GASB released two important standards intended to disclose the nature and extent of nonpension post-employment benefit liabilities largely related to health care. Governments are not required to fund the liability, but will face disclosure requirements and operational hurdles if funding is not made.
GASB Statement no. 45 , Accounting and Financial Reporting by Employers for Postemployment Benefits Other Than Pensions , and its companion, Statement no. 43, Financial Reporting for Postemployment Benefit Plans Other Than Pension Plans , have significant implications for both financial statement preparers and their auditors.
The general practice has been to report OPEB costs on a pay-as-you-go basis. The new standards generally require pension-type accounting for post-employment benefits. Most governments need to use actuaries to project future benefit costs, discount these costs to present value and assign these costs to the appropriate period.
GASB designed the new statements to resemble the previously issued pension statements no. 25 and 27. Because of the similarity in the disclosures and processes, preparers should find that disclosures are fairly straightforward. Many preparers may merge OPEB data in the same note in basic financial statements with existing pension data.
One of the statements’ more controversial aspects is the inclusion of any implicit rate subsidies afforded to retirees in the measurement of the liability and the annual required contribution.
Eric S. Berman , CPA, is deputy comptroller for the commonwealth of Massachusetts. Donald L. Rahn , CPA, MBA, is a partner in the public sector practice group at Virchow, Krause & Co. LLP. Their e-mail addresses, respectively, are firstname.lastname@example.org and email@example.com .
The authors would like to thank Elizabeth K. Keating , CPA, Ph.D., a visiting assistant professor at Boston College, and Reem Samra , CPA, of Deloitte, for their contributions to this article.
T wo GASB statements are sending ripples through American governmental finance. The statements establish clear, stringent standards for measuring and disclosing non-pension post-employment benefits provided—employee benefits that are largely related to health care.
Statement no. 45, Accounting and Financial Reporting by Employers for Postemployment Benefits Other Than Pensions , and its companion Statement no. 43, Financial Reporting for Postemployment Benefit Plans Other Than Pension Plans , demand budgetary transparency of state and local governments. The picture will be stark for the vast majority of governments. The total unfunded OPEB (other post-employment benefit) liability for the nation’s state and local governments has been estimated at $1 trillion, GASB board member Girard Miller wrote in a 2007 column in Governing Management Letter .
Governments are not required to fund this liability, though some governments may operate under either a legal, contractual or moral obligation to do so. Opting not to fund the liability will mean disclosure requirements and operational hurdles. Bond rating agencies have indicated that a government’s decision not to fund OPEB indicates a lack of management recognition of a major liability. This lack of recognition may weigh heavily in a rating decision and eventually may cost the government additional funds in extra interest costs.
The Pew Center on the States reported in 2007 that the combined OPEB and defined benefit pension unfunded actuarially accrued liabilities (UAAL) over the next 30 years “can be conservatively estimated at $2.73 trillion” nationwide. The report, Promises with a Price: Public Sector Retirement Benefits , continues, “Today, the need to intelligently control and manage the cost of post-retirement benefits is integral to states’ capacity to fund competing needs, such as adequate roads, bridges, water systems and high-quality public education.”
By measuring and disclosing OPEB liabilities, decision makers are equipped with better information about the present value of the cost of the future benefits— information that will allow them to make educated decisions about the post-employment health care benefits to be provided to employees.
AN OVERVIEW OF THE STANDARDS
Many actuaries assisting state and local governments with the new requirements may look to standards that they are familiar with in the for-profit world—namely FASB Statement no. 106, Employers’ Accounting for Postretirement Benefits Other Than Pensions . However, there are dramatic differences between the standards, as illustrated in Exhibit 1 .
Recently, FASB issued Statement no. 158, Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans , which primarily recognizes in statements of financial position the funded status of plans. This status is the difference between plan assets and accumulated liabilities. GASB Statement no. 45 requires the presentation of these amounts as required supplementary information.
Gather data on demographics and participants at or as close as possible to the valuation date. If spouses and other beneficiaries are involved in the plan, a full count of participants is needed.
