Other Postemployment Benefits or OPEB represents a large liability on the balance sheet of many municipal entities across the United States. As various stakeholders try to understand it, we wanted to answer many of the frequently asked questions to allow you to make better decision on your program.
1. What is OPEB?
Other Postemployment Benefits (“OPEB”) refers to benefits, other than pension, offered to employees after they leave employment. The most common benefits are medical, dental, and life insurance.
2. Does OPEB affect my bond/credit ratings?
OPEB is one element that rating agencies consider when they determine your bond rating. S&P and Moodys have recently increased the share of their rating based on municipal debt including General Obligation, Pension & OPEB.
3. How does OPEB impact my financial statement?
With the implementation of GASB 75, your OPEB liability has moved from the notes section of your financial statement to the balance sheet. While this doesn’t change your liability, it does make it more visible. Your OPEB assets (if any) may allow for the use of a higher discount rate which serves to reduce this disclosed liability beyond the actual amount of OPEB assets.
4. What are the key assumptions?
- Discount Rate
What interest rate is being used to value liabilities in today’s dollars?
- Termination Rate
What percentage of employees are going to leave each year prior to retirement?
- Retirement Rates
What percentage of eligible employees are going to retire each year?
- Election Percent
What percentage of employees are going to elect coverage for themselves in retirement? For their spouse?
- Trend Rate
How much are medical (and dental) costs expected to increase each year?
5. How is the discount rate determined?
There are five key factors that determine the discount rate:
- Employer Share of Costs
What is the portion of retiree medical, dental, and/or life benefits paid by the Employer each year?
- Municipal Bond Rate
What are high-grade municipal bonds earning as of the Measurement Date?
- Current Asset Level
What is the value of the assets currently held in an irrevocable OPEB trust?
- Funding Policy
How much is expected to be contributed to the OPEB Trust each year?
- Investment Policy
How will OPEB assets be invested (e.g., target % in stocks, bonds, cash, etc.)?
6. How high of a rate of return on investments should we assume?
The rating agency, Moody’s, has been calculating liabilities at a lower discount rate than the actuarial report if they feel the assumed rate of return is higher than can be justified by the investment policy, increasing the liability they use when determining the bond rating. Therefore, we recommend using an assumed rate of return that is in line with your investment policy rather than an overly aggressive rate.
7. What is Service Cost?
Service Cost represents the present value of the benefits to be paid in the future that are earned by active employees in the current year. This can be thought of as deferred compensation that active employees earn during the year that they are expected to receive in retirement (typically in the form of a medical, dental, and/or life insurance benefit).
8. What is the impact of Medicare Supplement plans on my OPEB liability?
If your OPEB plan offers Medicare Supplement plans, these plans generally represent the majority of your OPEB liability (usually 75% to 85%). While your active plans impact OPEB, most of the costs relate to the payments you make for your active employees rather than your retirees.
9. Why does the employer share of costs differ from what I am paying each year?
This is because your employer share of costs includes an implicit subsidy. The implicit subsidy arises because retirees who are not eligible for Medicare often are charged the same premium as active employees even though they are expected to incur higher medical costs as they age. Consequently, a portion of the premiums being paid for active employees “subsidize” the premiums of retirees. Actuarial Standards of Practice and GASB standards require the liability associated with this implicit subsidy to be valued.
10. Should I fund by OPEB Liability?
While you are not required to prefund your OPEB liability, the management of your OPEB liability (including the level of funding) is one element that rating agencies consider when determining a municipality’s bond rating. You should consider this, coupled with your other financial needs, when determining whether funding is right for you.
11. Am I required to prefund my OPEB Liability?
No. However, prefunding your liability may allow the use of a higher discount rate which may decrease your disclosed liabilities. Additionally, rating agencies look favorably upon prefunding OPEB liabilities as it shows the plan sponsor is engaged in managing these liabilities.
12. Are my peers funding?
While most municipalities are far from fully funded, with the implementation of GASB 74/75, we are seeing many municipalities begin to fund who had not previously done so.
13. What can we do with money in an OPEB trust?
At any time, regardless of your funding status, you can use money in your OPEB trust to pay up to the full amount of expected retiree contributions including implicit cost each year.
14. What else can we do to manage the liability besides funding?
- Change Medicare Prescription Drug Benefit
Since most OPEB Plans see 75%-85% of the total liability related to benefits paid after attainment of Medicare eligibility, this is the most impactful area to make changes. We’ve seen plan sponsors modify their drug formulary which can reduce current medical payments by 10% to 15% and OPEB liabilities by 15% to 20%.
- Make your Plan secondary to Medicare
If you haven’t already done so, you should mandate that those retirees who are eligible for Medicare enroll in it and allow your Plan to become a secondary payor.
- Change Cost Sharing
You may consider varying cost sharing based on the age of the retiree, years of service, retirement date, hire date, etc. Before making any changes you should confirm that such changes comply with state laws.
- Change in Eligibility
You may change the requirements necessary to be eligible for OPEB benefits to reduce cash costs and liabilities. Similar to changes in cost sharing, you should make sure that any changes to eligibility comply with state laws.
15. Are there any upcoming legislative actions that will impact our liability?
Under the Patient Protection and Affordable Care Act (“PPACA”), an excise tax will be imposed for tax years beginning after December 31, 2021 (formerly December 31, 2017, but amended by the Consolidated Appropriations Act) for high cost employer sponsored health coverage. The law specifies a 40% excise tax, to be paid by the provider of such coverage, of the excess value beyond a basic dollar amount plus an additional “kicker” for qualified retirees or those engaged in a high-risk profession. The impact of the excise tax should already be reflected in your OPEB liability.
Future Liabilities & Expenses
While your projected future Total OPEB Liability may appear daunting, a more relevant metric is the relation to your budget and your ability to pay. The following graph depicts a sample OPEB Plan and shows the relation of the Total OPEB Liability to the annual budget (assuming your budget increases 3.00% per year). As you can see, while the liability increases significantly, it only increases slightly as a percent of the budget.
The above graph is based on a Total OPEB Liability that is projected to increase from $15 million to $65 million between 2018 & 2056. The Total OPEB Liability as a percentage of budget is projected to increase from 72% to 98% between 2018 & 2056.
Similarly, while benefit payments (e.g. the portion of premiums that you pay for your retirees) will likely increase significantly in coming years, the increase in costs appears far more manageable when seen as a percentage of the annual budget.
The above graph is based on benefit payments (“Employer share of costs”) that are projected to increase from $700 thousand to $3 million between 2018 & 2056. Benefit payments as a percent of budget are projected to increase from 3.5% to 4.9% between 2018 & 2056.
If you have any questions or would like more information, please contact your Odyssey Advisors representative.
Parker Elmore, ASA, EA, MAAA, FCA is a Consulting Actuary in both the Las Vegas & Connecticut offices of Odyssey. Contact him at firstname.lastname@example.org.