THE BASICS OF THE GASB OPEB CALCULATION PRESENTED

THE BASICS OF THE GASB OPEB CALCULATION PRESENTED BY: MARK VAN BUSKIRK, PHD, ASA, MAAA HOLMES MURPHY AND ASSOCIATES SEPTEMBER 23, 2016 1

Quick Facts • Parallels GASB 67 and 68 for pensions • GASB 74 is for plans administered through a trust and replaces GASB 43, GASB 75 is for employers that sponsor OPEB plans and replaces GASB 45 • GASB 74 is effective for plans with fiscal years beginning after June 15, 2016, GASB 75 is June 15, 2017 – If your fiscal year ends 9/30, GASB 75 will first apply to FY ‘ 17 -’ 18

Quick Facts • Valuations can continue to be done every other year – A valuation can be “rolled forward” to the end of a fiscal year up to 30 months and 1 • Benefits include medical and Rx, dental, vision, life insurance – Benefits must be tied to retirement, not termination • The statements applies slightly different treatments to single employer plans, agent multiple-employer plans and cost sharing multiple-employer plans • For simplicity, we will focus on GASB 75 for single employer plans that have not been funding the benefit

Why 43 and 45?

Why 43 and 45? • Before 43 & 45, employers would just pay retiree benefits and account for them on a pay-as-you-go basis (cash accounting) • GASB viewed OPEB plans as “part of an exchange of salaries and benefits for employee services rendered” • GASB believes the cost of OPEB should be associated with the periods in which the “exchange” occurs (accrual accounting) rather than with the periods (often many years later) when benefits are paid or provided (cash accounting) • Conceptually, 43 and 45 are the standards that set up a giant, multi-year accounts payable for retiree OPEB benefits

When is there a liability? • Since the City contributes to the cost; there is an OPEB liability

When is there a liability? • Since the City does not contribute to the cost; there is no OPEB liability

When is there a liability? • • The retiree must pay for their full cost developed using only retiree experience Even though this looks like the retirees pay the full cost, there is an implicit subsidy because the total rate for a retiree on a stand-alone basis is $800

Difference between 43/45 and 74/75 1. Under GASB 45, the employer was free to use one of six cost allocation methods (methods of allocating the present value of benefits to each of the employee’s active service), under GASB 75, the entry age normal level percent MUST be used 2. Under GASB 45, OPEB expense was tied to funding, the liability was recognized over time and only appeared in the footnotes, under GASB 75 the expense is no longer tied to funding, the liability must be immediately recognized and in the financial statements

Difference between 43/45 and 74/75 3. Under GASB 45, net OPEB obligation = OPEB expense – (employer paid benefits + employer contributions to a trust) (the cumulative growth of employer underfunding); under GASB 75, net OPEB liability = PV of benefits accrued to date by the employees – PV of resources held in a trust to pay benefits (the unfunded liability) 4. Under GASB 45, actuarial and investment gains/losses and plan and assumption changes were generally amortized over 30 years, under GASB 75 it varies by item but each are much shorter periods

Change 1 – Entry Age Normal OVERVIEW • GASB 75 requires that the employer must use the entry age normal level percent of pay cost allocation method • What is a cost allocation method? • A cost allocation method is a method for taking the cost of benefits that are paid after retirement and allocating to the years of service while active • The method converts the recognition from cash accounting to accrual accounting

Change 1 – Entry Age Normal OVERVIEW AGE 30 AGE 40 Age 30 Liability Normal Cost Left to Accrue Liability AGE 55 Normal Cost Left to Accrue AGE 65 Age 50 Liability Normal Cost Age 65 Left to Accrue Liability Normal Cost Left to Accrue

Change 1 – Entry Age Normal OVERVIEW • GASB 75 requires that the employer must use the entry age normal level percent of pay cost allocation method • Under this method, the present value of benefits equals the present value of normal costs at the employee’s “entry” age – age 30 • The normal costs then increase as the salary increases

Change 1 – Entry Age Normal PV OF NORMAL COST Age 30 31 32 33 34 ------ 64 65 66 67 68 ------ PV OF BENEFITS

Change 1 – Entry Age Normal PV OF BENEFITS Project cost w/ trend, mortality, withdrawal, retirement Age 30 ------ 40 ---------- 65 66 Discount back to current age using the discount rate 67 -----

Change 1 – Entry Age Normal PV OF BENEFITS - PROJECTING • Assume we have two participants: – Age 40 active; hired at 30 – Retiree age 70 Assume retirement age is age 65 Monthly benefit $600; annual $7, 200; assume the same for all ages Medical trend rate 8% Ben 65 = ($7, 200)*(1. 08)^25 *(prob of living to 65)*(prob of still working w/ City at 65)*(prob retiree elects plan)*(1+prob of covering a spouse) • Ben 66 = Ben 65 * 1. 08 * (probability of living from 65 to 66) • In the same way calculate Ben 67, Ben 68, etc. • •

Change 1 – Entry Age Normal PV OF BENEFITS DISCOUNTING •

Change 1 – Entry Age Normal PV OF BENEFITS - PROJECTING • • • Age 70 retiree Monthly benefit $600; annual $7, 200 Medical trend rate 8% Ben 70 = $7, 200 Ben 71 = Ben 70 * 1. 08 * (probability of survival from 70 to 71) In the same way calculate Ben 72, Ben 73, etc.