Gather information on participants in cost-sharing arrangements and assess which government holds the risk of paying health care costs.
Gather claims data for the year previous to the valuation date.
Gather investment returns (if any) of assets held in an irrevocable trust to pay for OPEB. Statement no. 43 and Statement no. 45 require that the investment return used for a discount rate mirror the investments that are held in the portfolio to pay benefits. If no investments are held in an irrevocable trust to pay for OPEB, then gather a long-term series of investment returns of the government’s cash investments. A typical view would be monthly returns over five to 10 years, or more if available. Statement no. 43 and Statement no. 45 require a “long-term view of short-term interest rates.”
Document and locate all plan information including contributions, vesting, insured status, eligibility, deductibles, types of coverage, co-pays and spousal/dependent benefits. Make a table of each element by plan.
Don’t forget about non-health OPEB, including dental, vision, life insurance and other benefits.
Engage an actuary, preferably a health care actuary or one who has access to that expertise.
Talk to your auditor early about information such as trend rates and returns for a “reasonableness” check.
Engage the government’s bond disclosure counsel to assure proper and timely reporting to bondholders and other interested parties.
Presentation of Accrued Amounts. Both statements require measuring UAAL using accrual accounting, rather than pay-as-you-go accounting. OPEB liabilities increase based on normal costs and decrease based on contributions and changes in investments that are used to finance the liability. Accrual accounting is required because an exchange of compensation occurs between employer and employee with each pay period due to the promises of these future benefits or laws that require these benefits to be paid upon retirement.
Annual Required Contribution (ARC). Both statements require the measurement of an actuarially required contribution. This amount is the normal cost for the fiscal period, computed in a similar manner to normal pension cost, plus any amortization of the UAAL (or funding excess.)
Any amount of the ARC that is unfunded in a year is shown as a liability on the statement of net assets at fiscal year-end and is used in computing the ARC for the next fiscal year as an adjustment. A net OPEB obligation is arrived at, which is the cumulative difference between annual costs, including the UAAL (or asset) and contributions. Six actuarial methods are allowed; however, special disclosure is needed if the aggregate actuarial cost method is used.
Net OPEB obligation. The employer’s net OPEB obligation represents the difference between the annual OPEB cost and the employer’s contributions to the plan. The obligation is set at zero at the beginning of the transition year.
Inclusion of an array of costs. OPEB includes all other post-employment benefits, other than pensions, contained within a substantive plan (the terms understood by the employee and employer) and is updated with each valuation. OPEB may include dental, vision, longterm care, disability, life insurance or other costs that are borne in any part by the employer. OPEB may include spousal and dependent coverage. If the employee pays 100% of these costs, they are not included in the OPEB calculations. All of this is disclosed as part of the OPEB substantive plan. GASB, however, specifically exempts vacation, sick leave and termination benefits, as they are addressed elsewhere in standards.
Valuation frequency. Calculation of the liability must be done at least biennially, while the smallest governments (200 plan participants or less) have an exemption affording triennial valuations. Valuation of assets within a plan must be done annually. Because of this frequency mismatch, many governments may choose to value both the assets and liabilities annually.
Actuary Exemption. Governments with fewer than 100 members are permitted to use an arithmetic calculation, rather than an actuarial calculation. The standards refer to this as the “alternative measurement method.”
Implicit rate subsidies. One of the more controversial pieces of the statements is the inclusion of any implicit rate subsidies afforded to retirees in measuring the liability and the annual required contribution. These subsidies are generated as a result of the basic nature of insurance— one risk group subsidizes another to arrive at a blended premium. In all likelihood, current employees who are young and healthy subsidize older retirees.
Staggered implementation. Both statements afford an implementation schedule based on revenues, as illustrated in Exhibit 2 . Component units of a primary government must implement the standards at the same time as the primary government, irrespective of their revenue base.
