The Clock Is Ticking
This year marks the start of GASB 45’s phased-in implementation period. Are you ready?
By Sue Menditto
The phased implementation approach calls for smaller public institutions to comply in FY09–FY10, depending upon their revenues. An important caveat requires smaller institutions with qualifying postemployment benefits that are component units of their state governments to implement the standard’s requirements in the same year as their state does.
Officially titled “Accounting and Financial Reporting by Employers for Postemployment Benefits Other Than Pensions,” GASB 45 applies to all public or governmental employers that provide some or all of the cost of other postemployment benefits. The accounting standard is also referred to as OPEB—shorthand for “other postemployment benefits,” or those benefits promised to be paid or subsidized by employers to current employees during their retirement. The most common type of OPEB is health insurance, but the benefits can also include coverage for dental, vision, long-term care, prescription drugs, long-term disability, and the like.
The Cost of Promises
Before GASB 45, governmental employers recorded the costs associated with OPEB as they were paid to retirees. As life expectancies and health-care costs have increased, however, so has the concern that this cash-based, or pay-as-you-go, approach can lead to an unpredictable and perhaps crushing burden on future governments.
“The pay-as-you-go approach reveals limited information about the total cost of a plan,” says Cheryl Soper, controller and director of financial operations at the University of Michigan. “So the essence of GASB 45 is that postemployment benefits are promised to today’s employees as part of the compensation for the services they’re rendering to us. It’s an exchange transaction between the employer and employees; and it should be accrued as it is earned over the employees’ years of service—even though it won’t be paid out as a benefit until retirement well into the future.”
In other words, the imminent obligation relates to an existing promise and therefore needs to be measured now. GASB 45 establishes measurement, recognition, and display requirements for OPEB expenses. First, an institution must determine its inventory of postretirement benefits. The benefits may not be uniform, varying by date of hire. Current retirees, for example, may have richer benefits than today’s workers can expect to receive. The comprehensive inventory leads to a projection of cash outflows for benefits earned to date by all employees.
The basic calculation takes into account many actuarial assumptions, including workforce trends, life expectancies, dependent information, and the future benefits landscape (see sidebar, “Future Payment Projections”). The projected benefits are then discounted to present value. The discount rate is influenced by the rate of return earned on assets expected to be used to pay the future obligation.
“GASB 45 forces you to look at the overall package of what you’re providing and what that says about you as an institution,” observes Allen Steinberg, senior retirement consultant at Hewitt Associates LLC. “With this exercise, you’re looking at real economic drivers, rather than simply accounting drivers.”
Although GASB 45 shines a light on the future obligation, it does not require governments to fund the OPEB liability. Beyond requiring acknowledgment of the postemployment benefits promise, the standard leaves the planning, budgeting, and financing of that liability up to management.
To help accountants come to terms with OPEB measurement and disclosures, a NACUBO webcast in late 2007 began the discussion of implementation strategies that public institutions and systems ought to consider. (Go to www.nacubo.org/ x9440.xml to access the webcast.) Webcast presenters recommended that public institutions and systems consider the following three implementation approaches.
Know Your Baseline
Establish an approximation of your liability and the amortization period of the liability; the maximum under GASB is 30 years. These basics begin a drill down into what you might implement this year, next year, and so on—as well as a place to start experimenting with your resulting calculation and the assumptions that led to it. The sooner you know that baseline number, the better—because it enables you to foster dialogue with all stakeholders.
“This isn’t just an accounting department exercise,” says Soper. “It requires interaction with your human resources and benefits offices to make sure you have the correct assumption information—as well as outreach to your provost, budget office, and governing board. It’s important that all stakeholders are fully aware of the GASB 45 numbers and can put them into the context of your institution’s goals and objectives for retiree benefits.”
If your institution is satisfied with the types of postemployment benefits offered and wants to continue the benefits for at least the next generation, the business office needs to examine options for financial sustainability. Soper highly recommends the use of financial modeling and projections—and the assistance of an actuary (see sidebar, “Find the Right Actuary”).
