GASB 43 and 45 Accounting for Other Postemployment Benefits OPEBs

1. GASB 43 and 45Accounting for Other Postemployment Benefits (OPEBs) TAC Annual ConferenceAugust 17, 2006

2. Statement 45 (for Employers/Sponsors) Issued June 2004 Will generally affect an employer that offers retiree healthcare or other post employment benefits that are not pension benefits If applicable to an employer, will require accrual-basis accounting for expense and measurement and disclosure of funded status (UAAL)

3. Statement 43 (for Funded Plans) Issued in April 2004 Affects administrators and sponsors of plans (here, meaning a plan that has assets) For trusts, requires statements and disclosures similar to GASB 25; for non-trust funds, requires reporting as an agency fund

4. Executive Summary GASB Statement Nos. 43 and 45 in brief Government employers which sponsor certain post-retirement benefits programs (e.g., medical) are affected and must generally comply with and report under GASB No. 45 Results in recording expense and liabilities in financial statements rather than typical past practice of “pay as you go” expensing May have significant impact on sponsor’s financial statements Funded OPEB plans must generally comply with and report under GASB No. 43 Sponsors and funded plans will need actuarial and accounting analysis to evaluate impact on accounting treatment of these plans There is opportunity to understand implications and explore alternatives before effective date of Statements

5. What is an “OPEB”? Postemployment benefits other than pensions (“OPEB”): Includes postemployment healthcare benefits (medical, dental, etc.) Includes other types of non-pension benefits (e.g., life insurance) if provided separately from a pension plan (otherwise accounted for as part of pension benefits) OPEB does not include special termination benefits, early retirement incentive programs, etc. (however, effects of these special benefits on existing OPEB plans should be accounted for under GASB Nos. 43 and 45) OPEB does not include conversion of sick leave to individual defined contribution retiree healthcare accounts (but any subsidy in amounts charged for healthcare coverage and deducted from account are covered by GASB 43 and 45)

6. Current Practice Very few governmental OPEB plans have ever had an actuarial valuation Most OPEB plans are financed on a pay-as-you-go basis Financial reporting practice has generally focused on reporting outflows of current financial resources (i.e., the pay-as-you-go or cash basis) Therefore, current financial reporting generally fails to: Recognize the cost of benefits in periods when services are received Provide information about the current value of future promised benefits and associated liabilities Provide information useful in assessing potential demands on future cash flows

7. Accrual Recognition of OPEB The new standards require that OPEB costs generally be recognized over the working lifetime of employees The new standards are the GASB-equivalent of FASB’s SFAS No. 106 in the private sector The entity legally responsible for making the contributions should report and comply with GASB 45 Postemployment benefits (both pensions and OPEBs) are considered part of compensation for services rendered by employees, so theoretically should be expensed and accrued during the employee’s working lifetime GASB 45 does not apply to sponsor if retirees and beneficiaries pay 100% of actuarially determined cost of coverage, taking into account only retirees and their beneficiaries

8. Implementation Provisions for GASB 45 Prospective implementation; the initial Net OPEB Obligation on balance sheet is generally set equal to $0, regardless of funded status of plan Can develop retroactively determined Net OPEB Obligation if desired, but this will likely be very rare Effective for periods beginning after December 15: 2006 if sponsor has >$100M revenue 2007 if sponsor has $10M – $100M in revenue 2008 if sponsor has <$10M in revenue Earlier implementation is encouraged

9. Recognition in Governmental Entity Financial Statements Under GASB 45, financial statements of employers should recognize OPEB expense in an amount equal to Annual OPEB Cost for the period, regardless of the amount paid in cash The cumulative difference between amounts expensed and “contributions” to the plan will create a liability (or asset) on the sponsor’s balance sheet called the Net OPEB Obligation Additional footnote disclosure and supplementary information is required

10. GASB 43 and 45 Accounting Impact

11. Accounting for Employers The impact on the sponsor is a function of: Type of plan (Defined Benefit vs. Defined Contribution) Plan design Cost sharing provisions (sponsor vs. member) Assets in trust (if any) Demographics of covered members Currently virtually no government entities prefund or recognize a liability for OPEBs

12. Accounting for Employers Currently most governmental entities budget a year’s premiums/claims In future will need to budget the ARC (plus adjustments, if any) for enterprise and internal service funds Recognition may impact bond ratings which could change the cost of borrowing

13. Accounting for Employers Transition: employers may (not required to) calculate net OPEB obligation at transition Most employers will set Net OPEB Obligation at transition to zero Discussion later focuses on how the unfunded actuarial liability is factored into Annual OPEB Cost (expense) and potentially becomes a financial statement obligation On-going Net OPEB Obligation: Amount recognized at transition (if any), PLUS Cumulative difference between the annual OPEB cost and the employer’s contributions

14. GASB 45 Note Disclosures (Highlights) Note disclosure requirements for OPEB employers generally are similar to those for pension employers under GASB 27 Examples: Disclosures of plan description and funding policy (all employers) Disclosures of amount and components of annual cost, amount actually contributed, change in Net OPEB Obligation, and % of annual cost contributed (sole and agent employers)

