GASB Retiree Life & Health Valuations and Medicare Reform

1. GASB Retiree Life & Health Valuations and Medicare Reform Implications for Employers, Employees & Retirees SOUTHERN WESTCHESTER SCHOOL BUSINESS OFFICIALS November 4, 2005

2. Agenda • GASB 45 overview • Solutions to reduce GASB 45 liabilities • Coverage Plans and Impact on GASB 45 • Current Medicare program and plans • New Medicare reform and plans • Other Employee Benefits

3. What is GASB 45? • Government Accounting Standards Board issued Statement No. 45, Accounting and Financial Reporting by Employers for Post-Employment Benefits Other Than Pensions • GASB 43 applies to the plan itself • GASB 45 applies to the plan sponsor’s financial statements • Requires public agencies, including school districts and county offices of education (COE), to report their costs and obligations for post-employment healthcare and other post-employment benefits (called “OPEBs”) • Reporting - Similar to pensions • GASB 25 – Plan; GASB 27 – Employer • Recognized as a current cost during the working years of an employee (similar to pension) rather than after they retire.

4. Retiree Health & Life Valuations • Employers FAS 106 • Multi-Employers SOP 92-6 • Municipalities GASB 45

5. Impact on School Districts & County Offices • Identify and disclose OPEBs as an expense and liability on their financial statements for the first time. • This means each district or county office will have to evaluate whether they have an OPEB liability • Need to have an actuarial valuation done to determine the amount of the unfunded liability for their financial statements. • Each affected district and county office will have to address how best to manage this liability for the future.

6. Key Financial Data • Annual OPEB Costs (annual expense) • Net OPEB Obligation (balance sheet liability) • Actuarial Liability • Funding Status • Unfunded liabilities • May impact bond ratings

7. Annual OPEB Costs (AOC) • Employer’s Expense • Annual Required Contributions (ARC) • Normal Cost: Actuarial valuation • Amortization of Unfunded Actuarial Accrued Liability (30 years) • Amortization of gain/loss and plan changes depending on plan methods • Plan Adjustments • Contributions going up • ARC going down

8. What is ARC? • Annual Required Contribution of the employer (ARC). • Used to determine the expense and liability values that appear on the employer's financial statements for the purposes of GASB 45. • This does not refer to actual contribution requirements, but to employer's accrual expense.

9. Result of GASB 45 • Clients to recognize costs for OPEB when employee services are rendered (accrual accounting) • OPEB is part of employees’ compensation • Client under pressure to fund the obligation in advance rather than on the prior “pay as you go” basis. • Failure to pre-fund the obligation may impact: • Future borrowing costs • Credit ratings • Overall financial health of organization • “Perceived” financial health of organization • Most companies do not pre-fund liability (public or private)

10. Implementation Dates • Depending on the district or county office size, the compliance dates for GASB 45 are as follows: • 2007-08 fiscal year: Districts/COEs with total revenue of $100 million or more must comply in the fiscal year after December 15, 2006. • 2008–09 fiscal year: Districts/COEs with annual revenue between $10 million and $100 million must comply in the fiscal year after December 15, 2007. • 2009–10 fiscal year: Districts/COEs with annual revenue less than $10 million must comply in the fiscal year after December 15, 2008. • Figures based on 1999 fiscal year. • Frequency: • 200+ members (every 2 years) • Less than 200 members (every 3 years)

11. Difference between GASB and Pay-As-You-Go • GASB – Level to gradual growth over time since accruing future costs today • Pay-As-You-Go – Increases as population of retirees increase over time • Impact • Pay-As-You-Go: Manage on a year by year basis • GASB: Reflect future benefit costs now resulting in potential reduction in retiree benefits to be offered • Accrued Liabilites – 6 to 20 times current annual costs • Accrual Expense – 1.5 to 3 times current annual costs

12. Sample Calculations

13. OPEB – What is Included? • Medical • Dental • Vision • Hearing • Prescription drugs • Life insurance • Long-term care • Long-term disability • Death benefits • Other Benefits (e.g., Group Legal)

14. Necessary Data to Complete Valuation • Summary of Plan Offerings • Census Information • Plan Costs • Actuarial Assumptions

15. Summary of Plan Offerings • Multiple Plan Designs • Current Plan • Legacy Plans or variations based on hire dates/class • Coverage Groups • Retirees – Pre 65 & Post 65 • Covered Dependents • Coordination with Medicare • Contribution Rates • Flat Amount • Fixed % • Vary by class, date of hire, employee vs dependents

