Notes

Outline

Proposed GASB Statements on Reporting Of Postemployment Healthcare and Other Benefits by Employers and Plan Administrators Karl Johnson,  Project Manager Governmental Accounting Standards Board Texas Pension Review Board--Public Pension Seminar Austin, Texas, March 8, 2004

As Governments Wait...

...GASB Prepares to Issue Two Statements on OPEB in 2004 Accounting and Financial Reporting by Employers for Postemployment Benefits Other Than Pensions Accounting and financial reporting by employers for their other postemployment benefit (OPEB) expenses and obligations and related disclosures Financial Reporting for Postemployment Benefit Plans Other Than Pension Plans Financial reporting by plan administrators or sponsors regarding plan assets in their care and related disclosures

The Governmental Accounting Standards Board An independent professional standard-setting body established under auspices of the Financial Accounting Foundation, a private, not-for-profit foundation The prime source of GAAP for some 80,000 state and local governmental entities in the U.S. (recognized in AICPA Rule 2.03) The sister organization to the Financial Accounting Standards Board (FASB), which establishes GAAP for entities in the private sector

The Board 7 members (full-time chair and 6 part-time members)--with full-time research and technical staff Staggered 5-year terms (10-year max.) Convenes every 5-6 weeks (typically for 2-1/2 days) to deliberate issues --also meets by teleconference as needed Issues standards after extensive due process

Current GASB Board Members

Where Does GASB Get Its Authority to Enforce Compliance? A trick question.  GASB is not a governmental agency & has no power to mandate or enforce compliance with its standards Governments issue GAAP financial reports, not for GASB, but for other good reasons such as: Compliance with laws and expectations regarding public accountability Desire to maintain good credit in the municipal bond market to minimize the cost of borrowing For such reasons, it may be advantageous to obtain an auditor’s opinion that financials are fairly presented in conformity with GAAP

Scope: Things That Are OPEB “OPEB” refers to postemployment benefits other than pension benefits These include: Postemployment healthcare benefits (medical, dental, etc.) Others (e.g., life insurance) if provided separately from a pension plan* *  Otherwise, these would be accounted for as part of pension benefits

Things That Are Not OPEB: 1. Termination Offers and Benefits TOB include special termination benefits, early retirement incentive programs, etc. TOB are incentives to terminate services, not compensation for services--quite different in intent and substance from OPEB For that reason, TOB generally are subject to a different financial reporting standard* * However, if a TOB is given in the form of an increase in an existing OPEB, report the incremental effect under OPEB standards (so that the entire OPEB will be reported under the same standards).

Things That Are Not OPEB: 2. Sick Leave Conversions GASB 16 requires accrual of sick leave as compensated absences to the extent it will be provided through termination payments These include payments to a third party to establish an individual defined contribution account to be used for the retiree’s share of postemployment healthcare premiums (GASB 16, footnote 6) The effect is similar if the employer retains administration of the account

Things That Are Not OPEB: 2. Sick Leave Conversions (concluded) By termination, an employer should have fully accrued an amount equal to the balance of such a sick leave conversion account as expense and compensated absence liability Payment to a third party to establish the account--or payments of healthcare premiums from such an account thereafter, if the employer retains administration--discharge that liability to the retiree (no employer OPEB is created)

Proposed Employer Statement Currently in re-exposure through April 30, 2004 Expected to be balloted for approval to issue as a final Statement by June 30, 2004 Will affect all employers that offer OPEB Will require accrual-basis accounting for employers’ OPEB expense

What Is OPEB? Substance of the Transaction Postemployment benefits (both pensions and OPEB) are part of the compensation for services rendered by employees; that is, they are part of an exchange transaction* * Considered but rejected:  the view that OPEB represents a series of gifts or gratuities given by the employer that are unrelated to the services received from employees (that is, voluntary non-exchange transactions)

What Is OPEB? Substance of the Transaction (concluded) Benefits are “earned;” employers incur cost,  whether or not they choose to fund it concurrently; and benefit obligations accrue or accumulate as services are rendered (i.e., during employment) Payment or provision of benefits is deferred until after employment* * Thus, there is typically a very long time lag between the incurrence and the payment of the obligation

Current GAAP GASB 34 requires that government-wide financial statements be prepared on the accrual basis of accounting However, currently there is no uniform accrual-basis standard for OPEB*--a significant hole in the standards * SLG employers may apply GASB 27 or FASB 106 to OPEB on an interim basis; however, most don’t