Change 1 – Entry Age Normal PV OF BENEFITS DISCOUNTING •

Change 1 – Entry Age Normal PV OF BENEFITS - ASSUMPTIONS • We can see from this formula the assumptions required: – Expected claims: the $7, 200 – calculated using general underwriting methods; the per member per year should be age rated – Trend Rate: medical, Rx – typically starts with current medical in the first year and then grades down to long-term inflation – Mortality: dynamic table whereby mortality improves each year – Withdrawal or turnover: standard tables from SOA adjusted by actual experience (may be by age or service related or both)

Change 1 – Entry Age Normal PV OF BENEFITS – ASSUMPTIONS • We can see from this formula the assumptions required: – Discount rate: GASB prescribes • For the portion of benefits that are funded use the long-term expected rate of return • For the unfunded portion of benefits use the yield on a 20 -year, tax-exempt municipal bond with an average rating of AA/Aa or higher – Retirement: should vary by age generally from 55 - 70 • Note, in our example, we assumed everyone would retire at age 65 • For pension plans this is fine but not for retiree medical, why? Medicare – Participation rate – often overlooked; percent for percent reduction – Marriage assumption – percent of retirees covering their spouses

Change 1 – Entry Age Normal PV OF BENEFITS – DATA NEEDED • Census of each active and retiree with date of birth (age), date of hire (years of service), gender (some of the assumptions are gender specific • For the underwriting (the $7, 200), need retiree and active medical claims and counts • Admin fees, stop-loss premiums • Turnover statistics, early retirement statistics, participation rates, marriage percentage

Change 1 – Entry Age Normal PV OF NORMAL COST Age 30 31 32 33 34 ------ 64 65 66 67 68 ------ PV OF BENEFITS

Change 1 – Entry Age Normal PV OF NORMAL COSTS • Once the present value of benefits is calculated, it must be allocated to each year of service to accrue on the books • For the retiree, 100% of the benefit should be recognized; therefore the liability is $25, 000 and the normal cost is $0

Change 1 – Entry Age Normal PV OF NORMAL COSTS •

Change 1 – Entry Age Normal PV OF NORMAL COSTS •

Change 1 – Entry Age Normal RESULTS • Thus let’s assume we have the following actuarial results: – PV of benefits = $25, 000 + $10, 000 = $35, 000 – Liability = $25, 000 + $5, 000 = $30, 000 – Normal cost = $652

Changes 2&3 – OPEB Expense GASB 45 • Under GASB 45, the current $30, 000 liability would get amortized over 30 years (called the supplemental cost); let’s say that amortization comes to $1, 200 • We assume that the City pays $1, 000 for the retiree’s claims and admin cost • Then the OPEB expense and net OPEB obligation would be:

Changes 2&3 – OPEB Expense GASB 45

Changes 2&3 – OPEB Expense GASB 75 • Under GASB 75, the OPEB expense would look like:

Changes 2&3 – OPEB Expense GASB 75 • But you will have to immediately recognize the net OPEB liability in the financial statements:

Change 4 – Amortizations TYPES • Possible things to amortize: – – – Initial liability when standard is first adopted Plan changes Assumption changes Investment gains and losses Experience gains and losses • Under GASB 45, everything was amortized over 30 years (or less if desired)

Change 4 – Amortizations LENGTH • Under GASB 75, each of these vary – – – Initial liability when standard is first adopted - immediate Plan changes - immediate Assumption changes – average remaining service period (retirees count as 0) Investment gains and losses – over five years Experience gains and losses - average remaining service period • The amount left over to be amortized in the future are reported as deferred outflows or inflows of resources

Change 4 – Amortizations EXAMPLE •

Change 4 – Amortizations EXAMPLE • Under GASB 75, the OPEB expense for next year would look like:

Change 4 – Amortizations EXAMPLE • The change in the net OPEB liability table would look like:

Change 4 – Amortizations EXAMPLE •

Reporting Items NOTES TO THE INANCIAL STATEMENTS • General information about the plan – – Plan description Benefits provided Number employees covered Contribution requirements

Reporting Items NOTES TO THE FINANCIAL STATEMENTS • Net OPEB liability – Actuarial assumptions – Changes in the net OPEB liability table – Sensitivity of the liability to: • 1% decrease and 1% increase in the discount rate • 1% decrease and 1% increase in the healthcare trend rate – Fiduciary net position

Reporting Items NOTES TO THE FINANCIAL STATEMENTS • OPEB expense table • Deferred outflows and inflows of resources – Table showing all outflows and inflows – Table showing how the inflows and outflows will be recognized over the next five years

Reporting Items REQUIRED SUPPLEMENTARY INFORMATION • A 10 -year schedule of the changes in net OPEB liability table • A 10 -year schedule showing the net OPEB liability as a percent of payroll