The New GASB 74/75 StandardS Susan Lee, FSA, EA, PhD (Nov 2017) The New GASB 74/75 StandardS

Major Changes To the GASB OPEB Standards Bolton Partners Inc. Major Changes To the GASB OPEB Standards Focuses on balance sheet Measurements are closer to real time Less latitude in assumption selection Increased disclosure More volatile and possibly negative annual expense Implications for plan sponsors

Could mean a very big hit to the governmental entity’s net worth Bolton Partners Inc. Change in Focus The liability on the financial statements is now the unfunded actuarial accrued liability Could mean a very big hit to the governmental entity’s net worth In initial year, difference between unfunded liability and Net OPEB Obligation is immediately recognized as transition liability

Bolton Partners Inc. GASB74 – plan accounting Generally applies to financial reporting of an OPEB plan in stand-alone financial statements Effective for financial statements for fiscal years beginning after 6/15/2016 Most MD governmental entities have 7/1 plan year, hence GASB74 is first effective for 7/1/2016-6/30/2017 plan year

GASB74 – OPEB Trust Requirements Bolton Partners Inc. GASB74 – OPEB Trust Requirements Contributions and earnings on contributions are non revocable OPEB plan assets are dedicated to providing OPEB benefits to plan members OPEB plan assets are legally protected from creditors of employers, non-employer contributing entities, OPEB plan administrator, and creditors of plan members

Assets that do not meet trust requirements Bolton Partners Inc. Assets that do not meet trust requirements Report as assets of the employer If held in fiduciary capacity, report as agency fund May not be used as part of “crossover test” to determine discount rate GASB74 OPEB plan reporting is NOT required

GASB75 – Employer accounting Bolton Partners Inc. GASB75 – Employer accounting GASB75 is effective for fiscal years beginning after 6/15/2017 Most MD governmental entities have 7/1 fiscal year, hence GASB75 is first effective for 7/1/2017-6/30/2018 fiscal year Types of employers Single employer: most MD entities are of this type Agent employers (multiple ER OPEB plans) Cost sharing employers

Bolton Partners Inc. Typical MD PLan If OPEB plan does not issue a stand alone financial statement (OPEB plan is included in the financial report of a governmental entity subject to GASB75), government should present disclosure in a manner that avoids unnecessary duplication Unfunded plans are subject to GASB 74 if the plan is administered through a trust that meets the requirements mentioned previously

Terminology GASB 74/75 GASB 43/45 Total OPEB Liability (TOL) Bolton Partners Inc. Terminology GASB 74/75 GASB 43/45 Total OPEB Liability (TOL) Actuarial Accrued Liability Plan Fiduciary Net Position Actuarial Value or Market Value of Assets Net OPEB Liability (NOL) Unfunded Actuarial Accrued Liability OPEB Expense Annual OPEB Cost (AOC) Actuarially Determined Contribution (ADC) – sort of Annual Required Contribution (ARC)

Total OPEB Liability must be EAN accrued liability Bolton Partners Inc. Terminology Total OPEB Liability must be EAN accrued liability Alternative measurement method permitted if < 100 participants (active and inactive) Plan Fiduciary Net Position must be MVA Net OPEB Liability = Total OPEB Liability – Plan Fiduciary Net Position Net OPEB liability must be measured as of measurement date Actuarial valuation date can be different from measurement date

Bolton Partners Inc. GASB75 – OPEB Trust If trust meets requirements mentioned before, recognize net OPEB liability If trust does not meet requirements mentioned before, recognize total OPEB liability

Must be level % of pay EAN Bolton Partners Inc. Entry Age NOrmal Must be level % of pay EAN If EE does not have projected pay, use inflation rate instead of salary scale Beginning of attribution period is first period in which EE provides service under benefit terms End of attribution period is exit from active service DROP: attribution period continues until EE exits DROP (note different for pensions)

Liability Calculations Bolton Partners Inc. Liability Calculations Ad hoc changes, if substantively automatic, must be included in projections Consider established pattern of practice; legal or contractual benefit caps Projections of benefit payments must include taxes expected to be imposed on benefit payments (e.g. Cadillac tax) Must be based on claims costs or age adjusted premiums approximating claims costs Exclude administrative costs from benefit payments

Must be consistently applied from period to period Bolton Partners Inc. Measurement Date Must be consistently applied from period to period GASB74: must be the OPEB plan’s most recent fiscal year end GASB75 NO earlier than end of ER’s prior fiscal year NO later than end of ER’s current fiscal year

Measurement Date Example Bolton Partners Inc. Measurement Date Example 7/1/2017-6/30/2018 fiscal year GASB74: measurement date must be 6/30/2018 GASB75 Earliest measurement date: 6/30/2017 Latest measurement date: 6/30/2018 Most clients choose 6/30/2017

