What Is OPEB?

Other Post-Employment Benefits (OPEB) - Non-Pension Benefit Plans

Introduction

Employees of state and local governments, including public school districts, public universities and other governmental entities, may be compensated in a variety of forms in exchange for their services. In addition to a salary, many employees earn benefits over their years of service that will not be received until after their employment with the government ends through retirement or other reason for separation. The most common type of these postemployment benefits is a pension. As the name suggests, other postemployment benefits (OPEBs) are postemployment benefits other than pensions. OPEBs generally take the form of defined benefit health insurance, dental, vision, prescription drug, or other health care benefits. It may also include some types of life insurance, legal services, and other benefits. Private sector and non-profit employers have been subject to OPEB reporting since the early 1990s under the FASB 106/158 Standard. Governmental employers were exempt from this reporting obligation until the issuance of GASB Statement 45 in August of 2004.

What is the GASB requiring?

The value of the promise made to provide retiree benefits must now be actuarially calculated and accrued during the working years of employees and recognized as a financial obligation of the employer as the OPEB Cost. This amount needs to be reported on the financial statements of all public sector employers beginning in the first financial reporting period after December 15, 2006 for the largest employers while small employers had until 2008 to begin reporting. OPEB Cost is derived from an actuarial calculation that must be done every two or three years depending on employer size. Actuarial valuations take several assumptions into account:

  • Turnover rate and retiree rate
  • Medical care inflation
  • Mortality
  • Discount rate
  • Benefit design
  • Health care cost factors such as age, gender, family size, geographic area, industry
  • The promise to retirees
  • Salary scale assumption
  • Expected long-term (or short-term) rate of return on plan assets

The determination of the costs and obligations for postemployment benefits other than pensions is based on the calculation of the actuarial present value of the postemployment benefits that are expected to be paid to or on behalf of the employee under the terms of the plan and the attribution of such present value to periods of service. Generally, the attribution period is from the date of hire to the date the employee gains full eligibility for benefits (e.g., retirement). The largest component of OPEB Cost is retiree health care benefits. According to The Kaiser Family Foundation’s Employer Health Benefits 2006 Annual Survey, 82% of public sector employers employing more than 200 workers offer some form of retiree health care benefits. Continuing with a “pay-as-you-go” philosophy will create a significant new financial liability for these employers to deal with. This may be increasingly difficult in a time when most public sector employers are experiencing double-digit health care cost increases, reduced and restricted budgets, and reduced federal and state subsidies. In addition, many states have laws that mandate a provision allowing early retirees to remain on the active health care plan until they become eligible for Medicare. The cost difference between the blended plan cost (including actives and retirees) and the actual cost for the retirees must be recognized as an implicit rate subsidy by the employer. This amount adds additional liability for the employer, even if the employer is not contributing financially toward the retiree health care plan.

Does the GASB require funding of the OPEB Cost?

Although there is no requirement that the employer actually fund the OPEB Cost, not doing so could have a significant impact on the employer’s overall credit rating, consequently, affecting the cost of issuing debt financing for the public sector employer. Any Net OPEB Obligation needs to be reported as an unfunded liability on financial statements. Several of the Nation's rating agencies have indicated that they will now consider GASB 45 obligations in financial analyses. Standard & Poor’s, the Nation’s largest rating agency, issued a report stating: “The new [GASB 45] reporting may reveal cases in which the actuarial funding of postemployment health benefits would seriously strain operations, or, further, may uncover conditions under which employers are unable or unwilling to fulfill these obligations. In such cases, these liabilities may adversely affect the employer's creditworthiness. All Standard & Poor's rated employers will be monitored closely in terms of their reporting under GASB 45. Upon implementation of these new standards, we will include the new information as part of our ongoing analytical surveillance of ratings."
FitchRatings issued a report stating: “Initially, Fitch's credit focus will be on understanding each issuer's [GASB 45] liability and its plans for addressing it. Fitch also will review an entity's reasoning for developing its plan. An absence of action taken to fund OPEB liabilities or otherwise manage them will be viewed as a negative rating factor. Steady progress toward reaching the actuarially determined annual contribution level will be critical to sound credit quality."

How can the obligation be reduced?

A well designed GASB 45 OPEB mitigation strategy involves several different risk management strategies and funding techniques. First, any defined benefit promise by the employer should be funded, at least partially, in a qualified trust to enable actuaries to use a long-term discount rate during calculations. Second, consider your funding sources such as issuing OPEB obligation bonds or pooled financing to fund all or a portion of the Actuarial Accrued Liability. Lastly, combine the first two steps with an effective strategy to migrate to a defined contribution approach over time by blending a defined benefit approach with a defined contribution strategy. Collectively, OPEB liabilities can be successfully managed while still providing meaningful benefits for employees.

Defined benefit OPEB plans are those having terms that specify the benefits to be provided at or after separation from employment. The benefits may be specified in dollars (e.g., a flat dollar payment or an amount based on one or more factors such as age, years of service, and compensation) or as a type or level of coverage (e.g., major medical, prescription drugs, or a percentage of premiums). Defined benefit OPEB plans involve a complicated reporting obligation, making assumptions as to future medical care inflation, mortality, Medicare availability, and the probability of occurrence of events far into the future.
Defined contribution OPEB plans are those having terms that (a) provide an individual account for each plan member and (b) specify how contributions to an active member’s account are to be determined, rather than the benefits the member or his or her beneficiaries are to receive at or after separation from employment. For purposes of a defined contribution plan, “benefits” consist only of the contributions, earnings on investments of those contributions, and forfeitures allocated to the member’s account. Consequently, defined contribution OPEB plans involve simpler reporting obligations than defined benefit OPEB plans.

GASB accrual standards apply to defined benefit OPEB plans but NOT to defined contribution OPEB plans. Defined contribution OPEB plans are considered “funded” as the employer cost equals the required contribution. By changing the way you pay for retiree health care benefits can reduce, or even eliminate, the unfunded OPEB liability.

Shenandoah Valley Group can assist you and your advisors in designing an effective solution to reduce, and more effectively manage your postemployment benefit obligations. Following an in-depth evaluation process that will reveal areas of potential improvement, you will develop several strategies that may include defined benefit funding methods along with a transitional plan to defined contribution, thereby mitigating the financial impact of this new, and significant reporting obligation. Contact us for more details.

Click this link to GASB for more information

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