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Top 6 Reasons to Pre-fund Your OPEB
Bottom Line Up Front
- GASB 75 brought on a shift from pay-as-you-go funding to pre-funding an OPEB trust to mitigate liability costs and reduce the impact of rising medical costs and inflation
- Establishing an OPEB trust will allow you to invest the assets which will lower your OPEB costs over time, increase your credit rating, enhance generational taxpayer equity, and is considered a GFOA best practice
- Pre-funding your other postemployment benefits will ensure you always have funds available to pay for the benefits promised to your employees
Since the accounting standards of GASB 75 have been fully implemented, a majority of municipalities are addressing their large OPEB liabilities by opening an OPEB trust to manage and reduce the costs associated with these benefits.
While the pandemic has continued to add extreme pressure to municipal budgets, now is the time to implement a strategy to prevent the current situation from getting worse. Establishing an OPEB trust fund is the first step to addressing your growing OPEB liability.
Why Should We Establish a Trust to Pre-fund Our OPEB?
1. Assets in the trust can be invested and any returns the trust may generate can be used to help pay for the benefit
Let’s look at it over the span of an employee’s career that spans 30 years. Without an OPEB trust, you’ll be paying for the benefits as employees become eligible, at retirement. With an OPEB trust, you’ll be pre-funding the benefits throughout an employee’s career so by the time they are ready to retire, you’ll have already funded their postemployment benefits (other than their pension).
At first, you will be paying more to establish the trust, but in the long run, the contributions made to the account have the potential to generate investment returns which will ultimately lower the amount of the municipality’s liability even more.
2. These funds can be used in tough budget years to cover any OPEB related expenses
Funds in an OPEB trust can only be used for OPEB related expenses, but think of it as a sinking fund account in the world of personal finance. The advantage is that if you’re having a tough budget year, you can pull funds from the account ot cover that year’s OPEB expenses which can alleviate pressure in other areas of your budget.
3. You’ll receive a higher discount rate on your valuation when calculating your OPEB liability
When you establish an OPEB trust, your discount rate will be a blended rate equivalent to discounting all expected future benefit payments that my be funded by assets held in the OPEB trust at the expected long-term rate of return with all other payments discounted using the 20-year index of yields on high-grade municipal bonds.
Once your trust is fully funded, the discount rate is even greater since it’s the expected long-term rate of return (sum of inflation and the long-term real rate of return). A higher discount rate greatly decreases your accrued liability and required contribution which means the net impact on your budget is also less than if you didn’t have a trust.
Without a trust, your discount rate will be the 20-year index of yields on high-grade municipal bonds which is lower than if you were actively funding your OPEB liabilities.
Check out these 5 factors that can determine your OPEB discount rate.
4. Your credit rating will increase and your borrowing costs will be reduced
Rating agencies like Moody’s, Standard & Poor’s, and Fitch Ratings, determine a municipality’s bond ratings and are placing a much greater emphasis on both pension and OPEB liabilities. They evaluate your OPEB liabilities based on a few different factors which can include:
- The size of the bond issuer’s curent and future liabilities in comparison to income, expenditures, and revenue
- Any actuarially determined annual OPEB payments as a percentage of expenditures
- Whether or not the municipality is addressing their liabilities (do they have a funding policy, an investment policy, are they making benefit changes, etc?)
So if you are actively funding your OPEB, it shows rating agencies that you are taking proactive steps to improve your liability management and they will increase your bond rating.
5. You’ll enhance generational taxpayer equity
Establishing an OPEB trust will improve generational equity because you (and taxpayers) will be funding benefits as they are being earned by employees. If you use the pay-as-you-go model and do not have an OPEB trust, you are paying for OPEB benefits after they are earned or when an employee retires.
6. GFOA considers pre-funding your OPEB a “best practice”
The GFOA (Government Finance Officers Association) which is an organization that represents public finance officials around the U.S. and Canada, deems establishing an OPEB trust as a best practice.
The GFOA states that by establishing an OPEB trust, you can make long-term investments to cover OPEB obligations and overtime, they will result in a lower total cost for providing postemployment benefits.
Prefunding your OPEB provides the following benefits:
- Assets can be invested and you can use the investment income to pay for future retiree benefits which will reduce your future cash flow requirements
- Help alleviate budgetary pressures in tough budget years
- Actuaries can use a higher discount rate which decreases the OPEB liabilities reported on your annual financial statements
- Increase and preserve a positive credit rating which will lower your borrowing costs
- Enhance generational taxpayer equity
- GFOA best practice
Creating a pre-funded OPEB trust is going to come with some challenges. We understand that your budget is under pressure and you have competing voices urging you to fund everything from updating the 30-year-old middle school building to hiring new police officers. But it’s so important for you to manage your growing OPEB liability now before it gets to a point where it’s unmanageable. Establishing an OPEB trust will provide your municipality the security that you’ll always have funds available to pay for the benefits promised to your employees.
If you’re ready to take the next steps, we suggest working with an actuary to run through potential funding scenarios to see what’s possible given your organization’s current and future cash flows. Check out these 7 factors to consider when you’re hiring an OPEB actuary.
If you’re looking for an actuary to work with, we’d love to help you.
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