1. Permission to reprint or distribute any content from this presentation requires the prior written approval of Standard & Poor’s. Copyright (c) 2006 Standard & Poor’s, a division of The McGraw-Hill Companies, Inc. All rights reserved. “The Pros and Cons of Funding OPEBs” APPA’s 2007 Business and Financial Conference Austin, TX Peter Block, Director Standard & Poor’s September 25, 2007

2. 2. Permission to reprint or distribute any content from this presentation requires the prior written approval of Standard & Poor’s. Innovative Solutions: A Rating Perspective Preview: How GASB 45 can be used as a framework to manage OPEB liabilities An overview of how S&P would evaluate various solutions being examined from a credit standpoint How OPEB/GASB 45 and associated funding solutions fit into the rating process

3. 3. Permission to reprint or distribute any content from this presentation requires the prior written approval of Standard & Poor’s. Significance of GASB 45 It focuses attention on an important national (and global) issue: funding retiree healthcare The resulting actuarial valuations and new reporting will provide for greater transparency Disclosure will lead to an examination of the current viability and long-term deliverability of the current benefit levels

4. 4. Permission to reprint or distribute any content from this presentation requires the prior written approval of Standard & Poor’s. Significance of GASB 45…continued Let’s step back and review why GASB issued this statement: Current {OPEB} financial reporting generally fails to: –“Recognize the cost of benefits in periods when the related services are received by the employer –Provide information about actuarial accrued liabilities for promised benefits associated with past services and… to what extent those benefits have been funded –Provide information useful in assessing potential demands on the employer’s future cash flows” Source: GASB Statement No. 45, Accounting and Financial Reporting by Employers for Postemployment Benefits Other Than Pensions

5. 5. Permission to reprint or distribute any content from this presentation requires the prior written approval of Standard & Poor’s. GASB 45 as a tool to manage OPEB New valuable information, includes: Actuarial valuation, including the complete picture of what your future PayGo costs look like Funding Progress Annual Required Contribution: What is needed to fully fund the liability Net OPEB Obligation: The cumulative effect of funding or not All this information provides a framework to better understand the components of these liabilities and manage them more effectively. The key is to get a handle on costs before any funding method is considered.

6. 6. Permission to reprint or distribute any content from this presentation requires the prior written approval of Standard & Poor’s. Potential OPEB management strategies Funding solutions for OPEB break down to two options: -Enhance assets OR -Mitigate/manage liabilities

7. 7. Permission to reprint or distribute any content from this presentation requires the prior written approval of Standard & Poor’s. Asset Enhancement Strategies Enhance Assets: Increase payments toward retiree healthcare; move toward ARC funding Employee contributions may be initiated or increased Establish a trust Infusion of assets (bonds, cash contribution, asset sale)

8. 8. Permission to reprint or distribute any content from this presentation requires the prior written approval of Standard & Poor’s. Asset Enhancement Strategies Potential Benefits: Employer takes advantage of a higher discount rate under GASB 45 Receives the benefit of investment earnings from the trust Increases the benefit security to employees Potential Challenges Higher cost structure for benefits which will divert resources from other budget priorities Bonding could potentially limit capacity for other capital requirements Note: if partial funding is chosen…blended discount rate may be used

9. 9. Permission to reprint or distribute any content from this presentation requires the prior written approval of Standard & Poor’s. Mitigate/Manage Liabilities Options to reduce liabilities may include: Lower the level of retiree healthcare benefits granted outright Offer new employees (or new retirees) a reduced benefit level Place a cap on total (OPEB and pension) employer-provided benefits Closing the current plan Changing to a Defined Contribution model from a Defined Benefit model

10. 10. Permission to reprint or distribute any content from this presentation requires the prior written approval of Standard & Poor’s. Mitigate/Manage Liabilities Potential Benefits: Cost savings could be significant Liabilities will be reduced Potential Challenges Legal framework for altering benefits is uncertain Political obstacles May require tradeoffs in other areas that would create budget challenges

11. 11. Permission to reprint or distribute any content from this presentation requires the prior written approval of Standard & Poor’s. Credit Framework for Evaluating Solutions Credit approach to evaluating all strategies will involve the following: 1. Legal issues surrounding any targeted funding strategy including local and state law 2. Analysis of government deliberation/authorization process 3. Is identified strategy part of a more comprehensive financial planning process – long term budget or financial plan, capital plan, debt management, etc. 4. Is chosen strategy part of a more comprehensive post retirement management strategy

