1. 1 Basic Information about GASB Statement 45 Karl Johnson Project Manager Governmental Accounting Standards Board Norwalk, CT National Governors Association GASB Live Meeting Conference Call April 19, 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. 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. 3 Why the Board’s Sudden Interest in Accounting for Retiree Healthcare Benefits? Actually, the subject of “other postemployment benefits” (OPEB) was first placed on the Board’s technical agenda for research and development of standards in 1987 GASB issued interim guidance in 1989, 1990, and 1994, but even then contemplated a more comprehensive look at the subject (i.e., the OPEB Project that produced Statements 43 and 45 in 2004) The subject of OPEB was considered major for several reasons: The potential materiality of retiree healthcare The inadequacy of pay-as-you-go accounting practice to provide relevant, decision useful information about OPEB costs, obligations, and potential demands on future cash flows The complexity of issues related to measurement and recognition of costs and obligations

4. 4 The OPEB Project Nov. 1994—GASB issued Statements 25, 26, and 27 on pension accounting 1995-1996—GASB Board and staff attempted a quick adaptation of Statements 25 and 27 to OPEB but ran out of time because of competing project priorities, including Statement 34 1999-2004—Board and staff worked steadily on OPEB issues: Settled on an overall accounting approach (same as for pensions) Adapted pension requirements to OPEB Addressed issues unique to OPEB (including alternative measurement method for very small plans and implicit rate subsidies) Conducted extensive due process—utilized an expert Task Force to advise and assist, issued three Exposure Drafts (two for Statement 45), analyzed respondents’ comments on issues, and held two public hearings and a focus group meeting of financial analysts Issued Statements 43 and 45 in April and June 2004, respectively

5. 5 In a Nutshell: GASB Statement 45 (for Employers) Subject: accounting and reporting by employers for their OPEB 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. 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. 7 In a Nutshell: GASB Statement 45 (for Employers) (continued) Requires measurement and disclosure of the total actuarial accrued liabilities for 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. 8 Objective of Statement 45 To faithfully represent (reflect like a good, non-distorting mirror) the financial effects of the underlying financial transaction that creates OPEB The Board concluded that OPEB arises from 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 provide after employment a pension and OPEB such as retiree healthcare—all as components of a total compensation package That exchange, rather than the annual payments of premiums or claims costs for retired people that follow from it, is the basic transaction to be accounted for (the substance of OPEB)* *The Board considered but rejected the view that OPEB is a serial gift or gratuity (a series of non-exchange transactions in which the employer gives benefits for which it receives no value in return)

9. 9 Measurement Approach for OPEB: Broad Steps of Process to Develop Information for Accrual Accounting and Financial Reporting 1. Project cash outflows for benefits 2. Discount projected 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. 10 254062 80 Employee Age Timeline Age when hired Present age Assumed age at retirement Life Expectancy Service Period

11. 11 254062 80 1) Project Benefits 2) Discount A.P.V. 3) Actuarial cost method

12. 12 How Allocated Portions of the PV of Projected Benefits Affect Financial Reporting Amounts allocated to past 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 to current period ~ normal cost (service cost) The other principal component of annual OPEB cost Amounts allocated to future periods ~ future normal cost Not reported—pertains to services that haven’t occurred yet

13. 13 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.

14. 14 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

15. 15 Funded Status Information: Illustration (Two Employers) Information Disclosed in Notes to Financial Statements and Presented in RSI Govt. AGovt. B UnfundedPartially (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) 13,500,000 4,500,000 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%

16. 16 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

17. 17 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

18. 18 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

19. 19 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

20. 20 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

21. 21 Additional Resources GASB website, www.gasb.org: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