Benefit Plan Blog

This is one in a series of Benefit Basics postings that are intended to provide more extensive and technical background information on current benefit topics than regular postings.

Overview

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 (OPEB) are postemployment benefits other than pensions. OPEB generally takes the form of defined benefit health insurance, dental, vision, prescription drug, or other healthcare benefits. It may also include some types of life insurance, legal services, and other benefits.

The promise made to provide retiree benefits must now be 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 tax year 2006 for the largest employers while small employers have until 2008 to begin reporting.

Cost Elements

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
• 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

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, and consequently, affecting the cost of 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.

Cost Components

The largest component of OPEB Cost is retiree healthcare benefits. Continuing with a “pay-as-yougo” philosophy will create a significant new liability for employers to deal with. In addition, many states have laws that allow 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 to the retiree healthcare plan.

How Can The Obligation Be Reduced

A well designed GASB 45 OPEB mitigation strategy involves several different risk management and funding techniques. First, any defined benefit promise by the employer should be funded, at least partially, to enable actuaries to use a long-term discount rate during calculations. Second, combine this first step with a strategy to migrate to a defined contribution approach over time. Collectively, OPEB liabilities can be successfully managed.

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 (for example, 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 (for example, major medical, prescription drugs, or a percentage of premiums). Defined benefit OPEB plans involve the more complicated reporting obligation making assumptions as to future medical care inflation and Medicare availability until the participant's death.

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 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 which employers pay for retiree healthcare can reduce, or even eliminate, the unfunded OPEB liability.

Source: America's VEBA Solution.