GASB 45 – Other Post Employment Benefits GFOA SC October 19, 2010 Jack Beam, ASA, EA, MAAA

What is a consultant? 2

What we will do today  GASB 45 in general  Implicit vs. Explicit subsidies  Actuarial Assumptions  Critical issues  Key Results in SC 3

Retirement today?  A recent Towers Watson survey said 40% of US workers are planning to delay retirement  59% of workers who plan to delay retirement cite healthcare as the cause  Recent GAO Report indicated that healthcare spending has grown from 12% of overall state and local expenditures in 1978 to 20% in 2008  Life expectancy at 65 has increased by about 40% in the last 35 to 40 years  Local governments shed 76,000 jobs from their payrolls. Of those, roughly 50,000 jobs were cut from local schools 4

5 GASB 43 & GASB 45  GASB standards: ► Before GASB 45 – Cash Accounting OPEB expense equals cash contribution made by employer Balance sheet liability equals zero, Except for self-insured plans – may have IBNR liability attributable to retirees ► After GASB 45 – Accrual Accounting OPEB cost accrued during active member’s working career Cost “fully accrued” when active member retires Significant balance sheet liability may accrue if benefits funded on a pay-as-you-go basis

6 GASB 43 & GASB 45 Total RevenuesGASB 45 applies for Fiscal Years beginning after > $100,000,00012/15/2006 $10,000,000 to $100,000,00012/15/2007 < $10,000,00012/15/2008

7 GASB 43 & GASB 45  Statement 43 applies to pre-funded OPEB plans ► “Plan” usually refers to a trust or agency fund (that is, to assets under the stewardship of an administering entity) used to administer the financing of OPEB and the payment of benefits—regardless of the financing policy adopted  Statement 45 applies to the employers sponsoring OPEB plans ► “Plan” usually refers to an employer’s substantive commitment or agreement to provide OPEB, may be referred to as a “Program” if there is no trust

8 Implications  GASB 43/45 Key Disclosure Requirements ► Actual employer contributions ► Actuarial liabilities versus actuarial value of assets ► Annual OPEB Cost (Expense) Normal cost plus Unfunded Actuarial Accrued Liability amortization plus technical adjustment ► Net OPEB Obligation (Balance sheet liability) Cumulative difference between Expense and Employer Contribution

9 Explicit Rate Subsidy  When some or all retirees are charged less than the full cost of providing benefits  Often imaginative … ► X% per year of service subsidy up to Y% max ► A lower charge if retired prior to 10/1/19XX ► A lower charge if enrolled in HMO vs. PPO ► Retirees pay full active rate  It is clear that GASB would want an accounting of this type of subsidy. Many plans will contain both explicit and implicit rate subsidies.

10 Implicit Rate Subsidy – Insured Plans  Part of what is paid for actives is really for retirees  Collecting an average rate, but true incidence of cost is different  Retirees cost more than actives because they are older  So employers are “implicitly” subsidizing the retiree rate  GASB wants a proper accounting of this hidden subsidy

Actuarial Assumption Setting  Demographic assumptions similar to pension plan valuation  Election rates  Lapse rates – premium may change after a few years 11

Actuarial Assumption Setting  Economic Assumptions are somewhat unique  Discount rate should be the interest rate being earned by the assets that will pay the benefit  Per Capita Claim Cost – insured vs. self-funded  Medical Trend 12

Current Trend Assumption – SCEIP June 30, 2009 – inflation 3.0% 13

14 Payment Streams Trend Sensitivity – Medical Only 40% difference between Optimistic and Pessimistic Scenario in 2022

Discount Rate  Unfunded o Return on general assets o Historical returns o Investment horizon o 3% to 5% per year  Prefunded o Irrevocable Trust o Little or no assets to start o Like a pension plan o Little payout at first o 6.0% to 7.5% per year 15

Discount Rate Impact  Unfunded Plan – 3.0% vs. 4.5% 16 Unfunded Plan3.0% Discount Rate4.5% Discount Rate A. Employer Normal Cost $5,197,507$3,466,115 B. Amortization of UAL $2,369,687$2,091,217 C. Annual Required $7,567,194$5,557,332 Contribution (ARC) (A+B) Percent Difference -27% D. Active Accrued Liability $56,409,539$38,870,797 E. Retiree Accrued Liability $14,160,143$11,659,913 F. Total Actuarial Accrued $70,569,682$50,530,710 Liabilities Percent Difference -28%