16. Census Information • Date of Birth • Date of Hire • Gender • Status (Active, Retired, Terminated) • Benefit Election • Coverage Tier (Single, Dependents, etc.) • Salary • Benefit Amount (e.g., Life Insurance Face Amount) • Class • Contribution Rates

17. Plan Costs • Fully Insured Benefits • Current Premium Costs • Historical Premium Costs • Self-Funded Benefits • Current Admin Fees – TPA, PPO, UR • Claim Costs – Current & Historical • Stop Loss Insurance – Specific & Aggregate • Variations by Class & Plan • Pre-65 vs Post-65 • Contribution Rates

18. Actuarial Assumptions • Benefit costs – Pre 65 vs Post 65 • Healthcare cost trend rate • Interest discount rate • Retirement rates • Turnover rates • Disability rates • Mortality rates • Aging Assumptions (Age/Sex Factors) • Asset return on investments (if funded) • Salary increases (life insurance) • Plan Participation % • Actuarial cost methods

19. Benefit Costs • Baseline calculations drives financial results • Pre-65 vs Post-65 • Critical to negotiate favorable cost structure • Reduction in cost has magnified long term savings (lowers liability and future accruals) • Impacts collective bargaining negotiations • Future active and retiree benefits • Favorable impact to community

20. Benefit Costs (Continued) • Key Negotiation Factors • Medical inflation • Reserve completion factors • Insurance company risk charges (profit margins) • Insurance company administrative expense loads • Credibility factors • Values for plan changes • Other factors - Intangibles

21. Challenges in Valuation Process • Quality of Data • Impact of Current Experience • Limitations in collective bargaining flexibility • Fully insured vs. Self-funded

22. Implications for Current Employees • Increases expense and liabilities to be recognized. • Requires additional pressure to reduce costs of employee benefits. • Actives • Retirees • Impacts Budget Process • Impacts Collective Bargaining

23. What makes liabilities increase? • Increase in health care costs and inflation (trend) • Reduction in discount interest rates • More early retirements • Lower turnover (non-vested) • Mortality improvements

24. Strategies to Reduce Liability • Lower current medical costs • Managed care plans • Consumer Driven Health Plans • Mandate certain benefit requirements (mandatory mail order prescription drugs and generics) • Reduce benefit offerings • Terminate benefit coverages • Mandate Medicare Part B participation • Change future retiree benefits • Tighten eligibility • Increase employee contributions • Raise contribution rates • Implement dollar or inflation caps (limit future trend increases)

25. Other Solutions • Define contribution strategy • Cap employer subsidy • Give employees money to buy their own benefits • Medicare Part D will shave some costs for post-65 retiree population • Seamless administration will be critical for success • Retiree buyouts (selling off liabilities) • Be Proactive • Initiated discussions now with various departments • Discussions with collectively bargained personnel • Evaluate various scenarios to identify opportunities

26. Medicare “Parts” • Part A • Include: Hospital coverage, skilled nursing • Exclude: Custodial, long term care • Individual Deductible of $952 first 60 days (2006) • Free to most over 65 • Part B • Physician, ambulance, outpatient therapy and other professional services • Deductible + 80/20 coinsurance • Deductible: $124 (2006) • Monthly premium $88.50 (2006) • Part C • Medicare + Choice • Now re-named Medicare Advantage (MA) • Private plans made available in lieu of Parts A & B • Part D • New Prescription Drug plan

27. Medigap Plans • Secondary Payment Plans after Medicare (must have Medicare) • “Medigap” = Good housekeeping label • Labeled Plans A through J and new K and L • Provided by Insurance Companies • Standard features – all carriers, generally all states • Many provisions make little sense • Reimburse enrollee for Medicare deductibles and coinsurance • Limited or no coverage for Rx

28. Medicare Managed Care (Part C) • Exchange entitlement to Parts A and B for opportunity to enroll in private plan • Government pays private plan the value of the Medicare coverage (AAPCC) • Restricted networks (similar to Commercial HMOs and PPOs) • Offer increased benefits • Dental • Rx (e.g., generic coverage, discount cards)

29. Medicare Reform • The Medicare Prescription Drug, Improvement, and Modernization Act of 2003 (MMA) adds prescription drug coverage as of January 1, 2006. • Available to those eligible for Medicare benefits due to age, disability or end-stage renal disease. • Provides that employers who continue prescription drug coverage for retirees who would otherwise be eligible for Medicare drug benefits can receive a tax-free subsidy.