12. 12. Permission to reprint or distribute any content from this presentation requires the prior written approval of Standard & Poor’s. Case Study: Oakland County, Michigan GO Bond Rating = AAA / Stable Eligible for Benefits: Retirees = 1,954; Active Employees = 3,618 Unfunded accrued OPEB liability = $526 mil. (total liability = $830 mil.) ARC = $60 mil. in FY 2008 County attempted to secure a change in Michigan statutes to enable bonds to be issued, but the Governor vetoed the bill citing budgetary burdens on the State. Solution: issue $570 mil. of taxable COPs to fund to fully fund existing VEBA trust. Amortization = 20 years vs. 40 yr ARC COPs will be issued by Medical Benefit Trust under IRS Sec. 115 with VEBA as beneficiary. Structure allows for defeasance of COPs in event of national health plan or other situation that results in the plan being over-funded. NPV savings = $200 mil; DS = $48.5 mil. vs ARC of $60 mil. Retiree health care benefit package will be slightly modified to further control costs. Oakland County VEBA Trust Status: –Assets = $303 mil. (37% funded); avg ann. return = 7.58% –Switching to level dollar payment methodology to minimize future cost increases –Closed plan (2005); changed to health savings plan for new employees

13. 13. Permission to reprint or distribute any content from this presentation requires the prior written approval of Standard & Poor’s. Case Study: Nebraska Public Power District Gen Revenue Bond Rating = A / Stable Unfunded actuarial accrued OPEB liability = $422 mil. ARC = $32 mil. in FY 2008 w/ 5.75% Current pay-go = $10 mil. Solution: –continue pay-go for 2007. –fund $4 mil. over pay-go during 2008-2013 into trust fund. –Fund $10 mil. over pay-go starting in 2014 into trust fund. Strategy will require one-time 1% rate increase in 2014.

14. 14. Permission to reprint or distribute any content from this presentation requires the prior written approval of Standard & Poor’s. Some Preliminary Numbers AverageSmallestLargest Accrued Liability / member $ 44,000 $ 5,000 $ 151,000 ARC / member $ 4,200 $ 500 $ 13,000 ARC compared to pay-go3.1x1.4x5.7x ARC as % of FY revs4.10%0.30%10.10% Source: Milliman Based on 2006 valuations of 13 Phase I and II governments, using identical economic assumptions and funding methods.

15. 15. Permission to reprint or distribute any content from this presentation requires the prior written approval of Standard & Poor’s. How OPEB/GASB 45 fits into the rating process OPEB touches ratings in in three key areas: Management, Finances, and Debt

16. 16. Permission to reprint or distribute any content from this presentation requires the prior written approval of Standard & Poor’s. OPEB Rating Factors: Management Are the consequences of OPEB obligations fully understood by management or will the results of a GASB 45 actuarial valuation come as surprise? If liabilities are material, is management actively pursuing alternatives to soften the impact? Where does the OPEB problem rank in relation to other planning priorities? How conservative (or aggressive) are the methods and assumptions being used to determine OPEB liabilities and plan for the future?

17. 17. Permission to reprint or distribute any content from this presentation requires the prior written approval of Standard & Poor’s. OPEB Rating Factors: Financial Can the budget afford the OPEB ARC (or even an escalating PayGo scenario)? Are there other areas in the budget to cut to make room for increasing OPEB costs? Will total carrying charges of bond debt service, pension contributions, plus OPEB contributions be sustainable given existing (or projected) resources?

18. 18. Permission to reprint or distribute any content from this presentation requires the prior written approval of Standard & Poor’s. OPEB Rating Factors: Debt What is the source of payment for OPEB debt and do you have a favorable rating as bonds will be taxable? Are market conditions favorable (debt rate is less than expected returns on long-term investments in health care trust fund)? What is the legal obligation of the employer (how “debt-like”) to meet retiree healthcare obligations: i.e. to make contributions…. to pay benefits? How does OPEB alter the total long-term liability landscape for the employer: bonded debt + pension liabilities + OPEB liabilities? Does OPEB put the employer at a comparative disadvantage in relation to its peers from the standpoint of total long-term liabilities

19. 19. Permission to reprint or distribute any content from this presentation requires the prior written approval of Standard & Poor’s. NOT an Innovative Funding Solution

20. 20. Permission to reprint or distribute any content from this presentation requires the prior written approval of Standard & Poor’s. Date PublishedArticle Title February 27, 2007 Improved U.S. State Pension Funding Levels Could Be On The Horizon December 4, 2006 Credit FAQ: OPEB Liabilities Pose Minimal Near-Term Rating Risk For Public Finance Credits September 26, 2006 An Aging Population Challenges U.S. State Budgets And Renews Interest In Health Care Reform August 11, 2006How Big U.S. Cities Are Faring With The Pension Fund Meltdown June 15, 2006 Accounting for OPEB Liabilities: Can State & Local Governments Cope? May 3, 2006 Funding OPEB Liabilities: What It Means For Minnesota’s Local Governments December 15, 2005Funding OPEB Liabilities: Assessing The Options November 16, 2005Public Employers Are Exploring A Switch To Defined Contribution Pension Plans April 21, 2005Are OPEB Obligation Bonds A Viable Option To Fund Liabilities?

21. 21. Permission to reprint or distribute any content from this presentation requires the prior written approval of Standard & Poor’s. Contact peter_block@sandp.com 312.233.7040