods Allocate costs between normal cost and accrued liability Methods vary in stability and funding pattern 6 methods available for GASB valuation

Actuarial assumptions Need to match related DB retirement plan assumptions Investment return assumption (discount rate) is dependent on funding

– No pre-funding – use employer’s rate of return on assets (3%-4%)– Pre-funding – use rate of return on funded assets (7%-8%)

Healthcare cost trend assumptions– Based on experience of covered group– Reflects expected long-term future trends– Can differ by benefit– Typically starts at 10%-12%, then decreases 1% each year until ultimate

level is reached (typically 5%)


What Issues are Public Employers Facing?

Health benefit costs are increasing much faster than general inflation

Health costs increase as an employee/retiree gets older

Limited ability to fund liability out of current revenue flow – will OPEB destroy the budget?

Large OPEB liability can impair jurisdiction’s ability to issue bonds

How to explain large retiree health liability to stakeholders and general public

To fund or not to fund?

How to balance competing revenue interests


0.0

2.0

4.0

6.0

8.0

10.0

12.0

14.0

16.0

18.0

20.0

1999 2000 2001 2002 2003 2004 2005 2006 2007

An

nu

al P

erce

nta

ge

Incr

ease

Non-Network PPO POSHMO HD-PPO Rx RetailMedical Inflation Overall Inflation Workers Earnings

ACTIVES AND RETIREES UNDER AGE 65

Source: 2007 Segal Health Plan Cost Trend Survey and U.S. Bureau of Labor Statistics.

U.S. Projected Medical Trends (with Rx)

Gap


What are Employers Doing to Address the OPEB Liability?

Getting an early handle on the GASB OPEB liability

Rethinking the programs Eligibility and entitlement for retiree health benefits Plan design changes Looking at different subsidy approaches - separate for actives and

retirees

Investigating pre-funding options Retiree health trust options Redeploying existing fund balances Surcharging current employee and employer rates to build reserves Using retirement plan assets for funding retiree health benefits

Balancing retiree health against other revenue sources and uses

Reviewing total pay and the balance between pay and benefits

12Copyright © 2007 by The Segal Group, Inc., the parent of The Segal Company. All rights reserved. 12

June 30, 2009

GASB Timeline/Implementation Plan

June 30, 2006 June 30, 2007 June 30, 2008 June 30, 2010

FY2010 Deliver

Final GASB Valuation

& FinancialReporting

Budget Estimate

for FY2010

Data Collection

Assumptions&

Valuation

FY2009 Deliver

Final GASB Valuation


Budget Estimate

for FY2009

Data Collection

Assumptions&

Valuation

FY2008

Planning&

Analysis

Initial GASB

Liability Estimate

DeliverFinal GASB Valuation


Budget Estimate

for FY2008

Data Collection

Assumptions&

Valuation


Benefit Design Strategy to Manage Liabilities

The Three “R”s of Cost Containment:

Redefining Eligibility Requirements Tie retiree health eligibility to

service levels Consider institutional goals for work

force planning Review spouse coverage rules Eliminate retiree health benefits to get

rid of OPEB liability?


Benefit Design Strategy to Manage Liabilities continued


Restructuring Benefits Create new tier for new hires Reduce benefits for future retirees Review Medicare Coordination Method Review Prescription Drugs

– Leverage Medicare Part D– PDP vs. Subsidy– Eliminate Rx plan

Establish benefit caps Look at underlying health plan to

manage utilization and claim costs


Benefit Design Strategy to Manage Liabilities continued


Rethinking Cost Sharing Move to a flat dollar employer share Increase retiree contribution Tie benefit levels to service levels Defined Contribution approach

– Fund while employees are active


Key Decision: Pre-funding

OPEB Requires Disclosure – NOT FundingOPEB Requires Disclosure – NOT Funding

Experience already shows moving from pay-go to pre-funding increases annual costs 3–6 times.

Experience already shows moving from pay-go to pre-funding increases annual costs 3–6 times.

11

Debt Financing

33

22Options

Pre-funding

Pay-As-You-Go

44 Combination


To Pre-fund or Not to Pre-fund?

No simple solution for all jurisdictions

Opportunity trade-offs Pre-funding

– Lower liabilities, better rating, lower cost of capital, higher current year costs

Pay-Go– Higher liabilities, potential lower rating, higher cost of capital, lower

current year costs

Pre-funding requires clear set aside from jurisdiction accounts Separate retiree health trust Irrevocable trust within an existing

health fund trust


Pre-funding Trade-offs

Level of Pre-funding

Proportion of benefits pre-funded will dictate discount rate Pay-go (no pre-funding) is risk-free rate –

can base on internal ROI Pre-funding can use a market rate

used in similar retirement trusts

Irrevocable or Not?