Current Practice Many OPEB plans have never had an actuarial valuation done--even for managerial information purposes Most OPEB plans are financed on a pay-as-you-go basis (as premiums or benefits must be paid, with no funding of actuarial accrued liabilities) Financial statements generally report no financial effects of the employer’s OPEB obligation* until promised benefits finally are paid--and then they generally report only the amount paid *  Other than disclosure that benefits are provided

Current Practice (concluded) Accordingly, current financial     reporting generally fails to: Recognize the cost of benefits in periods when services are received Provide information about the actuarial accrued liabilities for promised benefits Provide information useful in assessing potential demands on future cash flows

In short, current financial reporting practice does not “faithfully represent” the substance of the underlying OPEB exchange or adequately report its financial effects on the employer.

Financial Reporting Objectives of This Project Recognize OPEB cost (expense) systematically over periods approximating employees’ years of service

Financial Reporting Objectives of This Project (continued) Provide relevant information about (a) actuarial accrued liabilities for promised benefits associated with past service, (b) the annual cost of OPEB,* and (c) the progress made in funding the plan *  And its effect on the total cost of government services

Financial Reporting Objectives of This Project (concluded) Report OPEB in a manner generally consistent with pensions; that is, following the same overall approach adopted in GASB 25/27* *  The Board concluded that a consistent overall approach is appropriate, because pension benefits and OPEB are conceptually similar.  However, limited differences between the two sets of standards also are appropriate as needed to address differences between pension benefits and OPEB.

The GASB 25/27 Measurement Approach Has been called a “funding based” approach to reporting pensions In its pension project, the GASB made an explicit decision to harmonize financial reporting with actuarial funding concepts, as commonly applied in the public sector, to the fullest extent deemed appropriate for accrual accounting purposes* * A significant departure from FASB Statement 87

The GASB 25/27 Measurement Approach (concluded) Although OPEB plans generally are not funded, an approach based on GASB 25/27 still will be “funding friendly” for OPEB, because an employer that chooses to fund (now or later) need not use different measures for accounting and funding purposes* * Note that the proposed employer OPEB Statement would not include any requirement with respect to an employer’s method of financing or budgeting of OPEB

Measurement Approach: Broad Steps 1.  Project cash outflows for benefits 2.  Discount projected benefits to present value (PV) 3.  Allocate the PV of projected benefits to      periods using an acceptable actuarial cost method

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Parameters for Actuarial Valuations

Required Frequency of Actuarial Valuations OPEB plans should obtain actuarial valuations:  At least biennially, if total plan membership (active, terminated/eligible, and retired and currently receiving benefits) is 200 or more  At least triennially, if total plan membership is fewer than 200 total members* *   Single-employer plans with fewer than 100 total members may choose to apply a simplified “alternative measurement method” in lieu of obtaining an actuarial valuation

The Alternative Measurement Method* Includes the same three broad measurement steps as an actuarial valuation Is governed by most of the same parameters But allows simplification of certain assumptions and techniques to permit potential application by non-specialists * Illustrated in the Exposure Drafts

Annual Required Contribution of the Employer (the ARC) A key measure that is the basis for OPEB expense recognition; like the ARC for pensions Represents the level of contribution effort necessary on an ongoing, sustained basis to: Cover the normal cost (service cost) for each year Amortize the unfunded actuarial accrued liability (UAAL) over a reasonable number of years* * The UAAL may be amortized as an aggregate amount, or components may be amortized separately, using level $ or level % of payroll methods, on a closed or open basis.  The maximum period (or ESAP) is 30 years.

Annual OPEB Cost An accrual-basis accounting measure, derived from the ARC, of the employer’s cost of providing defined-benefit OPEB each year Is the amount recognized as OPEB expense in accrual-basis financial statements (including government-wide statements) Is measured as follows: The ARC Plus interest on net OPEB obligation* Minus an “ARC adjustment”* * If amounts contributed have differed from the ARC in prior periods

Recognition in Accrual-Basis Financial Statements* Recognize OPEB expense in an amount equal to annual OPEB cost for the period, regardless of the amount paid The cumulative difference between amounts expensed and contributions or benefits paid will create a liability (or asset) called the net OPEB obligation *   Government-wide, proprietary fund, or fiduciary fund financial statements

