On its face, complying with the Governmental Accounting Standards Board's Statement 45 (GASB 45) is not that difficult. Employers in the public sector must obtain an actuarial valuation of their other-than-pension postemployment benefits (OPEBs) at two- or three year intervals, depending on the size of the plan. There's no requirement to prefund the benefits or take action of any kind.
But clearly, the intent of GASB 45 is to get employers thinking about the size of their OPEB liability—and what can be done to manage it. The most significant OPEB is retiree medical benefits. In creating the disclosure requirements, GASB wanted to address a growing concern over the potential magnitude of employer obligations. With an aging population and escalating medical costs, the old "pay-as-you-go" approach will leave taxpayers across the country on the hook for astronomical benefits costs.
GASB 45 amounts to a wake-up call for public plan sponsors. It's a warning signal to pay close attention to retiree medical benefits, a signal that was never there before in the public employer arena. Plan sponsors need to be aware of the huge cost of these benefits—not only what the cost is this year, but where the cost is going in the future. In almost every valuation we’ve done, the annual bill for retiree medical benefits is projected to double in the next 10 years; in some cases, it will triple. Even if plan sponsors didn't have GASB 45 requiring them to measure and disclose OPEB liabilities, for cash flow purposes they would certainly want to anticipate the impending climb in retiree medical expenses.
Penny wise, pound foolish
Unfortunately, many public plan sponsors seem to have not fully understood the implications of GASB 45. We've encountered a number of situations where the sole concern is to be able to check off the item that says, "I've supplied GASB 45 information to my auditor." Employers with this mindset tend to view the cost of complying with GASB 45 as simply the cost of hiring an actuary to do the valuation, without much regard for managing the liability.
But ignoring liabilities doesn't make them go away. Even if a public organization is not going to prefund the benefits, or if GASB 45 is just an exercise in completing an audit, the retiree medical, dental, and life insurance coverages for retirees are still important benefits that should not be overlooked. In the process of complying with GASB 45, public plan sponsors enlist an actuary from a firm like Milliman to collect important information about these benefits. The organization is thus in a great position to use that data to get a better handle on what the benefits cost and whether the level of provided benefits is sustainable over the long term. Accurate information is the basis for planning how to pay the bills as they come due down the road. A number of specific opportunities exist for public plan sponsors to improve their situation by working with experienced actuaries. It's a modest investment considering what's at stake: millions, hundreds of millions, or even billions of dollars of retiree medical obligations.
Setting appropriate assumptions
Accuracy is the chief reason why it is important to have an experienced actuary involved in GASB 45 work. A big part of the process is setting appropriate assumptions. An actuary specializing in the public sector will know from experience what makes public sector employee groups different from those in the private sector and will be able to choose assumptions accordingly.
For example, safety officers, like police and firemen, typically have little to no turnover and tend to stay in the job for an entire career. Public pension actuaries know this and are able to set appropriate assumptions for the employee population. Consider mortality—teachers tend to live longer than just about any other group of employees. There are numerous similar nuances that are not commonly known by actuaries without extensive experience in the public sector. That’s why specialized experience in the public sector is so important in performing GASB 45 valuations.
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Another example is the work health actuaries put into analyzing how medical costs vary by age. For larger employers with experience-rated benefits, best practices should include customizing this "age curve," taking into account the specific demographic profile of their employee groups and the benefits provided. Each client is different, the benefits are different, and the demographic profile is different. These differences will show up on the bottom line, as the calculation of liabilities using a customized age curve could be 25% or 30% different from the result obtained using a generic age curve.
That can make a big difference in dollar terms. Recently, we helped a town in Connecticut cut its liability by $3 million just by using customized assumptions, rather than generic New England or East Coast assumptions. Of course, it's possible that the more accurate assumptions could have increased the liability by a similar amount. The point is that it's important to have the right number.
Beyond the initial set of numbers
The moment when the actuary delivers the initial numbers is pivotal in the process. It's important to understand that the first set of numbers is not the endpoint. Plan sponsors who take GASB 45 seriously are more likely to view the presentation of the valuation report as the beginning of a meaningful discussion about the cost of the benefits that will be provided to future retirees. In our experience, when organizations receive the initial liability calculation, we start to hear from finance directors, personnel directors, and finance committee members. They ask a host of questions. Some are as basic as, "What can we do to make these numbers smaller?" Others are more scenario-driven: "What if we used different assumptions, along with the following changes in our benefit plan…?" Qualified public pension and health actuaries will be able to answer these questions and others.
In many cases, prefunding future benefits using appropriate investment vehicles can help plan sponsors more effectively finance the benefits. We have written about these options in some detail in other publications.1
Learn from pension plan designs
Historically, many public employers have been generous when it comes to retiree medical benefits. For example, one large employer provides essentially free lifetime family medical and dental benefits for anyone who retires with just 10 years of service. This is a very expensive benefit to provide to employees who may have devoted just a fraction of their working lifetime to the employer. Taking a page from the design of traditional pension plans, public employers might consider reshaping their retiree medical benefits to be more in line with the philosophy underpinning pension benefits.
