Transcript Client Name

How Consultants Determine Local
Government Liability for OPEB
Public Employee Forum on GASB Statement #45
February 7, 2007
J. Richard Johnson
Senior Vice President
Public Sector Health Practice Leader
The Segal Company
Copyright © 2007 by The Segal Group, Inc., the parent of The Segal Company. All rights reserved.
What’s Different in GASB Financial Statement Disclosure?
In the past…
 Annual outlay for retiree health premiums or benefit costs
 Only took current retirees into account
 Usually handled as a footnote
Going forward…
 Actuarial valuation of retiree health liabilities
 Reporting incorporated into financial statements
– Annual Required Contribution (ARC)
– Net OPEB Obligation (NOO)
– Required Supplementary Information
 Takes into account both active employees and retirees
Copyright © 2007 by The Segal Group, Inc., the parent of The Segal Company. All rights reserved.
1
Financial Statement Disclosure
Income Statement
 Annual Required Contribution (ARC)
– The Actuarial Accrued Liability (AAL) is the portion of the actuarial present
value of total projected benefits allocated to years of employment prior to the
measurement date
– The Normal Cost is the portion of the actuarial present value of total projected
benefits allocated to the year following the measurement date
– The ARC is equal to the normal cost and the amortization of the unfunded
accrued liability.
– There is no requirement that the ARC is funded
Balance Sheet
 Net OPEB Obligation (NOO)
– The NOO is the cumulative difference between the
ARC and the actual contributions made (if any).
– At transition the NOO may be set at zero
Notes to Financial Statements
 Generally similar to Retirement Supplement Information
Copyright © 2007 by The Segal Group, Inc., the parent of The Segal Company. All rights reserved.
2
What Benefits Are Included in OPEB Valuations?
Medical benefits
Dental
Vision
Prescription drugs
Life insurance
Legal services
Copyright © 2007 by The Segal Group, Inc., the parent of The Segal Company. All rights reserved.
3
What Goes Into the GASB OPEB Valuation?
Actuarial
Cost Method
Claims and
Premium Cost
Funding and
Financial Data
Employee and
Retiree Data
Plan
Provisions
Actuarial
Valuation
Actuarial
Assumptions
Results
Copyright © 2007 by The Segal Group, Inc., the parent of The Segal Company. All rights reserved.
4
Calculation Begins with Starting Costs
Monthly claims and
enrollment information for
recent period of time (one
to three years)
Includes active employees
and retirees
Consider plan changes
during the
claim/enrollment period
Determine initial average
cost – actives and retirees
 “Starting costs” are the
true costs at age 65 for
the following:
 Male, pre-65
 Female, pre-65
 Male, post-65
(post-Medicare)
 Female, post-65
(post-Medicare)
True cost increases with
age. Project starting costs
to reflect “cost curve”
Copyright © 2007 by The Segal Group, Inc., the parent of The Segal Company. All rights reserved.
5
What’s Different in Rate Calculations?
Traditional Rate Setting
POOL:
Actives
Retirees
Medicare Retirees
$500/mo
GASB Rate Determination
Active Employees
Pre-65 Retirees
Medicare Retirees
RATES:
Total
Active
$500
Pre-65 Retiree
$500
Medicare Retiree $300
Actual
Total
IMPLICIT
SUBSIDY
Active
$375
$125
Pre-65 Retiree
$675
($175)
Medicare Retiree $325
($25)
RATES:
Copyright © 2007 by The Segal Group, Inc., the parent of The Segal Company. All rights reserved.
6
Establish Methods and Assumptions
Funding methods
 Allocate costs between normal cost and accrued liability
 Methods vary in stability and funding pattern
 6 methods available for GASB valuation
Actuarial assumptions
 Need to match related DB retirement plan assumptions
 Investment return assumption (discount rate) is dependent on funding
– No pre-funding – use employer’s rate of return on assets (3%-4%)
– Pre-funding – use rate of return on funded assets (7%-8%)
 Healthcare cost trend assumptions
– Based on experience of covered group
– Reflects expected long-term future trends
– Can differ by benefit
– Typically starts at 10%-12%, then decreases 1% each year until ultimate
level is reached (typically 5%)
Copyright © 2007 by The Segal Group, Inc., the parent of The Segal Company. All rights reserved.
7
What Issues are Public Employers Facing?
Health benefit costs are increasing much faster than general inflation
Health costs increase as an employee/retiree gets older
Limited ability to fund liability out of current revenue flow – will OPEB
destroy the budget?
Large OPEB liability can impair jurisdiction’s ability to issue bonds
How to explain large retiree
health liability to stakeholders
and general public
To fund or not to fund?
How to balance competing
revenue interests
Copyright © 2007 by The Segal Group, Inc., the parent of The Segal Company. All rights reserved.
8
U.S. Projected Medical Trends (with Rx)
ACTIVES AND RETIREES UNDER AGE 65
Annual Percentage Increase
20.0
18.0
16.0
14.0
12.0
10.0
8.0
Gap
6.0
4.0
2.0
0.0
1999
2000
2001
Non-Network
HMO
Medical Inflation
2002
2003
PPO
HD-PPO
Overall Inflation
2004
2005
2006
2007
POS
Rx Retail