Accrual-Basis Illustration (Initial Year of Implementation) Normal cost (service cost for year)           $ 29,000 Amortization of the UAAL              30,000 Annual required contribution (ARC) and    annual OPEB cost/expense* 59,000 Actual employer contribution (PAYG    amount = 42% of annual OPEB cost)              (25,000) Increase in net OPEB obligation              34,000 Net OPEB obligation--beginning             (---0---) Net OPEB obligation--ending              34,000 *  Assuming that the net OPEB obligation at transition was set at zero (prospective implementation)

Recognition--Modified-Accrual Financial Statements* Recognize OPEB expenditures in the amount (actually) contributed to the plan or “expected to be liquidated with expendable available financial resources” *   Governmental fund financial statements

Contributions An employer is deemed to have contributed to an OPEB plan if, and only if, the employer: Made direct payments of benefits, Paid insurance premiums, or Irrevocably transferred assets to a trust, or equivalent arrangement, in which the assets are dedicated to payment of plan benefits as they come due in the future and are protected from creditors of the employer(s) and the plan administrator

Contributions (concluded) An employer should treat as employer assets: Net assets that the employer designated for OPEB in a governmental or proprietary fund Assets transferred to a separate governmental or proprietary fund for future OPEB payments Assets transferred to a 3rd-party administrator of a multiple-employer plan in excess of PAYG requirements, if the plan is not administered as a qualifying trust, or equivalent arrangement* * In the latter case, the employer also should apply the standards applicable to an agent employer.

Note Disclosure Changes (Highlights) Note disclosure requirements for OPEB employers generally are similar to those for pension employers under GASB 27 Examples: Disclosures of plan description and  funding policy (all employers) Disclosures of amount and components of annual cost, amount actually contributed, change in net obligation, and % of annual cost contributed (sole and agent employers)

Note Disclosure Changes (Highlights) (continued) However, the Board has added or modified disclosure requirements for OPEB at several points Examples: OPEB note disclosures include disclosure of the funded status of single-employer and agent plans in which an employer participates, as of the most recent actuarial valuation (not required for pensions)

Note Disclosure Changes (Highlights) (concluded) Examples (continued): There should be expanded explanatory disclosures about actuarial methods and assumptions* * The purpose of these is to make reported financial information about OPEB understandable to a wider range of financial report users

Required Schedule of Funding Progress (RSI) Employers also will be required to disclose as RSI multi-year trend information about the UAAL and progress made in funding the plan, as for pension plans, including: Actuarial accrued liability (AAL) Actuarial value of plan assets--generally a market related value Unfunded actuarial accrued liability (UAAL) (AAL minus plan assets) (continued)

Required Schedule of Funding Progress (RSI) (concluded) (continued) Funded ratio (actuarial value of plan assets/AAL) Ratio of UAAL to covered payroll Notes to RSI regarding changes affecting the interpretation of trends in the amounts reported

Illustration of Funded Status/Funding Progress:  Year of Implementation Actuarial accrued liabilities (AAL) (a)      $6,370,000 Actuarial value of plan assets (b)       (-----0-----) Unfunded actuarial accrued    liabilities (UAAL) (a-b)        6,370,000 Funded ratio (b/a)       0.0% Covered payroll (c)      $4,228,000 UAAL as a % of covered payroll    (a-b/c)              150.7%

Proposed Implementation Provisions:  Employers Implementation will be prospective; that is, the initial net OPEB obligation may and generally will be set at zero* * But financial statement preparers that have actuarial information for prior years will be permitted to calculate and report a net OPEB obligation at transition, if they wish.

Proposed Implementation Provisions:  Employers (concluded) Implementation will be staggered, in three phases (based on employer’s total revenue, as in GASB 34), to alleviate concerns regarding supply and demand for actuarial services

Revised Employer Exposure Draft

Implicit Rate Subsidy: an Illustration Employer provides healthcare benefits to active employees and to retirees to age 65 Plan members include 4 active (average age 47) and 1 retiree (age 56) Employer pays 100% of blended premium of $240/month/plan member for active members; retiree pays 100% of blended premium Age-adjusted premiums approximating claims costs are $200 for active employees and $400 for retirees

The Employer’s Commitment to Retirees Involves a Real Cost By committing to allow retirees to remain in the group at the blended premium, the employer is committing to provide a subsidized benefit (that is, one to which the employer contributes, or OPEB) Employer’s contribution for OPEB in current year is measured as $400 age-adjusted premium - $240 contributed by retiree = $160