In addition, the auditor must understand the nature of the specialist’s work. That understanding should include the objectives and scope of the specialist’s work; the specialist’s relationship to the client; the methods or assumptions used; a comparison of the methods or assumptions with the prior period; the appropriateness of the specialist’s work; and the specialist’s findings that will enable the auditor to conclude that the related financial statement assertions are supported.
Finally, for the auditor to conclude that the specialist’s findings support the related financial statement assertions, the auditor must make appropriate tests of data provided to the specialist (for example, the payroll database) and evaluate whether the specialist’s findings support the relevant financial statement assertions.
Timing can be an issue. Auditors should ask for the actuarial report early in the planning phases of the audit whenever possible. The report should provide the ARC by function (for the governmentwide statements) and fund (for full accrual funds). Auditors should confirm that the actuary is using GASB standards for the calculations instead of FASB standards.
Other audit considerations include whether the investment rate of return assumption is guided by paragraph 13c of Statement no. 45. That is, if there are no plan assets, the actuary cannot use a rate of return higher than the entities’ own internal earnings rate on liquid investments. In addition, the health care cost trend needs to be reasonable. Auditors should find out the source of the trend used by the actuary.
As noted earlier, governments with fewer than 100 members are permitted to use an alternative measurement method in lieu of an actuary. However, we believe that because of the complexity of the calculation, the data elements that are needed and the audit risk involved in the calculation, it is likely that even the smallest governments may seek out an actuary to produce a report of these liabilities.
The standards also require significant footnote disclosures. Most, if not all, of the disclosure information will be taken directly from the actuary’s report. Since the footnotes are part of the basic statements, the auditor should evaluate whether the footnote information is supported by the actuary’s report.
GASB Statement no. 45 also requires the presentation, as required supplementary information, of various trend information behind the footnotes. The auditor’s responsibility for such information is described in AU Section 558.
An OPEB valuation is the beginning of a government’s journey into finally realizing the full costs of compensation promises made. With this information, governments are better equipped to make decisions and plan for the future. There are many facets of the new rules that both governmental financial statement preparers and their auditors will need to consider.
by Bruce W. Chase and Vivian Calkins-McGettigan
A study of counties and cities in Virginia found significant differences in responses from governments that had performed an actuarial study of other postemployment benefit liabilities and those that had not. The finding suggests that as governments measure their actuarial liability and annual required contributions, they are more likely to consider options that will reduce these costs, such as making changes to benefits or funding future costs. The survey also found a significant impact related to using a trust fund to provide for future OPEB costs.
Radford University in July 2007 sent a survey to 134 counties and independent cities in Virginia to gauge plans for implementing GASB Statement no. 45. Fifty-nine surveys, or 44%, were returned. Of the responding governments, 13 22%) had completed an actuarial study. All six localities with a population of more than 90,000 had done an actuarial study, while only 13% of localities with populations under 90,000 had completed such a study.
The survey also found:
For governments that had performed an actuarial study, 16% were considering a pay-as-you-go approach, paying for OPEB costs only as insurance and other invoices are due, and another 16% were undecided. In addition, 47% of the governments that had performed an actuarial study were considering changing the benefits they offered. Of these, 33% said they were considering changing benefits for all employees and 67% would only change benefits for new employees.
For governments that had not performed an actuarial study, 59% were considering the pay-as-you-go approach and 39% were undecided. In addition, 11% were considering changing benefits.
Fifty-four percent of governments that performed an actuarial study were considering using a trust fund, 16% an internal service fund, and 8% creating some type of reserve in the general fund. The remaining 22% were undecided or were not planning to fund their OPEB liability.
If a trust fund was used, the actuarial liability was on average 46% lower than the amount computed assuming no separate investment of funds, and the annual required contribution (ARC) was on average 36% lower than the amount computed assuming no separate investment of funds. Higher discount rates and the consistent funding of the ARC through the use of a trust can cause unfunded actuarially accrued liabilities to drop 40% or more.