Workers Earnings
Source: 2007 Segal Health Plan Cost Trend Survey and U.S. Bureau of Labor Statistics.
Copyright © 2007 by The Segal Group, Inc., the parent of The Segal Company. All rights reserved.
9
What are Employers Doing to Address the OPEB Liability?
Getting an early handle on the GASB OPEB liability
Rethinking the programs
 Eligibility and entitlement for retiree health benefits
 Plan design changes
 Looking at different subsidy approaches - separate for actives and retirees
Investigating pre-funding options
 Retiree health trust options
 Redeploying existing fund balances
 Surcharging current employee and employer rates to build reserves
 Using retirement plan assets for funding retiree health benefits
Balancing retiree health against other revenue sources and uses
Reviewing total pay and the balance between pay and benefits
Copyright © 2007 by The Segal Group, Inc., the parent of The Segal Company. All rights reserved.
10
GASB Timeline/Implementation Plan
June 30, 2007
June 30, 2008
Planning
&
Analysis
Budget
Estimate
for FY2008
Data
Collection
Assumptions
&
Valuation
Initial
GASB
Liability
Estimate
Budget
Estimate
for FY2009
June 30, 2009
June 30, 2010
Deliver
Final GASB
Valuation
& Financial
Reporting
Data
Collection
FY2010
FY2009
FY2008
June 30, 2006
Copyright © 2007 by The Segal Group, Inc., the parent of The Segal Company. All rights reserved.
Assumptions
&
Valuation
Budget
Estimate
for FY2010
Deliver
Final GASB
Valuation
& Financial
Reporting
Data
Collection
Assumptions
&
Valuation
Deliver
Final GASB
Valuation
& Financial
Reporting
11
Benefit Design Strategy to Manage Liabilities
The Three “R”s of Cost Containment:
Redefining Eligibility Requirements
 Tie retiree health eligibility to
service levels
 Consider institutional goals for work
force planning
 Review spouse coverage rules
 Eliminate retiree health benefits to get
rid of OPEB liability?
Copyright © 2007 by The Segal Group, Inc., the parent of The Segal Company. All rights reserved.
12
Benefit Design Strategy to Manage Liabilities continued
The Three “R”s of Cost Containment:
Restructuring Benefits
 Create new tier for new hires
 Reduce benefits for future retirees
 Review Medicare Coordination Method
 Review Prescription Drugs
– Leverage Medicare Part D
– PDP vs. Subsidy
– Eliminate Rx plan
 Establish benefit caps
 Look at underlying health plan to
manage utilization and claim costs
Copyright © 2007 by The Segal Group, Inc., the parent of The Segal Company. All rights reserved.
13
Benefit Design Strategy to Manage Liabilities continued
The Three “R”s of Cost Containment:
Rethinking Cost Sharing
 Move to a flat dollar employer share
 Increase retiree contribution
 Tie benefit levels to service levels
 Defined Contribution approach
– Fund while employees are active
Copyright © 2007 by The Segal Group, Inc., the parent of The Segal Company. All rights reserved.
14
Key Decision: Pre-funding
1
Pre-funding
2
Debt Financing
Options
3
Pay-As-You-Go
4
Combination
Experience already shows moving from pay-go to
pre-funding increases annual costs 3–6 times.
OPEB Requires Disclosure – NOT Funding
Copyright © 2007 by The Segal Group, Inc., the parent of The Segal Company. All rights reserved.
15
To Pre-fund or Not to Pre-fund?
No simple solution for all jurisdictions
Opportunity trade-offs
 Pre-funding
– Lower liabilities, better rating, lower cost of capital, higher current year
costs
 Pay-Go
– Higher liabilities, potential lower rating, higher cost of capital, lower
current year costs
Pre-funding requires clear set aside from
jurisdiction accounts
 Separate retiree health trust
 Irrevocable trust within an existing
health fund trust
Copyright © 2007 by The Segal Group, Inc., the parent of The Segal Company. All rights reserved.
16
Pre-funding Trade-offs
Level of Pre-funding
Proportion of benefits pre-funded will dictate
discount rate
 Pay-go (no pre-funding) is risk-free rate –
can base on internal ROI
 Pre-funding can use a market rate
used in similar retirement trusts
Irrevocable or Not?
If funding vehicle is not irrevocable, jurisdiction cannot count
assets as OPEB assets in the financial statement
However, full disclosure and discussions with rating agencies may
help mitigate rating risk
Copyright © 2007 by The Segal Group, Inc., the parent of The Segal Company. All rights reserved.
17
Debt Financing
OPEB Obligation Bonds
Taxable municipal “arbitrage” bonds
Trading soft debt for hard debt
First one—Gainesville, Florida
Does long term debt for retiree health make sense
with future of nationalized health care unknown?
Insurance approaches paired with OPEB bonds
 Life insurance policy purchase for active employees
 Perception issues among elected officials re betting people
will die as a way to fund retiree health
 Complex, multi-tiered funding approach is difficult for
taxpayer to understand
Copyright © 2007 by The Segal Group, Inc., the parent of The Segal Company. All rights reserved.
18
Pre-Funding Options
Pre-Funding Vehicle
Shortcomings
Merits
Employer General Asset
Accounts
 Simple set-up
 Considerable flexibility in funding and plan design