The “Implicit Rate Subsidy” Is Paid in Hard Cash Where the employer’s contribution comes from:  $240 paid per active member by employer - $200 age-adjusted premium = $40 difference X 4 active employees = $160 As the illustration shows, the “implicit rate subsidy” is an actual cash outlay* *  Though easily overlooked because it is nominally part of the payment for active employee healthcare

Effects Implicit Rate Subsidy Exemption: A.  On Financial Reporting of Active Employee Healthcare Benefits Expense based on age-adjusted premium:  $200/month X 12 months X 4 active employees = $9,600 But if expense were based on blended premium:  $240/month X 12 months X 4 active employees = $11,520 Active-employee healthcare expense would be overstated by $1,920* *  Which is more accurately the actual employer contribution for OPEB ($160 per month X 12 months = $1,920)

Effects Implicit Rate Subsidy Exemption: B.  On Financial Reporting of Retiree Healthcare Benefits (OPEB) There would be no projection of future cash outlays for OPEB* There would be no measurement or financial reporting of (a) annual OPEB cost, (b) net OPEB obligation, or (c) actuarial accrued liability related to services already received *  Recall that there actually is a current cash outlay of $1,920 for a single retiree--an amount that would be expected to increase with healthcare trend rate increases and additional retirements

How Significant Could It Be? To provide an idea of the potential significance of omitted OPEB information, we did calculations for the illustrative plan using alternative measurement method spreadsheets* The following information would not be reported if the implicit rate subsidy exemption was taken * Additional assumptions were of course required

OPEB for Our Illustrative Five-Member Group Actuarial accrued liability (beginning):  $62,117 Annual required contribution (ARC):  normal cost $4,267 + amortization of actuarial accrued liability $2,916 = $7,183 Annual OPEB cost (expense):  also $7,183 in year of implementation* Net OPEB obligation (liability, ending):  annual OPEB cost $7,183 - actual employer contribution $1,920 = $5,263 * Making total expense for healthcare $9,600 active + $7,183 OPEB = $16,783 (compared to $11,520 active)

Proposed Plan Statement Final Statement is currently in preballot draft stage; to be balloted for approval to issue in April 2004 Affects administrators and sponsors of plans (here, meaning plan assets) For trusts, statements and disclosures similar to GASB 25; for non-trusts, reporting as agency fund

OPEB Plan Reporting OPEB plan reporting requirements apply to accountability for stewardship of OPEB plan assets--they provide a framework for financial reporting of plan assets and changes in plan assets each year For plans administered as qualifying trusts (discussed previously), financial reporting and disclosure requirements will be similar to those for pension plans, with some enhancements of note disclosures similar to those for OPEB employers

Plan Financial Statements Statement of plan net assets* Statement of changes in plan net assets** Accrual basis (liabilities for benefits and refunds recognized when due) Investments at fair value in the financial statements (but at market-related value in actuarial valuations to calculate the UAAL and the ARC) *   For plans reported as agency funds, assets equal liabilities (no plan net assets). ** Does not apply to plans reported as agency funds.

Required Supplementary Information Schedule of funding progress (the same as or similar to that required for sole and agent employers--at plan administrative level) Schedule of employer contributions (disclosing the ARC applicable to the plan’s fiscal year and the % of the ARC recognized by the plan as additions from employer contributions)

Required Supplementary Information (concluded) For cost-sharing employers (new): Employers will be required to present RSI for the plan as a whole, if  the plan administrator or plan sponsor does not issue a GAAP-compliant plan (or OPEB trust fund) report* *  If a multiple-employer plan is not administered as a qualifying trust, the plan should be be classified as an agent plan, and the employers should report as agent employers--even if a plan is otherwise referred to as a “cost-sharing” plan.  (No trust, no plan assets; therefore, no ability to pool responsibilities for financing benefits.)

Effective Dates Staggered implementation based on a government’s phase for implementing GASB 34 The employer Statement will be effective for the employer’s fiscal year beginning after December 15, 2006 (Phase 1), 2007 (Phase 2), or 2008 (Phase 3) The plan Statement will be effective for the plan’s fiscal year beginning after December 15, 2005 (if largest employer is Phase 1), 2006 (if largest is Phase 2), or 2007 (if largest is Phase 3) Earlier implementation is encouraged