Accounting transparency and the public sector: The political and philosophical costs of GASB 45

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By Bill J. Thompson, Rebecca A. Sielman | 01 May 2007

An accounting rule affecting thousands of public entities across the country—from state and local governments, school districts, and police and fire departments to county hospitals, community colleges and state universities, as well as many other tax-funded public institutions and organizations—presents daunting challenges to public sector political and administrative leaders. They will be required to identify and disclose liabilities associated with the "other post-employment benefits" (OPEB) offered to their retired employees beyond pension or termination benefits—that is, they will need to begin accounting for the projected cost of their retirees’ medical, prescription drug, long-term care, disability, and life insurance benefits.

Early reaction to Government Accounting Standards Board Statement 45 (GASB 45) has generally focused on its dire implications. The most expensive OPEB component, retiree medical benefits, looms large in these discussions, prompting news articles that warn of the "next retirement time bomb" and moving one mayor to proclaim, "We can’t pay for it." 1 The largest government entities will see the effect of GASB 45 in their financial statements for fiscal years ending in 2008. Other public sector employers will see it in 2009 and 2010.

We have addressed some of the important aspects of this issue on the Milliman Web site (see GASB 45 FAQs). Yet, the sheer number and variety of public entities affected by GASB 45—as well as various provisions for its phased implementation—make it impractical for any single analysis to serve as a template for action in the face of myriad uncertainties.

Instead, it might be useful to point out a few of the political and philosophical challenges that decision-makers in the public sector must address as they search for solutions specific to their circumstances. After all, their decisions regarding retiree medical benefits and other OPEB elements affect not only employees and retirees but also taxpayers, voters, and constituents.

The promulgation of GASB 45 flows from four considerations that align the public sector with similar requirements for accounting transparency in the private sector as specified in Financial Accounting Standards Board Statement 106 (1990). First, OPEB liabilities represent largely unquantified encumbrances against the future revenue of the public entities that provide these benefits. Second, public officials, employees, and taxpayers alike can act responsibly only when they have access to as much information as possible regarding OPEB commitments and costs. Third, prudent public policy-making requires that the cost of OPEBs be accounted for in the context of the cash flow needed in coming years to pay for them. And finally, there is an intergenerational issue: As soon as public employers promise to provide OPEBs, they must understand the implications and value of that promise—both today and in the future.

Before the advent of GASB 45, most public entities funded their OPEB obligations on a pay-as-you-go basis and did not set aside funds during employees’ working years to prefund their retiree benefits. Costs for the OPEBs were relatively low, and often were not identified separately from the costs for insurance benefits provided to employees. However, for many public employers, this pay-as-you-go approach is compromised by the sheer number of people now entering retirement and by the rapid escalation of healthcare costs. While these trends affect both private and public employers, their effect on the public sector is more dire, because this sector has historically opted to redress the perceived imbalance in compensation between the public and private sector by leveraging a favorable employee-to-retiree ratio in order to provide generous healthcare and retirement benefits.

A number of politically sensitive alternatives are emerging that will fundamentally change long-standing compensation policies in the public sector. No single alternative offers a complete solution to the looming problems of financing retiree healthcare and other OPEB. Moreover, all of these alternatives are vulnerable to the law of unintended consequences, in that they potentially create more problems than they solve. In the end, some combination of solutions will likely be needed as public sector decision-makers attempt to address the huge shortfalls in their retiree healthcare programs:

PREFUNDING establishes dedicated financial pools. Ideally, these pools will be run by professional investment managers working with a long-term investment strategy approved and overseen by a board of directors whose primary fiduciary obligation is to the dedicated fund itself. Prefunding typically requires a phase-in process of four to eight years and, of course, a source of revenue specifically directed to its purposes. Depending on where its money comes from, a prefunding scheme can soak up a large percentage of available tax or fee revenues and so compete with every other function financed by the public entity that creates it. Prefunding has long been used for pension benefits in both the public and private sectors.