State-Law Grantor Trusts
(Integral IRC Section 115
Trusts)
 Considerable flexibility in funding and plan design
 Use of trust assets may be limited to the exclusive benefits of the
covered employees and their families
 Employee contributions only permitted on an after-tax basis
 Varying state laws for establishment and governance of trusts
 Subject to certain nondiscrimination requirements
Voluntary Employees’
Beneficiary Association
Trusts (VEBAs)**
 VEBA assets and earnings specifically earmarked for the sole
purpose of providing the intended benefits (e.g., life, sickness,
accident or other benefits) to members of the association or their
dependents or designated beneficiaries
 Considerable flexibility in funding and plan design




Section 401(h) Retiree
Medical Accounts within
a Pension Plan***
 Use of assets restricted to medical purposes
 Pre-tax employee contributions permitted through a mandatory
“pickup” arrangement in which all eligible employees must
participate
 On plan termination, excess assets revert to the employer
 Possible employee dissatisfaction stemming from mandatory and irrevocable
“pickup” arrangement
 Additional administration required: separate funding and accounting for pension
and medical benefits
 Contributions limited to 33 1/3% of total retirement contributions. Sponsors of wellfunded pension plans may not be able to make contributions because of this limit.
Health Reimbursement
Arrangements (HRAs)
 Allows year-to-year carry-over of unused value
 Encourages careful consumption of health care services
 May discourage employee or dependent from seeking needed medical care now,
resulting in potentially greater insured costs later
 Additional administration required
 Coordination of HRAs with Medicare may be problematic
Health Savings Accounts
(HSAs)
 Vehicle for active employees to save for retiree health premiums
 Account balance carries over and is portable if employee leaves
 Employer may contribute to savings account to fund part of the
high deductible
 Employee/employer contributions are limited (Archer IRA limits)
 Must be paired with a high deductible health plan ($1, 000 single/$2,000 family),
retiree savings vehicle not available by itself
 Low paid participants with significant health claims may not be able to have money
left in account to carry over for retiree health premiums later
 May discourage employee or dependent from seeking needed medical care now,
resulting in potentially greater insured costs later
 Additional administration required for savings and investment component
Copyright © 2007 by The Segal Group, Inc., the parent of The Segal Company. All rights reserved.
Employee contributions only permitted on an after-tax basis
Use of account assets not restricted to plan purposes
Assets subject to the claims of general creditors.
Subject to certain nondiscrimination requirements
Employee contributions only permitted on an after-tax basis
Funding limits differ for bargained and non-bargained employees
Limits on types of benefits offered
Subject to certain nondiscrimination requirements
19
How Does Retiree Health Fit Into Total Rewards?











Organization commitment
Organization support
Work environment
Organization citizenship
Title
Base salary
Incentives
Ownership
Cash recognition
Premium pay
Pay process
 Benefits
 Non-cash
recognition
 Perquisites
Affiliation
Direct
Financial
Work
Content
Employee
Value
Proposition
Indirect
Financial
Copyright © 2007 by The Segal Group, Inc., the parent of The Segal Company. All rights reserved.





Career




Variety
Challenge
Autonomy
Meaningfulness
Feedback
Advancement
Personal Growth
Training
Employment security
20
Looking Ahead – New Themes in Retiree Health Benefits
What can/should be done to ensure
that health benefit promises made to
retirees are kept?
What are acceptable trade-offs
between generations?
Is it better to have pressure on bond
ratings or pressure on current year
budget?
How to balance among pay
increases, pension benefits and
retiree health benefits?
How important are retiree health
benefits in light of total
compensation?
Copyright © 2007 by The Segal Group, Inc., the parent of The Segal Company. All rights reserved.
21
Questions?
J. Richard Johnson
[email protected]
Copyright © 2007 by The Segal Group, Inc., the parent of The Segal Company. All rights reserved.