For instance, in most pension plans the amount of benefit increases in proportion to time on the job. Translating this philosophy into the realm of retiree medical benefits, instead of providing full coverage for all retirees, a pension-like strategy might begin with retirees who have fewer than 15 years of service paying for most or all of their premiums, while those who have longer service pay a lower portion of their premiums.
Also, recipients of traditional pension benefits don’t get more money just because they are married. But a lot of public plans provide retiree medical benefits for employees and their spouses and dependents. As a result, people who are married with children get at least twice as much of a benefit as people who are single. That's a well-intentioned, but costly, provision. To keep their benefits programs solvent, today’s employers may want to move in the direction of keeping spousal coverage available, but having the retiree pay part or all of the premium for the extra benefits.
Finally, most public pension plans require employees to contribute a portion of their earnings toward the cost of the benefits, so that the overall cost is shared between workers and employers. This concept can be extended to retiree medical benefits as well. Every 1% of pay that employees contribute to an OPEB trust means 1% of pay less that the employer (and taxpayers) will have to pay.
Modify the medical plan
Faced with rising bills for medical and dental benefits, many employers have already been looking at changes that will cut the cost of benefits for both employees and retirees. These include increasing copays, offering managed care plans (HMOs) instead of indemnity plans (PPOs), or implementing consumer-driven health plans. The savings that result from these changes may be relatively modest, but anything that lowers the bill for medical benefits will lower the liability for OPEBs as well. There are other options that employers should consider when looking for ways to bring down their GASB 45 liability.
For instance, one significant driver of GASB 45 liabilities is the assumption about future medical inflation, also known as the "trend rate." Implementing disease management or wellness programs can make a measurable difference in controlling costs. Plan sponsors who take such steps may be able to lower the trend rate, which in turn will lower the liability for OPEB benefits.
Larger municipalities typically self-insure for most medical benefits, but often provide a Medicare supplement policy on a fully insured basis for their older retirees who are covered by Medicare. The employers may be paying an inflated premium for this coverage that hasn't been checked against the market. Or they may be located in a market that doesn’t have many competitive options, which keeps the price high. In these cases, it may be beneficial to change the funding arrangement to a self-insured basis. This can substantially cut costs because the employer is no longer paying premium taxes and has more control over claims margins and reserves.
Another option for chipping away at the size of the GASB 45 liability is an employer group waiver plan (EGWP). EGWPs are insurance products that build in the federal government’s subsidy for prescription drugs under Medicare Part D. If the subsidy is built into the employer's premium via an EGWP, employers can receive a double benefit in the form of lower premiums and a reduction in the GASB 45 liability. For example, one large employer reduced its premium by $1 per member per month by moving to an EGWP—not much to crow about all by itself. But the move reduced its OPEB liability by $15 million—significant savings by any measure.
Purpose of benefits
In the immediate aftermath of GASB 45, there were reports of a few towns that decided to terminate their retiree benefits programs. We seriously doubt whether that will be the prevailing trend. Historically, public sector employers have had a strong commitment to taking care of their employees and retirees. They don’t want to end benefits, but they will need to answer the wake-up call that GASB 45 represents.
In today's environment, plan sponsors have no alternative: They must prudently look at how to control the cost of benefits. If an employer decides that existing programs are sustainable, it will also need to know its options for managing them as efficiently as possible. Alternatively, a plan sponsor may conclude that it has to reduce the level of benefits; in that case, the sponsor will need to be able to explain to constituents the facts and analysis that guided the decision.
When reviewing their programs, employers need to balance the cost of the benefits with their purpose—the reason they offer employee benefits in the first place, which is to attract and retain quality workers. GASB 45 encourages greater discipline in making retiree health benefits more manageable and cost effective, and helping employers fulfill longstanding obligations—provided they don’t hit the snooze button.
Becky Sielman is a principal in the Hartford, Conn., office of Milliman. She has extensive technical and consulting experience in all aspects of retiree medical programs and defined benefit pension plans, including actuarial valuations, experience studies, accounting calculations, plan design, employee communications, and modeling.
Roscoe Haynes is a principal and consulting actuary with the Albany office of Milliman, serving governmental, multiemployer, nonprofit, and corporate clients. His consulting activities include the design, valuation, and administration of pension and retiree medical programs.
Steve May is a healthcare consultant with the Hartford, Conn., office of Milliman and specializes in the public sector market. He has provided benefits consulting for the states of Connecticut and Vermont. His work includes budget projections, funding arrangement analysis, and strategic plan design analysis.