Discount Rate Impact  Funded plan – 6.0% vs. 7.5% 17 Funded Plan6.0% Discount Rate7.5% Discount Rate A. Employer Normal Cost $2,410,351$1,739,332 B. Amortization of UAL $1,885,851$1,730,437 C. Annual Required $4,296,202$3,469,769 Contribution (ARC) (A+B) Percent Difference -19% D. Active Accrued Liability $27,840,004$20,627,555 E. Retiree Accrued Liability $9,811,134$8,408,856 F. Total Actuarial Accrued $37,651,138$29,036,411 Liabilities Percent Difference -23%

Amortization Period  Maximum of 30 years under GASB 45  30 years may not be appropriate  Plan amendment shifts majority of liability to retirees  Accounting principles for guidance  Payout period – retiree life expectancy 18

Amortization Period - Example  Impact of shorter amortization period 19 Original ValuationNew Plan Design New Plan Design w/ Appropriate Amortization Amortization Period (years) A. Employer Normal Cost $507,501$25,501 B. Amortization of UAL $254,802$41,556$70,812 C. Annual Required $762,303$67,057$96,313 Contribution (ARC) (A+B) Percent Difference -91%44% D. Total Actuarial Accrued $6,021,867$982,108 Liabilities Percent Difference -84%0%

20 Look At Critical Issues Facing Both Member And The Employer  Access to health care coverage when retired  Affordability to the retired member  Sustainability of the Plan by the employer (and subtopic of “velocity”)  Equity among the population segments (equity not necessarily meaning equal)

21 Sustainability  Retirees do not want the Plan to vanish  To ensure sustainability, the employer must know the long term ongoing annual commitment and assess whether the resources exist to meet the obligation  The first step in measuring sustainability is to assess the impact on the annual budget of the current program

22 Sustainability  Next, the employer should estimate what could be a long term annual budget amount that could be allocated to the retiree medical program  Then, the employer could look at the benefit strategies that could be implemented to bring the rate to a manageable level while keeping benefits as affordable as possible

23 General Fund Encroachment Means Less Funding Available for Other Activities Project NOO assuming cash pay-go funding. Assess impact on: Cost of capital/bond rating Borrowing restrictions that make access to capital markets more difficult Ability to meet pay-go requirements in all years Some entities are exploring non cash contributions (refer to formal legal counsel) Example- firefighters just don’t feel they can cut into training budget- or their capital budgets- so are looking to find the money in the pension plan- how real is that solution?

24 Understanding “Velocity”  The speed for change to take effect (e.g. the lowering of the GASB liability and costs) depends on what employee groups can have benefit changes. ► If new hires only, we find it takes a generation to fully feel the impact of the change ► If actives only (prospective benefits), the velocity of change can be sooner, depending on the depth of the change ► Changing for all members (active, retiree and new hire) creates the highest velocity.  A governmental entity may say “the Actuarial Required Contribution must go from 15% to 7% in 7 years”.

25 Current Retirees vs. Future Retirees 30 Year Closed Level Percent Amortization (3% Growth) Current Retirees under current Pay- As-You-Go Current Active Employees under current Pay-As-You- Go Future Hires under current Pay-As-You- Go Contributions under Full Advance- Funding

26 ARC per Active Member – Unfunded Discount Rate – 4.5% Survey of GASB 43 & 45 reports from GRS South Carolina clients

27 AAL per Plan Participant – Unfunded Discount Rate – 4.5% Survey of GASB 43 & 45 reports from GRS South Carolina clients

28 ARC per Active Member – Funded Discount Rate – 6.0% Survey of GASB 43 & 45 reports from GRS South Carolina clients

29 AAL per Plan Participant – Funded Discount Rate – 6.0% Survey of GASB 43 & 45 reports from GRS South Carolina clients

Key findings in SC OPEB work 30 The state wide plan is not included in these survey results.

Key findings in SC OPEB work 31 Type of PlanNumber of Plans Average Unfunded - ARC per active Benefit varies based on service or points15$2,963 Same dollar benefit for all retirees9$1,627 Employer pays entire premium6$4,203 Other2$1,586 Grand Total32$2,734 Over half of GRS’s South Carolina clients vary the retiree benefit based on years of service or points at retirement.

Key findings in SC OPEB work 32 Type of BenefitYesNo Subsidized over age Provides spousal coverage311 Provides explicit subsidy for spouse1714

Key findings in SC OPEB work Average Monthly Cost per Individual Average claims cost by age and gender for the 32 valuations surveyed Average Pre-65 Cost per Month AgeMaleFemale $216.85$

Healthcare Reform  Early Retiree Reinsurance Program, go to  Retiree only plans exempt  Medicare Advantage and Medicare Part D plans are exempt 34