How Cities Can Prepare for the New OPEB Accounting Requirements

This is a guest post by Les Richmond, pension actuary for Build America Mutual.

The new Government Accounting Standards Board changes described in this posting have implications for all cities. Here are some suggestions for cities that offer retiree healthcare benefits and sponsor those benefits themselves.

Beginning in the fiscal year ending June 30, 2018, cities who sponsor “other postemployment benefit (OPEB)” plans (e.g., retiree healthcare) will have to recognize the unfunded liabilities of those plans on their balance sheets. OPEB plans provide benefits other than pensions in retirement: typically health coverage, but sometimes life insurance or other benefits. Cities that participate in statewide OPEB plans will soon face new accounting requirements, but will have limited ability to manage their liabilities – so this article is directed to cities that sponsor their own plans.

Unlike pensions, most employers who sponsor their own OPEB plans have not been setting aside assets in a trust to fund these benefits, which means they are already carrying an OPEB liability on their balance sheets. The disclosures under the new OPEB accounting standards, GASB 74 and 75, require a new methodology for calculating that liability, and the results may be startling to stakeholders like ratings agencies, unions, and taxpayers – with perhaps the biggest surprises coming in communities that thought their OPEB liabilities were well-defined and manageable.

Given the potential magnitude of this disclosure, it is important for municipal leaders, residents, and employees to know that the coming change in the OPEB liability calculation is due to a change in accounting rules, not any error or malfeasance. In fact, this disclosure can serve as a wake-up call that can encourage all stakeholders to take action to help build a sustainable OPEB plan. Unfunded OPEB liabilities can be reduced by lowering plan liabilities (some type of plan benefit or administration change), increasing plan assets (increased plan contributions), or a combination of the two.

It is crucial that city leaders understand the legal and collective bargaining barriers to any strategy they wish to employ to lower OPEB liabilities. Then, assuming the primary benefit under the OPEB program is retiree health coverage, consider the following:

Seize the low-hanging fruit. Because OPEB plans deliver a non-cash benefit, cities that focus on reducing health plan claim and administrative costs can reduce their liability without cutting benefits. For example:

  • When was the last time you sought competitive bids from healthcare coverage providers? If more than a couple of years ago, it may be time to seek proposals.
  • Encourage healthy behaviors by implementing a wellness program. These programs cover items such as smoking cessation and weight loss. These have been shown to lower health claims.
  • Add a new option to your health plan offerings, featuring lower premiums but a higher deductible. Encouraging consumer-driven behavior has been known to lower health plan costs.

Consider funding the OPEB plan. The act of accumulating plan assets to pay future benefits allows the plan’s actuary to use a higher discount rate to determine plan liabilities, thus lowering them. This can have a significant impact on the size of the OPEB liability. It makes good economic sense as well, because benefits will be partly paid by investment income on plan assets, not just by current year revenues. Of course, the down side to funding is that, initially, plan cash requirements will be higher than a pay-as-you-go funding scheme.

Consider benefit reductions. There are many possible design options to be considered. For example:

  • Increase the portion of the health premium paid by the retiree. This can be done by: (i) increasing retirees’ monthly premium payments; (ii) setting a cap on the amount of the premium paid for by the employer; or, (iii) increasing plan deductibles and copayments.
  • Shorten the period of time over which the health coverage is provided. This can be done by raising retirement eligibility requirements for the health benefits or by curtailing coverage after the retiree becomes eligible for Medicare.
  • Offer fewer benefits, by eliminating such items as Medicare Part B premium reimbursements, vision care, or dependent coverage.

Legal and collective bargaining barriers are especially important when considering benefit reductions such as these. In some cases, it may be necessary to apply these changes only to future retirees, or even only to new employees going forward.

When considering any of these strategies, it is important to consult with your legal and actuarial advisors. However, when applied thoughtfully, one or more of these actions can mitigate the impact of GASB’s new OPEB accounting standards on your balance sheet, and can help you take better control of your OPEB plan’s costs.

les_richmond_125x150About the author: Les Richmond is the in-house pension actuary for Build America Mutual (BAM), which NLC’s preferred provider of municipal bond insurance and the leading insurer of municipal bonds sold by small- and mid-sized governments in the U.S. He reviews the pension risks for every issuer BAM considers for insurance, and is an expert on the impact of the new accounting rules on municipal financial statements.