Bruce W. Chase , CPA, Ph.D., is an accounting professor at Radford University. His e-mail address is firstname.lastname@example.org . Vivian Calkins-McGettigan , CPA, MBA, CPFO, is the finance director for Fauquier County and Fauquier County Public Schools. Her e-mail address is email@example.com .
Policy Decisions and OPEB
by Eric S. Berman
The new GASB standards may affect budgetary and other policy of state and local governments. While there is no explicit provision in Statements no. 43 or 45 to fund other post-employment benefits (OPEB), there are tremendous benefits of funding those costs in advance of payment. Because of higher discount rates and the use of consistent funding of the annual required contribution (ARC) through the use of an irrevocable trust, unfunded actuarially accrued liabilities may drop 40% or more.
Some governments may use a hybrid approach, phasing in funding over a period of years while deciding on other strategies to manage OPEB liabilities. During this period leading up to full ARC funding, a liability will appear on a government’s statement of net assets for the cumulative ARC that wasn’t funded.
Assuming a government decides to fund OPEB, the first decision is identifying the revenue source. Revenue alternatives may include:
General obligation or OPEB bonds. Like pension obligation bonds, OPEB bonds may solve a need to fund at least some of the OPEB liability. However, these bonds are not without risks. Because of the volatility in health care costs, benefits and the possibility of third-party funding, the Government Finance Officers Association warned governments to "refrain from issuing OPEB bonds until all issues concerning the proper establishment of a qualified trust fund, investment procedures, and investment guidelines have been resolved."
Pledges of revenue streams. For years, taxes, lottery or gambling profits, tobacco settlement receipts and other revenues have been pledged for one government function or another. OPEB is a likely candidate for those pledges. For states, tobacco settlement receipts or tobacco taxes may solve at least part of the OPEB funding puzzle. Endowments and trusts holding some of those revenue streams may also present a source of funding for OPEB. Finally, special one-time revenues, such as asset sales, may present an infusion of funding.
Voluntary Employee Benefits Associations (VEBAs). A VEBA trust is what General Motors has used to wrestle with its enormous OPEB obligation. The state of Ohio has also used a VEBA as one of its more successful strategies to fund OPEB costs. Governments sponsor the VEBA along with a third party, typically a union. The union gathers the employee contributions, invests them and pays the employees’ share of contributions.
Other financing possibilities include Health Reimbursement Accounts (HRAs). These accounts are financed by employers for employee costs of OPEB.
One of the more intriguing possibilities includes leave conversion plans. Under such a plan, a government gives an option to a retiring employee to allow the employee to use the value of accumulated sick and vacation buyouts to invest in an account, accumulate earnings and pay for the retiree’s portion of OPEB. This can be a tremendous benefit to the government and the new retiree as the government realizes lower cash flows and the retiree has a large portion of future out of pocket health care costs prepaid.
Plan Changes Inevitable?
Strategies that governments have used or that are being considered include shifting OPEB costs from the government to employee (or retiree). Most governments will attempt to do this, unless there is a legal provision not to. Massachusetts Gov. Deval Patrick has proposed to raise employee contribution percentages for higher income employees starting in fiscal 2009. Employees earning more than $50,000 would pay a 25% share, up from 15% or less. If employee contribution rates are raised, OPEB liabilities will fall.
Another option is modifying OPEB eligibility. Many governments vest after a short time. This practice is a large contributor to OPEB costs. Governments are lengthening vesting periods, enacting graduated scales similar to pensions and are exploring setting maximum limits on amounts paid for medical expenses or defined contribution plans for new hires to lower OPEB costs. Other options to consider include shifting coverage away from spouses and beneficiaries.
Governments may not have the expertise or the administration to manage OPEB on their own. Many governments have pooled resources for investments, bonding and other operations. Spreading risk among a larger group of participants may reduce health care costs and would likely cut administrative costs by eliminating redundant structures.
No single strategy can solve the entire problem. A successful implementation of OPEB should include pieces of many of the above items.
For more information or to place an order or to register, go to www.cpa2biz.com or call the Institute at 888-777-7077.