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May 2006 · Volume 88 · Number 4
OPEB: Coming to Grips with the Cost of Retiree Health CareCity and county officials across the United States are talking about staff retirement benefits. This reflects the national media scrutiny that pensions—both public and private—have received lately. In addition, the Governmental Accounting Standards Board (GASB) recently issued new government accounting standards related to other post-employment benefits (OPEB). OPEB consist primarily of retiree health insurance coverage, which in many cases carries a hefty price tag; reporting costs of retiree health insurance in audited financial statements reflects the significant effect that these benefits sometimes have on a government’s finances. Many government entities have granted OPEB in lieu of current wage or benefit increases because the financial impact of OPEB often is not realized for many years. WHY IS EVERYONE TALKING ABOUT OPEB?In 2004, GASB issued Statement No. 45, Accounting and Financial Reporting by Employers for Postemployment Benefits Other Than Pensions. (The GASB also issued Statement No. 43, which applies to financial reporting by OPEB plans themselves.) Essentially, Statement 45 extends the accounting and financial reporting rules that apply to pension benefits to all other retirement benefits provided to government employees. The most expensive item included in OPEB is post-retirement health insurance coverage, but OPEB also include other types of post-retirement benefits such as dental, vision, and prescription plans, and some types of life insurance, legal services, and other benefits. The GASB issued the new standards because the annual costs and long-term obligations associated with OPEB were not fully reported in the financial reports of state and local governments. Like pensions, OPEB are a part of the compensation that employees earn each year, even though these benefits are not received until after employment has ended. Therefore, the cost of these future benefits is a part of the cost of providing public services today. Most governments, however, currently report their cash outlays (direct payments to or on behalf of retirees) for OPEB in a given year instead of reporting the cost of OPEB earned by employees in that year. These two amounts may be vastly different. Furthermore, most governments do not report information about the nature and size of their actuarially determined long-term financial obligations and commitments related to OPEB. Consequently, readers of financial statements—including rating agencies, mutual fund analysts, and taxpayers—have incomplete information with which to assess the cost of public services and analyze the financial position and long-run financial health of a government. WHAT DO THE NEW STANDARDS REQUIRE?As they do for their pension benefits, many cities and counties will need to hire an actuary to evaluate their OPEB. (Some governments with a small number of employees in OPEB plans may be eligible to use an alternative approach that allows the use of simplified methods and assumptions.) The actuary calculates how much should be contributed now to ensure that an adequate level of resources is available in the future. The future cash outlays for OPEB are projected on the basis of economic and demographic assumptions such as the number of employees, how long they are expected to live after re- tirement, and how much the costs of health care are expected to rise, if ap- plicable. These cash outlays are then discounted to their actuarial present value—their estimated value if paid today—using a discount rate equal to an assumed long-term rate of return on investments. The actuarial present value gener- ally is spread over a period that ap- proximates the anticipated years of an average worker’s employment with the government. The portion of the actuarial present value allocated to a particular year is called the normal cost. The actuarial calculations take into account not only benefits as they are earned, but also those benefits the employees have already earned. One reason for this is that governments have already been granting pensions and OPEB for many years. Second, governments sometimes retroactively improve the benefits they provide to their employees. The prospect of starting to report OPEB obligations to the public has prompted many public officials to consider whether it makes sense to start setting aside funds for OPEB in advance and, more fundamentally,whether their benefits are affordable as currently structured. The portion of the actuarial present value allocated to prior years of employment—and thus not provided for by future normal costs—is called the actuarial accrued liability (AAL). If an OPEB plan has cash, investments, or other resources, these may be applied to fund the AAL. The value of these resources is referred to as the actuarial value of assets. The excess of the AAL over the actuarial value of assets is the unfunded actuarial accrued liability (UAAL, or unfunded liability). Governments are not required to put the whole unfunded liability on their financial statements initially; instead, the unfunded liability is amortized (spread) over a period of up to 30 years. The normal cost and the portion of the UAAL to be amortized in the current period together make up the annual required contribution (ARC) of the government for the period. For a government with its own plan or a government participating in a multiple-government plan in which there is no commingling of contributions, the annual OPEB cost equals the ARC plus or minus certain adjustments