OPEB Funding - The Pros & Cons - Case Study
Parker Elmore, ASA, MAAA, EA, FCA | Kurtis Thompson
With the issuance of GASB 45 in 2004 and the recent issuance of GASB 75 in 2015 for governmental Other Postemployment Benefits (“OPEB”) Plans, many municipal entities are considering pre-funding their OPEB liabilities and wondering if it makes sense. To help you decide, we thought it might be helpful to share a case study of a client who faced a similar dilemma.
What Was The Situation?
The Town of Middleborough, Massachusetts (“Middleborough”) is a mature town settled in 1660, incorporated in 1669 and home to nearly 25,000 people. While the town has a manufacturing base along with their residential population, their ability to raise revenue is constrained by Massachusetts Proposition 2 ½ which caps their locally raised revenue at 2.5% of the fully & fair cash value (the “Levy Limit”) of all taxable real & personal property in the Town. As with many municipalities across the United States, Middleborough offers medical & life insurance benefits to their long time employees upon their retirement for the rest of their lives with the retirees paying 25% to 40% of the costs of such coverage. As of July 1, 2012, Middleborough had an Actuarial Accrued Liability (“AAL”) under GASB 45 of $79.5 million, an Annual Required Contribution (“ARC”) of $8.8 million and annual net pay-as-you-go (“pay-go”) costs for retirees of $2.9 million plus a $900k per year OPEB funding charge. Additionally, Middleborough is part of a county-wide retirement system which has a mandated funding schedule with required contributions of $4.9 million for 2014 increasing to $11.1 million by 2034.
As they looked to the future, they saw the AAL for their OPEB Plan would increase to $682.7 million by 2054 with pay-go costs increasing to $19.8 million over the same period. Given the Levy Limit and a stable tax base, the situation needed to be addressed to ensure that retirees would receive their promised benefits in the future without requiring major cuts to town services.
OPEB, Pensions, Debt & Bond Ratings?
The various ratings agencies have begun looking more closely at the long-term debts of municipalities when doing their analysis. Key among these debts are OPEB and Pension plans. While it has been argued that OPEB plans are not a real debt as they can be changed and renegotiated, the ratings agencies treat these as an obligation of the municipal entity that will need to be satisfied. As such, higher debt in relation to your ability to service such debt will lead to lower ratings assuming all else is equal. Therefore, the key issue is how do you address this obligation (both OPEB and Pension) and begin to get it under control.
So, What Did We Do?
As Middleborough looked at exploding OPEB costs into the future, growing pay-go costs for their OPEB Plan, significant current & ongoing pension contributions for the next 20 years and constraints on their ability to raise local revenue due to Proposition 2 ½, it may have seemed hopeless. So, working with Judy MacDonald (Treasurer/Collector at Middleborough), we took a holistic look at the entire retirement obligation (pension & OPEB) instead of viewing the OPEB and Pension plans as individual entities. Middleborough faced a mandate via Massachusetts General Law (“MGL”) to fund their pension obligation but there is no such requirement to fund their OPEB plan. Therefore, if we lengthen our view and treat them as one overall liability, we can effectively maintain “pay-as-you-go” funding for the OPEB plan with modest installment payments for the next 20 years and then “rollover” a portion of the pension funding amount to the OPEB plan in 2035 & beyond. While taxpayers may be looking forward to relief in 2035, simply taking 50% of the pension funding amount (releasing the rest to the general budget) will enable them to achieve full funding of the pension plan by 2034 and a 26% funded level in the OPEB plan by 2054 – thereby providing additional benefit security to their retirees and protecting the town and their taxpayers from future uncertainties.
Additional Incentives To Pre-Fund?
With GASB 45 and even more so with GASB 75, the discount rate used to determine plan liabilities is based on your funding policy (how much you’ll set aside each year) as well as your investment policy (how will these funds be invested). In general, the more you fund each year, the higher discount rate your actuary can use for your valuation. As you’re likely aware, increases in the discount rate will decrease disclosed plan liabilities on your financial statement – it doesn’t change the actual cost of the plan, but it may help for an improved bond rating and therefore lead to lower borrowing costs.
Does This Work For Everyone?
Each situation is different and we wouldn’t presume that this approach makes sense for every organization. Rather, we do encourage you to look at the totality of your long-term obligations and look to solve them. We have clients who have dedicated revenue streams (e.g., meals tax, hotel tax, etc.) to OPEB funding, others with sufficient general revenue to fund and others for whom funding isn’t currently financially viable.
What’s the Impact?
The chart below shows how we are able to reduce the current OPEB funding schedule by redeploying Pension funding after 2034 to create current budgetary relief while creating a path to full funding of the obligation for both programs. This approach still allows the Pension plan to be fully funded in 2034, but increases the OPEB funding in 2054 from 15% to 26%.
If I Have Questions, Who Can I Contact?
If you have any questions about OPEB funding and what is may mean for your OPEB Plan and the impact on your OPEB accounting, please let us know.