15. GASB 45 Note Disclosures (Highlights) However, the Board has added or modified disclosure requirements for OPEB at several points Examples: OPEB note disclosures include disclosure of the funded status of single-employer and agent plans in which an employer participates, as of the most recent actuarial valuation (not required for pensions under GASB 27)

16. GASB 45 Note Disclosures (Highlights) Examples (continued): There should be expanded explanatory disclosures about actuarial methods and assumptions* * The purpose of these is to make reported financial information about OPEB understandable to a wider range of financial report users

17. GASB 45 Note Disclosures (Highlights) Information about funded status of the plan: Actuarial valuation date Actuarial accrued liability (AAL) Actuarial value of plan assets – generally a market related value Unfunded Actuarial Accrued Liability (UAAL) Funded ratio (actuarial value of plan assets/AAL) Ratio of UAAL to covered payroll Notes regarding changes affecting the interpretation of trends in the amounts reported

18. GASB 45 Required Supplementary Information (RSI):Schedule of Funding Progress Employers also will be required to disclose as RSI multi-year trend information about the UAAL and progress made in funding the plan (similar to pension plans under GASB 27), including: Actuarial accrued liability (AAL) Actuarial value of plan assets--generally a market related value Unfunded actuarial accrued liability (UAAL): (AAL minus plan assets)

19. GASB 45 RSI: Required Schedule ofFunding Progress (continued) Funded ratio (actuarial value of plan assets/AAL) Ratio of UAAL to covered payroll (an indicator of the relative size of the UAAL) Notes to RSI regarding changes affecting the interpretation of trends in the amounts reported Information is required for the most recent actuarial valuation plus the two preceding valuations Special provisions for sponsors in cost-sharing plans (information on entire plan to be included as RSI)

20. GASB 43 Financial Statements for Plans Required statements for defined benefit plans Statement of net plan assets Statement of changes in net plan assets Required Supplementary Information (RSI) This presentation is for those plans administered as trust or equivalent Accrual basis (liabilities for benefits and refunds recognized when due) Investments at fair value in the financial statements (but at market-related or “actuarial” value in actuarial valuations to calculate the UAAL and the ARC)

21. GASB 43 Financial Statements for Plans Note disclosures: Plan description Summary of significant accounting policies Contributions/legally required reserves (includes sources and rates of contributions and funding policy) For single and agent employers Information about funded status as of most recent valuation date (similar to GASB 45) General information on actuarial methods and assumptions

22. Comparison with GASB Nos. 25 and 27 as they come due. These would be plan investments for a funded plan, the employer’s investments for a pay-as-you-go plan, or a weighted average of expected plan and employer investments for a plan that is partially funded. as they come due. These would be plan investments for a funded plan, the employer’s investments for a pay-as-you-go plan, or a weighted average of expected plan and employer investments for a plan that is partially funded.

23. Comparison with GASB Nos. 25 and 27 (cont.) as they come due. These would be plan investments for a funded plan, the employer’s investments for a pay-as-you-go plan, or a weighted average of expected plan and employer investments for a plan that is partially funded. as they come due. These would be plan investments for a funded plan, the employer’s investments for a pay-as-you-go plan, or a weighted average of expected plan and employer investments for a plan that is partially funded.

24. Annual Required Contribution of Sponsor (“ARC”) Key measure that is basis of OPEB expense recognition, very similar to ARC for pensions under GASB 27 Represents the level of contribution effort necessary on an ongoing, sustained basis to: Cover the normal cost for each year (normal cost is the value of the portion of the ultimate benefit allocated to the current year by cost method), and Amortize the unfunded actuarial liability (“UAL”), or the difference between the actuarial liability and plan assets; actuarial liability is the value of future plan benefits attributable to past service of members In calculating UAL, due and unpaid or excess contributions should not be included in assets unless settlement is expected not more than one year after the deficiency has occurred or if excess is to be used within one year

26. Actuarial Valuations Generally must perform actuarial valuation to calculate cost and obligations Valuations will be required under GASB OPEB standards: At least biennially for plans with 200 or more members At least triennially for plans with fewer than 200 members More frequent valuations are acceptable Generally, expected that calculations would be performed by credentialed actuaries with appropriate expertise Alternative measurement method permissible if fewer than 100 members “Members” are current retirees or surviving spouses receiving retirement benefits plus active employees who could receive benefits in the future under current plan provisions

27. Date of Actuarial Valuation Does not need to be as of financial statement date Must be within 24 months of first day of financial statement period if annual valuations are completed Must be within 24 months of first day of first year of a multi-year valuation cycle if valuations are biennial or triennial New valuation should be performed if significant changes in plan or participants covered since last valuation

28. Substantive Plan The terms of the plan as understood by the employer and participants whether written or not Usually documented through Plan documents, SPDs, or other written communications to the participants Pattern of actual practice and procedures Legal or contractual caps apply for valuation purposes depending on sponsor’s record of enforcing them and other relevant facts and circumstances Note that subsidized benefits to retirees produce OPEB obligations (e.g., if retirees were required to pay only active employee rate)