if the government’s actual contributions in prior years differed from the ARC. The annual OPEB cost is the OPEB expense that a government would report in its financial statements. Generally, the cumulative sum of differences between an employer’s annual OPEB cost and the amounts actually contributed to the plan since the effective date of the GASB standards makes up a liability called the net OPEB obligation, which is reported on the balance sheet. If a government makes contributions each year at least equal to the ARC, no OPEB-related liability ever appears on the balance sheet. For a government participating in a multiple-government plan in which contributions are pooled and costs are shared among the participating governments, the annual OPEB expense is equal to the government’s contractually required contribution to the plan—the amount assessed by the plan for the period—which may or may not equal the ARC. The information reported in the financial statements will be accompanied by note disclosures and supporting schedules. The notes to the financial statements will include the annual cost of OPEB, contributions made, the net OPEB obligation (if any), the AAL, and the extent to which assets have been set aside to fund the AAL. The notes will also present descriptions of the types of benefits provided and how contributions are made toward financing them, the types of employees covered and the benefits they receive, and the methods and assumptions used to calculate the OPEB costs and obligations. Supporting schedules will be presented in either the government’s financial report or a separately issued financial report of the OPEB plan. One schedule describes the “funded status” of the OPEB over time by comparing the actuarial value of assets set aside for OPEB with the AAL and the annual payroll of covered employees. A key piece of information in this schedule is the “funded ratio,” which is calculated by dividing the assets by the AAL. For example, if the value of the assets is $1 million and the AAL is $2 million, then the OPEB are 50 percent funded. The other supporting schedule compares the ARC with actual contributions made by the government over several years. FREQUENTLY ASKED QUESTIONSIf a government does not pay for retirees’ health insurance, does it have OPEB? If a government’s retirees and current employees are insured together as a group, then the premiums paid by the retirees may be lower than they would have been if the retirees were insured separately—this is called an implicit rate subsidy. Although such a government may require these retirees to pay the premium themselves, the government is in fact subsidizing the cost of the premium by paying higher premiums for current employees. The value of that subsidy is considered to be OPEB and should be reported. Do cities and counties have to start setting money aside for OPEB? When similar requirements for pension benefits were introduced a decade ago, many governments were already setting money aside every year in a retirement system. Consequently, when the long-term liability associated with pensions was calculated, it was at least partially offset by the value of investments that had been made over many years to help finance pension benefits. Few localities, however, have set aside any resources for their OPEB, and therefore OPEB obligations are largely unfunded. The prospect of starting to report OPEB obligations to the public has prompted many public officials to consider whether it makes sense to start setting aside funds for OPEB in advance and, more fundamentally, whether their benefits are affordable as currently structured. Note that the GASB standards do not require cities and counties to set aside resources in advance to fund their OPEB. Local governments can continue to finance OPEB on a pay- as-you-go basis. Local governments should be aware, however, that there may be financial reporting consequences for not setting aside resources to fund OPEB. As described above, the difference between the ARC and a government’s actual contribution is added to the balance sheet as a liability. Such liabilities can grow quickly because the ARC is often much larger than current cash outlays. As the net OPEB obligation grows, it could adversely affect a government’s financial position as portrayed in the financial statements—liabilities are increasing without any offsetting assets. When do local governments have to comply? Localities that prepare audited annual financial reports should implement the new standards in three phases that are based on a government’s total annual revenues in the first fiscal year ending after June 15, 1999:
If an OPEB plan issues financial statements of its own, it will implement the standards one year prior to its related government or its largest participating government (if it is a multiple-government plan). Where can I learn more about OPEB? The GASB provides materials about the OPEB standards on its Web site (www.gasb.org), including a two- page fact sheet with basic questions and answers and a plain-language summary of the pertinent GASB statements. They can be found on a special page set aside for OPEB information (look in the “Project Pages” section of the Web site). As governments begin to implement the OPEB standards, this page will include a list of the implementers. GASB has also published a guide to implementing the OPEB standards; it includes more than 250 detailed questions and answers as well as extensive illustrations and examples. The guide can be ordered through the Web site or by calling 800/748-0659. |
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