Remember, the accounting standard does not require that employers fund OPEB plans. The unfunded liability is disclosed in the notes and recognized over time (not to exceed 30 years) in the financial statements. However, progress—if any—toward funding the OPEB plan must be disclosed as required supplementary information.
“There will be much more transparency and public knowledge of the cost of your plans,” points out Noel Thomas, senior retirement consultant at Hewitt Associates LLC. “For many universities, this will be the first time they have any recognition or awareness of the size of their liability—and that could be quite large, relative to the current pay-as-you-go cost.”
The business office and stakeholders also need to be aware of rating agencies’ reactions to OPEB liability. Over time, ratings will likely be affected by an institution’s approach to future benefit obligations and financial sustainability. As Thomas says, “It’s clear that having no plan for management of the liability is not an option.”
Look for Cost Savings
|Future Payment Projections|
Measuring the cost of a future promise—in this case, postemployment benefits— requires a complex analysis best done by an actuary. When calculating your institution’s liability, the actuary will require such information as:
The timing of future benefits payments and how demographics may affect that timing.
The future of health care costs.
The plan design, as it currently exists and as promised today (anticipated future changes cannot be included in the GASB 45 calculation unless they’ve been formally announced and communicated).
“Have strong documentation to support your actual experience or expected future trends,” recommends Noel Thomas, of Hewitt Associates LLC. “Auditors will be looking closely at all of the assumptions used to develop liability calculations.”
Factors other than GASB 45 are driving employers to think about benefits. Many business officers routinely lose sleep over nearly double-digit increases in health-care rates that continue to outpace inflation. That’s not to mention the pending retirement and replacement of the baby boomers—or maybe not, as people live longer and stay in the workforce well past typical retirement ages. The Medicare Modernization Act of 2003—Medicare Part D prescription drug coverage—has also prompted employers to revisit retiree benefits.
Keeping in mind that any changes to benefits structure or premiums may affect recruiting, retention, and retirement patterns, you can look for cost-savings strategies in five categories:
- Funding policy—how an organization decides to finance the benefits. The options and decisions influence your discount rate, your current year cost, and the size of your liability.
- Retirement eligibility—when people can retire and begin receiving benefits. The stricter the benefit eligibility criteria, the lower the costs.
- The employer premium subsidy—the percentage of premium that the employer provides to retirees.
- The plan design—the range of possibilities, which includes indemnity plans, HMOs, Medicare Advantage, and employer prescription drug plans in partnership with Medicare Part B.
- Medicare Part D—new sources of funding for prescription drugs for postage 65 retirees. Given how the GASB treats certain Part D coordination strategies, this area warrants separate attention.
The University of Michigan has implemented changes in several of these categories, notes Pam Gerber, associate director of HRAA and benefits. For example, the university has extensively adjusted its health-care plan mix over the past few decades, adding various types of HMOs, discontinuing its traditional plan, and introducing a more affordable PPO.
Gerber explains that as employee and retiree benefits continued to represent a significant and rapidly escalating cost to U.S. employers, the university undertook two major initiatives in 2003.
Containing prescription drug costs. The university carved the prescription drug benefit out of its medical plans, moved from a two- to a three-tier health-care coverage structure, and moved the plan administration to a single provider. In addition, it established an internal oversight committee of expert faculty and staff, which helps evaluate, oversee, and manage the formulary and the prescription drug program.
Examining policies on health-care premium sharing. The university appointed a committee composed of faculty and staff members chosen for their technical and scholarly expertise in the fields of health-care management, insurance, and benefits administration. The committee’s narrow charge was to recommend changes in the structure of premiums paid by the university and co-premiums paid by employees for health and drug insurance coverage, while maintaining both choice and quality of plans for the insured population.
Before forming the committee, the university contributed, on average, 95 percent of the total health-care costs for the organization. The committee recommended and the university adopted the following plan revisions:
- Increasing the retiree premium sharing in 2005 for post-1987 retirees.
- Reducing the aggregate university contribution for health premiums from 100 percent to 85 percent, with a higher university subsidy for employees and retirees than for their dependents.