29. Implicit Rate Subsidy – An Illustration Assume a sponsor provides healthcare benefits to active employees and to eligible retirees until age 65 The sponsor pays 100% of the blended premium of $250 per month per member for active members The retirees pay 100% of blended premium of $250 per month Actual age adjusted premiums (approximating claims costs) are $200 for active members and $400 for retirees By committing to allow retirees to pay only the blended premium, the employer is indirectly paying the difference between the true cost of retiree coverage and the amount being paid by the retiree by paying higher costs for the active members – this subsidy creates an OPEB obligation under GASB 45

30. Actuarial Valuation Process

31. Suggested GASB 45 Implementation Approach Perform actuarial study of current plan Analyze funding options (could affect discount rate assumption) Evaluate impact on financial statements, future cash flows Consider modification of program to best meet needs of organization and employees if current plan cost is unacceptable Actuarial study of alternative plan designs Implementation of changes (if any)

32. Determining Cost of Current Plan (per GASB 45) Identifying affected benefits Identifying substantive plans Collecting data for measurement Selecting actuarial assumptions and procedures Measuring liabilities

33. Identifying the Substantive Plan Review plan summaries Collective bargaining agreements Written documents to employees Review of actual practices Clarify cost-sharing arrangements (with retirees) New Medicare Prescription Drug Coverage (Part D) Subsidy or through plan design? Affects treatment under actuarial valuation

34. Collecting Data for Measurement Could be an issue because normally this data has never been collected before, so could take more time the first time Census data for active employees Could include: name, employee ID, DOB, DOH, sex, coverage information, marital status, salary (if applicable) Census data for retirees Could include: name, ID#, DOB, sex, coverage information, marital status Claims and/or premium data to set claims costs Effect of HIPPAA on obtaining employee data Concerns with distribution of protected health information (PHI)

35. Selection of Actuarial Assumptions and Procedures Demographic assumptions Mortality Turnover Retirement age Marital status Should be consistent with those used for pension accounting where entity also has a pension plan Economic assumptions Discount Rate – depends on “funding” Health care cost trend Depends on plan experience and benefits offered May be different for pre-65 and post-65 benefits Typically, grades down over a period of years Salary increases (where applicable)

36. Actuarial Assumptions In general Same assumptions should be used for plan financials (GASB 43) and sponsor financials (GASB 45) for same or related information Actual experience should be used if credible, but experience must by analyzed for anomalies and reasonableness Reasonableness of each assumption should be independently assessed (each one should be reasonable on its own) Each assumption should also be consistent with other assumptions (e.g., underlying inflation component of discount rate and salary increase assumptions)

37. Actuarial Assumptions Liability discount rate (investment return rate) Long-term investment yield on assets that will be used to pay benefits Based on plan assets, if funded, or Employer assets if pay-as-you-go, or Combination/blend if plan is partially funded OPEB expense will very likely be higher if plan is not funded Consider differences in discount rates for funded and unfunded arrangements

38. Actuarial Assumptions Medical trend Medical trend in past few years has been in range of 10% - 15%+ Claims costs Should be based on expected actual claims costs and expenses associated with current and future retiree population (not the insurance premium for an insured plan due to subsidy involved) If in community-rated plan, rates reflect experience of all those participating in plan, and same premium is charged for all of those in plan (active and retired), can use premium as basis for claims costs Demographic Assumptions “Likelihood” of receiving benefits Termination, disability, retirement and death Marital status, percentage electing spousal coverage

39. Selection of Actuarial Cost Method and Procedures Actuarial Cost Method Several acceptable choices – unlike accounting standard for “private sector” OPEB arrangements With sufficient lead time, can model costs under different alternatives Amortization of initial obligation Have some flexibility in choosing amortization approach Period of up to 30 years Numerous potential methods, should discuss with actuary

40. More on Actuarial Cost Methods The cost method determines the allocation or attribution of the actuarial present value of benefits to different periods of time Plan costs in the long run are the plan benefits that are ultimately paid, so the method just allocates those costs to periods in different ways Method selected will impact the OPEB cost Differences in attribution can vary greatly depending on plan specifics; should discuss with plan actuary to understand differences applicable to the specific plan and alternatives available

41. Example – Full Valuation Substantive Plan Large municipality has self-funded medical plan providing postretirement benefits Benefits are paid from the Government’s general assets Approx. 4,300 active employees with annual payroll of $175 million and 600 retirees Each retiree pays 20% of the average active/retiree cost of the plan ($300/month for single coverage) Under GASB 45, Sponsor’s OPEB Commitment is: To pay 80% of average active/retiree plan cost for each retiree To pay retiree claim costs in excess of avg. active/retiree plan cost Assumed investment return assumption 4½ % Low rate due to unfunded status of plan

42. Example #1 – Impact on Expense

43. Example 1A – Impact on Government-wide Statements

44. Questions?