Actuarial Valuation Date Bolton Partners Inc. Actuarial Valuation Date GASB74 and GASB75: must perform actuarial valuation at least biennially GASB74: can be up to 24 months earlier than OPEB plan’s most recent fiscal year end GASB75: can be up to 30 months and 1 day earlier than ER’s most recent fiscal year end Roll forward liability from valuation date to measurement date if necessary

Earliest Actuarial Valuation Date Example Bolton Partners Inc. Earliest Actuarial Valuation Date Example 7/1/2017-6/30/2018 fiscal year GASB74: 7/1/2016 GASB75: 12/31/2015

Plan Fiduciary Net Position Bolton Partners Inc. Example, FYE 2018 Total OPEB Liability Plan Fiduciary Net Position Net OPEB Liability Balance 6/30/2017 $24,518,674 $13,200,106 $11,318,568 Balance 6/30/2018 $26,199,390 $13,499,271 $12,700,119 Assume GASB75 measurement date is 6/30/2017: $11,318,568 is imputed to be the 6/30/2018 Net OPEB liability GASB74: $12,700,199 is the 6/30/2018 Net OPEB Liability

Less Latitude in assumption setting Bolton Partners Inc. Less Latitude in assumption setting Mandated actuarial funding method (EAN) Cannot use smoothed assets (no AVA) Discount rate rules more prescribed Unfunded plans: index rate for 20 year tax exempt general obligation muni bonds AA/Aa (or higher) Funded plans: more rigor in setting long term rate of return in assets More guidance in computation of blended rate Additional disclosure requirements

Discount Rate Rules – PLans with assets Bolton Partners Inc. Discount Rate Rules – PLans with assets See numeric example in implementation guide Must disclose long term inflation assumption Must disclose target asset allocation and assumed long term real rate of return by asset class Must project plan’s assets, using projected benefit payment stream (closed group), projected contributions, assumed rate of return on assets

Discount rate – Projected contributions Bolton Partners Inc. Discount rate – Projected contributions Apply professional judgment to project cash flows for ER contributions (open group basis) Consider most recent 5 year contribution history Must subtract normal cost of future hires from the projected ER contribution levels

Discount rate – PV of benefit payments Bolton Partners Inc. Discount rate – PV of benefit payments Calculate PV of benefit payment stream Use long term expected rate of return to discount benefit payments while BOY MVA > expected benefit payments for that year Use bond index as of measurement date to discount benefit payments thereafter Determine single equivalent discount rate

Long term rate of return example Bolton Partners Inc. Long term rate of return example Asset Class Target Allocation Long Term Expected Real Rate of Return Weighted Average Calculation Domestic Equity 40% 5.8% 2.3% Fixed Income 35% 1.0% 0.4% Private Equity 20% 6.0% 1.2% Real Estate 3% 5.9% 0.2% Cash 2% 0.0% Total 100% 4.1% Inflation 3.0% Rate of Return 7.1%

Annual Expense - components Bolton Partners Inc. Annual Expense - components Service cost Interest cost Minus benefit payments Minus administrative expenses Minus expected rate of return on assets Plan changes <= immediate recognition Amortizations Liability Experience Gains or Losses Asset Experience Gains or Losses Assumption Changes

Annual Expense - Amortization Period Bolton Partners Inc. Annual Expense - Amortization Period Amortize over closed period Use expected remaining service lives of employees and retirees Liability Experience Gains or Losses Assumption Changes Use 5 years for asset experience gains or losses Just divide!! Unrecognized portion reported as deferred outflow or inflow of resources

Comparison with FAS GASB 74/75 FAS Entry age normal (level % of pay) Bolton Partners Inc. Comparison with FAS GASB 74/75 FAS Entry age normal (level % of pay) Projected unit credit Market value of assets Market related value of assets Flexibility re: measurement date NO flexibility re; measurement date Deferred outflows/inflows of resources Accumulated other comprehensive income Liability gain/loss amortized over remaining service lives of actives and retirees Unrecognized gain/loss amortized over average future service to retirement for actives Asset gain/loss amortized over 5 years Part of unrecognized gain/loss Immediate recognition of plan amendments Prior service cost amortized over average remaining service period of actives Biennial valuations Typically annual valuations N/A Transition obligation

Together with ASOP 6, more disclosure is required than ever before Bolton Partners Inc. Increased Disclosure Together with ASOP 6, more disclosure is required than ever before Liability sensitivities (trend and discount rate) 10 year histories Liability reconciliations Asset reconciliations Comparison of actual contributions versus Actuarial Determined Contribution

If plan is closed to new entrants that must be disclosed Bolton Partners Inc. Increased Disclosure If plan is closed to new entrants that must be disclosed Date of experience studies Description of contribution requirements Source of mortality assumptions OPEB plan description, including authority under which benefit terms are established or may be amended

Implications for Plan sponsors Bolton Partners Inc. Implications for Plan sponsors Generally higher and more volatile amounts on balance sheet More attention will be paid to OPEB benefits Increased efforts to limit liabilities Plan changes Plan closures Increased funding Limiting Volatility Caps on employer subsidies Fixed dollar benefits Funding (possibly with less volatile asset mixes)