- Keeping contributions the same for employees age 65 and older as for active employees.
- Changing the Medicare Part B premium reimbursement in 2006.
In these ways, the University of Michigan pursued a coordinated set of actions to manage the cost of its health-care benefits and continues to explore additional options.
Decide Whether (and How) to Fund
The discount rate is the linchpin of the OPEB calculation and something that employers can influence because it’s based upon the earnings of assets that will be used to pay the future liability. Consequently, an organization’s funding decisions profoundly affect the discount rate.
An institution might simply continue pay-as-you-go funding—financing benefits out of internal university assets, which means zero savings. At the other extreme is fully prefunding, or saving enough (considering conservative earnings and growth projections of a fund) to meet the entire future obligation. Because money saved earns a return (interest, dividends, appreciation), fewer nonsaved dollars will be needed in the future to meet the obligation. Even setting aside a portion of assets, or partial prefunding, will provide you with a blended discount rate.
Many in higher education are familiar with the term “intergenerational equity” as it applies to growing an endowment to maintain purchasing power for future generations. Noel Thomas suggests applying that same concept when considering the positive impact that prefunding can have on the institution’s long-term financial position and its ability to sustain benefits for current and future generations of employees.
“Based on your financing decision,” asks Thomas, “can you afford to sustain the impact on your statement of net assets in the long term?” For example, he continues, “If you decide not to prefund, you need to look at projections to figure out whether that impact is sustainable 5, 10, and 15 years in the future. You’d be surprised how quickly the liability can grow—and that can have some serious consequences.”
Consider a trust. Prefunding through a separate trust reduces the GASB obligation, levels out cash-flow implications, positively affects your bond rating, and generates earnings that can help defray the cost of providing the benefits. Most important, it reduces benefit costs.
As an example, Thomas points to one public university that went from a pay-as-you-go model to fully funding its obligation through a separate, segregated trust fund. “The accrued liability was reduced from $650 million to about $150 million,” he reports. “And, the ongoing annual OPEB costs for expense were reduced from $51 million to $14 million, with a more than 70 percent decrease in liabilities and expense.”
On the other hand, prefunding calls for cash that the institution may have a greater need for in another area. In addition, the trust is irrevocable, which can worry some organizations. Some might argue also that prefunding creates an aura of permanence around retiree medical benefits—a perception that may be difficult to change in the future. Finally, separate funding takes an institution into territory where Internal Revenue Service (IRS) guidance is a bit sparse.
|Find the Right Actuary|
Even if your institution’s implementation of GASB 45 is still two years off, engage the services of an actuary today, advises Cheryl Soper of the University of Michigan. “The calculation involves complicated financial modeling and projections, and you’ll need an actuary to assist you,” she says. Here’s Soper’s list of what to consider when looking for that specialized assistance.
Firm cohesiveness. Many different people at the actuarial firm will play a role in developing assumptions and determining your institution’s liability, so look for a team that can work well together.
Effective communication skills. Because they work with statistics, actuaries are prone to speak in a dry, technical style. Look for an individual who breaks that mold—someone “who can communicate in lay language that you can understand and that your board and management can understand,” says Soper.
Sample reports. The University of Michigan asks for actuarial reports customized to its needs, which include modeling of future projections and varying assumptions and scenarios. “Pick an actuary who will be flexible and work with you,” Soper advises, “not just give you an off-the-shelf report or off-the-shelf answers.”
Actual personnel. If you use a request for proposal (RFP) process to find a firm, make sure the people who give the presentation are the same ones with whom you’d be working. Otherwise, you might discover that the service you actually receive doesn’t live up to the terrific sales presentation.
Clearly, the funding decision and allocation of current resources have their complexities. Should you decide to pre fund, the GASB has four requirements:
- Set up the fund in a separate legal entity.
- Make the contributions irrevocable.
- Dedicate the assets to providing retiree benefits
- Legally protect the assets from creditors.
