Basic Information about GASB Statement 45

1. Basic Information about GASB Statement 45 Karl Johnson Project Manager Governmental Accounting Standards Board Norwalk, CT International Association of Fire Fighters Public Employee Forum on GASB Statement #45 Washington, DC, February 7, 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.

2. 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

3. Why the Board’s SuddenInterest in Accounting for Retiree Healthcare Benefits? • Nothing sudden about it: • The subject of “other postemployment benefits” (OPEB) was first placed on the Board’s technical agenda for research and development of transactions in 1987 • GASB issued interim guidance related to OPEB reporting in 1989, 1990, and 1994, but even then contemplated a more comprehensive look at the subject (the OPEB Project that produced Statements 43 and 45 in 2004) • Why was OPEB considered important from an accounting and financial reporting perspective? • Potential materiality, complex issues related to measurement and recognition of costs and obligations • Inadequacy of pay-as-you-go accounting practice to provide complete, decision useful information to financial report users

4. The OPEB Project • Nov. 1994 —GASB Statements 25, 26, and 27 on pension accounting issued • 1995-1996—the staff and Board attempted a quick adaptation of Statements 25 and 27 to OPEB, but ran out of time (competing project priorities, including Statement 34) • 1999-2004—intensive, sustained work resumed on OPEB issues, leading to issuance of Statements 43 and 45 • Settling on a basic approach (same as for pensions) • Adapting pension requirements to OPEB • Addressing Issues unique to OPEB (including alternative measurement method for very small plans and implicit rate subsidies) • Exposure Drafts (two required for Statement 45) and analysis of respondents’ comments

5. In a Nutshell:GASB Statement 45 (for Employers) • Subject: accounting and reporting byemployers for theirOPEB 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”

6. 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)

7. In a Nutshell:GASB Statement 45 (for Employers)(continued) • Requires measurement and disclosure of thetotalactuarial accrued liabilitiesfor 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)

8. Objective of Statement 45 • To faithfully represent (reflect like a good, non-distorting mirror) the financial effects of the underlying financial transactionthat creates OPEB • The Board concluded that the underlying transaction is 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 provideafter employment a pension and OPEB such as retiree healthcare, all as components of a total compensation package

9. Measurement Approach:Broad Steps of Process to Develop Information for Accrual Accounting and Financial Reporting 1.Project cash outflows for benefits 2.Discountprojected 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

10. How Allocated Portions of the PV of Projected Benefits Affect Financial Reporting • Amounts allocated topast 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 tocurrent period ~ normal cost (service cost) • The other principal component of annual OPEB cost • Amounts allocated tofuture periods ~ future normal cost • Not reported—pertains to services that haven’t occurred yet

11. Annual OPEB Cost and Net OPEB Obligation: Illustration (Employer in Year 2 of Applying Statement 45) Normal cost (current service cost) $ 350,000 Amortization of the UAAL (for past services) 600,000 Annual required contribution (ARC)* 950,000 Interest on beginning net OPEB obligation* 50,000 ARC adjustment*(58,500) Annual OPEB cost* = expense 941,500 Actual employer contribution* (PAYGO method of financing) (250,000) Increase in net OPEB obligation* 691,500 Net OPEB obligation—beginning* 650,000 Net 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.

12. 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

13. Funded Status Information: Illustration (Two Employers)Information Disclosed in Notes to Financial Statements and Presented in RSI Govt. AGovt. B Unfunded Partially (PAYGO)Funded Actuarial accrued liabilities (AAL) (a) $13,500,000 $13,500,000 Actuarial value of plan assets (b) -0--9,000,000 Unfunded actuarial accrued liabilities (UAAL)(a-b)13,500,0004,500,000 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%

14. 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

15. 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

16. 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 encouraged • Employers may apply Statement 45 prospectively—that is, may report zero beginning net OPEB obligation as of the beginning of the year of implementation

17. 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

18. 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

19. 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