30. Prescription Drug Program – Medicare Part D • Voluntary Drug Benefit in 2006+ • Stand-alone benefit, for a premium (compete with Medicare Advantage) • Provided through private plans • Enrollment begins 11/2005 • “Standard” plan or actuarially equivalent plan • Catastrophic coverage, with minimal benefits for those with lower costs • Subsidies to employers who provide coverage

31. Prescription Drug Program – Medicare Part D (continued) • Prescription Drug Plan Design • $250 deductible • Medicare covers 75% of cost up to $2,250 • Medicare covers 0% from $2,250 to $5,100 • Medicare covers 95% of costs above $5,100 • Low income subsidies • Waive premiums/deductibles & increase benefits for low income patients • Medicare will be primary payer (over Medicaid)

32. Okay…so how do we assess the cost of all these benefits?

33. Part D -- Illustrative Cost Sharing Retiree also pays $420 Annual Premium Overall reimbursement Is about 50% of cost

34. Impact on Individual Beneficiaries -- 2006

35. Impact of Medicare Reform on These Employers • Employers maintaining Rx plans get tax-free subsidies of 28% of gross drug costs between $250 and $5,000 (indexed) • Worth perhaps $500 (cash) per year if programs are kept in place • Reflect present values in FAS 106 (or GASB 45) valuations • Larger savings if plans are dropped • Requirements for subsidy • Plan must be at least actuarially equivalent to the Medicare Rx plan • Provide actuarial certification • Maintain records, disclose as required • Plan redesign may be needed • Meet minimum requirements for subsidy • Reduce or eliminate coverage

36. How the Subsidy Will Operate • A cash credit to the Employer – tax-free • Based on the amount of claims underlying the benefits provided • 28% of the amounts between $250 and $5,000 per person per year. • Estimate subsidy and actuarial equivalence: • Model Rx costs by person, projecting costs to 2006 • Use both current employer design, and Medicare design

37. Planning Issues for Employers with Retiree Plans • Should an Employer keep a plan or not? • A question of potential savings vs. retiree reaction • Subsidy estimated as $400 to $500 per person (cash savings) • Total elimination could be $1,600 to $2,200 per person (cash) • FAS106 & GASB 45 expense and obligation are also reduced • Alternative strategies: • Eliminate Rx coverage, but pay the Part D premium (projected to be $420 in 2006, but increasing by drug trend). • Encourages members to enroll in Part D, but benefit levels will not be the same as under the Employer Plan.

38. Retiree Response • Retirees with employer coverage and/or low drug bills may not want to buy in to Part D • Potentially difficult choice • Premiums are substantial for low risk individuals: breakeven point is at $810 of drug expense – in 2006. Higher in future years. • Those opting out will be taking a risk, as they may not be able to enroll at will • Contributions likely to be a driver • If Employer plan costs less than Medicare, retirees likely to stay with Employer • High cost Employer plan may push retirees to Medicare

39. Impact on Medigap Policies • Recognition that current plans encourage utilization • NAIC to be asked to develop new plan standards to recognize changed conditions and need for cost controls • New ground rules effective 1/1/2006 • Prohibits sale or renewal of Medigap with Rx coverage • But, those who decline Part D may renew such plans • Current Plans H, I & J to be modified to exclude drugs and offered to new enrollees • Two new plans • 50% and 25% coinsurance, and OOP limits • No coverage of Part B deductibles

40. Other Medicare Reforms • Medicare to provide: • Cover preventative screenings • Pay for Medication Therapy Management services, which can be administered by a pharmacist • Cover Chronic Care Improvement programs for patients with high healthcare costs or multiple chronic disease states • Standards for Electronic Prescribing to be set (compliance required by 2008?)

41. Resources for Information“Websites to Know” • Medicare - www.medicare.gov • Centers for Medicare & Medicaid Services (CMS) – www.cms.gov • American Association of Retired Persons (AARP) - www.aarp.org • State Specific • New York: Health Insurance Information, Counseling & Assistance Program- www.hiicap.state.ny.us/medicare/ • Many other resources

42. Open Discussion

43. Thank you Michael L. Frank, ASA, MAAA, FCA President & Actuary Aquarius Capital Phone: (914) 933-0063 E-Mail: michael.frank@aquariuscapital.com Donald J. Rusconi II, CFA Vice President & CFO Aquarius Capital Phone: (203) 458-1495 E-Mail: donald.rusconi@aquariuscapital.com Website: www.aquariuscapital.com