Major Changes To the GASB OPEB Standards Bolton Partners Inc. Major Changes To the GASB OPEB Standards Focuses on balance sheet Measurements are closer to real time Less latitude in assumption selection Increased disclosure More volatile and possibly negative annual expense Implications for plan sponsors

Appendix – Expense Illustration Bolton Partners Inc. Appendix – Expense Illustration

Expense Example – reconcile liability Bolton Partners Inc. Expense Example – reconcile liability 2018 2019 2020 OPEB Liability 52,000 41,500 56,500 Plan Fiduciary Net Position (i.e. assets) 25,000 31,000 35,000 3. Net OPEB Liability (1.-2.) 27,000 10,500 21,500 Reconciliation of OPEB Liability 1. Service cost 1,200 1,000 900 2. Interest cost 3,500 3,600 2,900 3. Change in benefit terms - (8,200) Difference between expected and actual experience 2,800 5. Changes of assumptions (6,300) 11,900 6. Benefit payments (500) (600) (700) 7. Net change in total OPEB liability 7,000 (10,500) 15,000 8. OPEB liability beginning 45,000 9. OPEB liability ending

Expense Example – amortizations Bolton Partners Inc. Expense Example – amortizations Liability (Gain)/Loss Period 2018 2019 2020 2,800 7 400 Net increase/(decrease) in expense Assumption Change Increase/ (Decrease) Period 2018 2019 2020 7 (6,300) (900) 11,900 1,700 Net increase/(decrease) in expense 800

Expense Example – Reconcile assets Bolton Partners Inc. Expense Example – Reconcile assets 2018 2019 2020 1. OPEB Liability 52,000 41,500 56,500 2. Plan Fiduciary Net Position (i.e. assets) 25,000 31,000 35,000 3. Net OPEB Liability (1.-2.) 27,000 10,500 21,500 Reconciliation of plan fiduciary net position Contributions 3,500 2,300 2. Net investment income 400 3,200 2,500 3. Benefit payments (500) (600) (700) 4. Administrative expenses (100) 5. Net change in plan fiduciary net position 3,300 6,000 4,000 6. Plan fiduciary net position beginning 21,700 7. Plan fiduciary net position ending

Asset changes recognized in expense Bolton Partners Inc. Asset changes recognized in expense 2018 2019 2020 Asset Expense Impact Contributions 3,500 2,300 2. Net investment income 400 3,200 2,500 3. Expected Investment Income 1,400 1,700 2,000 4. Investment Gain (loss) (1,000) 1,500 500 5. Current investment gain (loss) recognized (200) 300 100 6. Past investment gain (loss) recognized - 7. Benefit payments (500) (600) (700) 8. Administrative expenses (100) 9. Recognized in Expense [3.plus 5. through 8.] 600 1,100 Reconciliation to Net Fiduciary Position 10. Cumulative assets recognized 25,800 30,400 34,100 11. Minus deferred outflows 800 12. Plus deferred inflows 1,200 1,300 13. Net fiduciary position 25,000 31,000 35,000

Expense Example – Asset gain/loss Bolton Partners Inc. Expense Example – Asset gain/loss Asset (gain)/ loss Period 2018 2019 2020 1,000 5 200 (1,500) (300) (500) (100) Net increase/(decrease) in expense (200) 2018 2019 2020 Liability (gain)/loss 400 Assumption change (900) 800 Asset (gain)/loss 200 (100) (200) Net increase/(decrease) in expense 600 (600) 1,000

Bolton Partners Inc. Expense Example 2018 2019 2020 Liability Expense Impact (Note: Expected remaining service lives=7) 1. Service cost 1,200 1,000 900 2. Interest cost 3,500 3,600 2,900 3. Change in benefit terms - (8,200) 4. Difference between expected and actual experience recognized in first year 400 5. Changes of assumptions recognized (900) 1700 6. Deferred from previous years 400+(900)=(500) 7. Benefit Payments (500) (600) (700) Recognized in expense 4,600 (4,700) 4,300 Reconciliation to Total OPEB Liability 9 . Cumulative liability recognized 49,600 44,900 49,200 10. Deferred outflows 2,400 2,000 1,600+10,200=11,800 11. Minus deferred inflows 5,400 4,500 12. Total OPEB liability 52,000 41,500 56,500

Expense Example – Combined Bolton Partners Inc. Expense Example – Combined GASB 75 expense 2018 2019 2020 1. Service cost 1,200 1,000 900 2. Interest cost 3,500 3,600 2,900 3. Expected investment income (1,400) (1,700) (2,000) 4. Administrative expenses 100 5. Change in benefit terms - (8,200) 6. Difference between expected and actual earnings recognized in current year 200 (100) (200) 7. Difference between expected and actual experience recognized in current year 400 8. Changes of assumptions recognized in current year (900) 800 10. Total Expense (income) 4,000 (5,800)