A separate trust to house the assets used for OPEB should be set up in accordance with the proper IRS code. If, for example, you’re considering a trust that uses IRS Section 115—which exempts other governmental bodies from federal tax—you’ll face two hurdles. First, there must be a benefit to the core function of the governmental unit; second, a separate legal entity must retain the assets rather than the governmental unit.
Alternatively, “some entities that are units of government themselves may be able to prefund using the ‘integral part doctrine,’” adds Allen Steinberg. Simplistically, an organization that is an integral part of a unit of government is not subject to federal tax. Consult with your legal or tax counsel to determine the appropriate prefunding structure.
Use an earmarking option. Borrowing another endowment concept, the institution might consider internally earmarking funds, setting a funding policy, and investing those assets similar to a fund functioning as an endowment. This tactic can provide a compromise to establishing a legally separate trust.
This approach has several advantages. It doesn’t require setting up a trust; the real liability cost is lowered over time; and the liability cost reduction lowers the discount rate. If you go this route, be sure to document the strategy, develop a written policy, and have the governing board approve the plan. The downside, from a GASB reporting perspective, is that you cannot report these earmarked assets as plan assets and you will continue to recognize a growing liability on your balance sheet.
Set up a tax-exempt trust. Another type of separate funding vehicle is a Voluntary Employees’ Beneficiary Association. Authorized by Internal Revenue Code Section 501 (c) (9), a VEBA is a special type of tax-exempt trust vehicle that provides employee benefits. VEBA assets accumulate tax free.
Basic requirements for establishing this kind of trust include limiting it to employees and former employees (including spouses and dependents) and meeting the criteria for types of benefits provided (including health, life, accident, etc.). Because earnings of VEBA assets can be subject to unrelated business income tax (UBIT), work with tax and legal experts if considering this mechanism.
Issued to address government exposure that is not historically revealed in the financial statements, GASB 45 calls for financial reporting transparency as well as understanding the future obligation. This has implications for governing and making business decisions. Although actuaries and accountants are involved, the calculation mechanics are not the challenge. Rather, understanding the drivers of results and the options that make sense for your institution or system provides the real challenge.
“This is not simply a choice of vanilla, chocolate, or strawberry,” says Steinberg. “There are 40 or 50 different ‘flavors’ for your institution, and the choice depends upon the context and your institution’s focus.”
In addition to coordinating finance and benefit teams to address these issues, business officers need to communicate to stakeholders and influence governing boards to make decisions for the future that involve today’s resources. Because people are the greatest resource in a service industry like higher education, decisions involving funding and benefit selections are extremely important and can become extremely public in a hurry.
GASB 45 is here to stay. Now is the time to work across your campus, system, or state to accurately and creatively address the standard’s requirements for reporting other postemployment benefits.
SUE MENDITTO is director, accounting policy, for NACUBO.
- Tuition Increases Slow, While Student Loan Borrowing Declines, College Board Reports
- IRS Response to NACUBO on 1098-T Penalties Offers No Relief
- IRS Publishes Final Rules on Overpayments of Arbitrage Rebate on Tax-Exempt Bonds
- 2015 Intermediate Accounting and Reporting - Winter
January 22-23, 2015
- 2015 Endowment and Debt Management Forum
February 4-6, 2015
- 2015 Unrelated Business Income Tax
February 25-27, 2015
- ON-DEMAND: How to Build, Develop, and Support a Compliance Program at Your Institution
- ON-DEMAND: Strategic Tuition Assessment and Tuition Restructuring
- ON-DEMAND: Are Shared Services Right for Your Organization – The KU Journey
- ON-DEMAND: VIRTUAL: 2014 Annual Meeting
- ON-DEMAND: VIRTUAL: Student Financial Services Conference
- ON-DEMAND: VIRTUAL: Higher Education Accounting Forum
- A Guide to College and University Budgeting: Foundations for Institutional Effectiveness, 4th ed. - by Larry Goldstein
- NACUBO's Guide to Unitizing Investment Pools - by Mary S. Wheeler
- Managing and Collecting Student Accounts and Loans - by David R. Glezerman and Dennis DeSantis