CUTTING BENEFITS has always been the "third rail" in public policy, at least for the affected constituencies, and can run afoul of existing collective bargaining agreements, contracts, or statutes. More important, this strategy represents a fundamental policy reversal, given the fact that benefits of all kinds, including OPEB, have been used to attract and retain the public workforce. A cut in benefits is generally regarded by those who suffer it as a pay cut or some such diminution of their compensation. Because benefits are important components of the compensation package, cuts in this area may also lead to demands for higher wages and salaries.

RESTRICTING BENEFIT ELIGIBILITY for new hires creates different castes or classes of employees who may perform similar functions at the same pay levels, at least during the transition in the workforce from those enjoying better benefits to those working with reduced eligibility. As with benefit cuts, reduced eligibility is perceived as a fundamental shift in policy that changes the terms of employment and compensation in the public sector.

BONDING THE UNFUNDED OBLIGATIONS and placing the proceeds and investment returns in a trust fund specifically dedicated to retiree healthcare is not yet permitted in most states. Even if it is permitted, it requires a degree of political will to incur the costs, sequester the revenues, and enforce the agreements necessary to fashion a program that will meet the bonding industry’s standards for performance.

RAISING TAXES will encounter a significant wave of resistance from a public that has been conditioned by the rhetoric of tax cuts for the last 25 years. Politicians are loath to admit that increased taxes are on the table. It is especially difficult to argue for higher taxes if the revenue will not be used to provide new services or facilities. Yet, whether through a decision to prefund or through a series of cost shifts or a reduction in benefits, state and local public entities must find new revenue to meet their unfunded OPEB obligations.

Any of the solutions proposed here will require tough decisions, as leaders must choose among options that are all flawed in one way or another. Where local custom allows it, government officials may need to act unilaterally and will risk strong criticism from constituents. These tough decisions may prove impossible in areas that are governed by collective bargaining.

Implementing GASB 45 will reveal an actuarial reality that requires political solutions in the widest sense of the word: The situation changes long-standing terms of employment, alters traditional relationships between public employees and the governments that employ them, and rekindles the philosophical debate over who pays for what, how much they should pay, and when they should pay it. Moreover, these solutions will not occur in a vacuum. State and local governments share taxpayers, voters, and constituents with the federal government, which confronts its own daunting funding requirements with respect to Social Security and Medicare. According to the head of the General Accountability Office, U.S. Comptroller David Walker, federal retiree healthcare programs will capture the lion’s share of the federal budget by 2040 if they are left unaddressed; the rest of the federal budget will be devoted to little else but debt service.2

Public sector employers will need to confront the implication of GASB 45. They will need to determine the magnitude of the costs they face and the cash flow available in the coming years to meet them. They will need to decide whether prefunding makes sense, and what steps are required to implement it. Like their counterparts in the private sector, they will need to cast a critical eye on ways to reduce the overall costs of medical benefits for existing retirees and control the growth of healthcare costs for future retirees. And they will need to do all of this under scrutiny from their employees, the taxpayers they rely upon, and the constituents they serve.


BECKY SIELMAN is a principal and consulting actuary in Milliman's Hartford, Conn., office. She has extensive technical and consulting experience in all aspects of defined benefit pension plans and has also been involved in all aspects of postretirement benefits accounting, from valuation to plan design to strategic consulting.

BILL THOMPSON is a principal and consulting actuary in Milliman’s Hartford, Conn., office, where he directs the healthcare consulting practice. He focuses on providing strategic and operational solutions to challenges in all areas of healthcare. He is currently assisting clients with GASB 45 education, valuations, and tactics for managing their liability.


1 Milt Freudenheim and Mary Williams Walsh, "The Next Retirement Time Bomb," The New York Times, December 11, 2005.

2 David Walker interview, 60 Minutes, CBS, March 4, 2007.