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Session 305 - GASB 45 Developments
Presenters: Sherry S. Chan, William B. Fornia, Thomas G. Vincente
Recorder: Derek A. Scott

GASB 45 in General

In June 2004, the Governmental Accounting Standards Board (GASB) published GASB Statement No. 45 (GASB 45), targeting other post-employment benefits (OPEB) for public employees. Up until this standard, public employers often booked retiree healthcare costs on a pay-as-you-go (PAYGo) basis without considering that active employees earn a right to this benefit during their working years. The statement requires a valuation performed by an actuary to calculate the value of benefits being earned by current employees, similar to structure of a defined benefit pension plan.

Discount Rate Selection & Pre-Funding

A key component in an actuarial valuation is the discount rate assumption, i.e., time value of money. According to GASB 45, the discount rate for this purpose needs to be consistent with “investments that are expected to be used to finance the payment of benefits.” Therefore, an employer that establishes a trust and contributes toward satisfying the obligation may recognize a reasonable rate of return based on the trust’s investment policy. For this purpose, 8 percent seems to be the generally accepted assumption for a balanced portfolio. Sponsors that continue funding on a PAYGo basis can only reflect a rate of return consistent with investments of their general revenues (short-term, low-risk), a typical assumption being 4 percent or less.

Obviously, funding at a level that completely covers the OPEB liability qualifies for pre-funding and utilizing the applicable discount rate for a funded plan. With most sponsors unable to fully fund upon application of GASB 45, this leaves a lot of discretion to the actuary. Most have taken the position that contributing the annual required contribution (ARC) or annual OPEB cost (AOC) as determined under GASB 45 is considered pre-funding. In the case of the State Teachers Retirement System (STRS) of Ohio, the discount rate was set a 5.5 percent (i.e., the value between 4 and 8 percent, prorated on the funded ratio and the percent of the ARC contributed each year).

Difficulties with discount rate selection have emerged in the second year for many actuaries. There can be instances in which the plan sponsor indicates a funding policy (even in writing) in the initial year with no follow through on that commitment. What does the actuary do in year two? What if the sponsor still indicates it intends to fund? Other abuse includes a high salary-increase-rate assumption. For a percent-pay-based liability method, this results in heavily back-loaded liability and cost.

To Pre-Fund or Not?

Arguments for pre-funding are that it is the only guarantee of future benefits and enables a sponsor to provide benefits at a lower long-term cost with the exposure to equity investments. Those that oppose pre-funding cite the fact that unlike a corporation going out of business or bankrupt, there is no real risk of an inability to pay future benefits. Ultimately, funding on a pay-go basis results in the lowest current cash outlay and provides for maximum budget flexibility. However, this is just pushing the expense to future generations.

New Jersey and Pennsylvania have opted for a pay-go approach while Massachusetts has chosen to fund annually and utilize special revenue sources. Colorado is partially funding based on a fixed dollar value rather than on any basis related to actual healthcare costs of the program.

Funding Sources

Other than an employer’s general revenues to pre-fund or to continue to PAYGo, there are some creative approaches to funding these obligations. Special revenue such as tobacco settlement funds or lottery proceeds can be utilized as a one-time startup or ongoing source. Bond issuance/debt funding is a popular sales pitch with bond salesman. The sponsor can earn investment income at a level much higher than the current borrowing rates. However, there are problems with borrowing to fund, including taking on significant investment risk and trading “soft” debt for a hard “debt.” Also, not all sponsors have the authority to issue debt. Sponsors also have to consider what happens with the funds if nationalized healthcare becomes a reality. These funds would clearly not go towards the use that was initially intended.

Ohio House Bill 315 is intended to provide an ongoing dedicated revenue stream for the State Teachers Retirement System (STRS) and its health care stabilization fund. Since the current funding level is only 1 percent of payroll, the proposed changes would increase both employee and employer contributions by 2.5 percent over a five-year period. The resulting 6 percent of payroll annual contribution would be sufficient to fund the program’s GASB 45-determined Annual Required Contribution (ARC).

Multiple Employer Arrangements

There are some benefits to creating a multiple-employer benefit program and trust. Under a “cost-sharing plan,” one valuation is performed and all employers have same cost basis; this reduces administrative costs and maintains a level of consistency. However, this can create difficulty in getting all employers to be in agreement. In an “agent plan,” every employer has flexibility in funding decisions. However, every employer needs to have a separate valuation performed, leading to inconsistency in assumptions, methods, and results.

Ohio’s STRS is a cost-sharing multiple-employer plan operating at the state level, covering city/local school districts, colleges, universities, and vocational/technical schools—approximately 1,100 employers in total. The plan’s OPEB liability is approximately $12.2 billion as of Jan. 1, 2008, with its health care stabilization fund currently valued at $4 billion.

Regardless of the funding vehicle, source of funds, plan design, or size of the employer, GASB 45 is necessary to ensure governmental employers fully disclose future obligations to the taxpayers, its creditors, and the general public.