If funding vehicle is not irrevocable, jurisdiction cannot count assets as OPEB assets in the financial statement

However, full disclosure and discussions with rating agencies may help mitigate rating risk


Debt Financing

OPEB Obligation Bonds

Taxable municipal “arbitrage” bonds

Trading soft debt for hard debt

First one—Gainesville, Florida

Does long term debt for retiree health make sense with future of nationalized health care unknown?

Insurance approaches paired with OPEB bonds Life insurance policy purchase for active employees Perception issues among elected officials re betting people

will die as a way to fund retiree health Complex, multi-tiered funding approach is difficult for

taxpayer to understand


Pre-Funding Vehicle Merits Shortcomings

Employer General Asset Accounts

Simple set-up Considerable flexibility in funding and plan design

Employee contributions only permitted on an after-tax basis Use of account assets not restricted to plan purposes Assets subject to the claims of general creditors. Subject to certain nondiscrimination requirements

State-Law Grantor Trusts (Integral IRC Section 115 Trusts)

Considerable flexibility in funding and plan design Use of trust assets may be limited to the exclusive benefits of the

covered employees and their families

Employee contributions only permitted on an after-tax basis Varying state laws for establishment and governance of trusts Subject to certain nondiscrimination requirements

Voluntary Employees’ Beneficiary Association Trusts (VEBAs)**

VEBA assets and earnings specifically earmarked for the sole purpose of providing the intended benefits (e.g., life, sickness, accident or other benefits) to members of the association or their dependents or designated beneficiaries

Considerable flexibility in funding and plan design

Employee contributions only permitted on an after-tax basis Funding limits differ for bargained and non-bargained employees Limits on types of benefits offered Subject to certain nondiscrimination requirements

Section 401(h) Retiree Medical Accounts within a Pension Plan***

Use of assets restricted to medical purposes Pre-tax employee contributions permitted through a mandatory

“pickup” arrangement in which all eligible employees must participate

On plan termination, excess assets revert to the employer

Possible employee dissatisfaction stemming from mandatory and irrevocable “pickup” arrangement

Additional administration required: separate funding and accounting for pension and medical benefits

Contributions limited to 33 1/3% of total retirement contributions. Sponsors of well-funded pension plans may not be able to make contributions because of this limit.

Health Reimbursement Arrangements (HRAs)

Allows year-to-year carry-over of unused value Encourages careful consumption of health care services

May discourage employee or dependent from seeking needed medical care now, resulting in potentially greater insured costs later

Additional administration required Coordination of HRAs with Medicare may be problematic

Health Savings Accounts (HSAs)

Vehicle for active employees to save for retiree health premiums Account balance carries over and is portable if employee leaves Employer may contribute to savings account to fund part of the

high deductible

Employee/employer contributions are limited (Archer IRA limits) Must be paired with a high deductible health plan ($1, 000 single/$2,000 family),

retiree savings vehicle not available by itself Low paid participants with significant health claims may not be able to have money

left in account to carry over for retiree health premiums later May discourage employee or dependent from seeking needed medical care now,

resulting in potentially greater insured costs later Additional administration required for savings and investment component

Pre-Funding Options


How Does Retiree Health Fit Into Total Rewards?

Employee Value

Proposition

Direct Financial

Affiliation

WorkContent

CareerIndirect Financial

Organization commitment Organization support Work environment Organization citizenship Title

Base salary Incentives Ownership Cash recognition Premium pay Pay process

Benefits Non-cash

recognition Perquisites

Advancement Personal Growth Training Employment security

Variety Challenge Autonomy Meaningfulness Feedback


Looking Ahead – New Themes in Retiree Health Benefits

What can/should be done to ensure that health benefit promises made to retirees are kept?

What are acceptable trade-offs between generations?

Is it better to have pressure on bond ratings or pressure on current year budget?

How to balance among pay increases, pension benefits and retiree health benefits?

How important are retiree health benefits in light of total compensation?

Copyright © 2007 by The Segal Group, Inc., the parent of The Segal Company. All rights reserved.

Questions?

J. Richard [email protected]

Copyright © 2007 by The Segal Group, Inc., the parent of The Segal Company. All rights reserved. How Consultants Determine Local Government Liability for.

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