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GENERAL
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What does it mean to “pre-fund Retiree
Health Benefits”?
Pre-funding means setting aside and investing money now
to cover the cost of obligations that come due in the
future. One of the most common examples of pre-funding
is pension funding – governments that provide pension
benefits to their employees generally set aside money in
a pension fund and then invest it to get the highest
possible returns, so that the money is there when it
comes time to pay out those pension payments to
retirees.
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Why is pre-funding the best approach?
First, it costs a lot less in the long run. A large
portion of the money you pay out in the future can come
from investment returns instead of taxpayer’s money.
Pre-funding also makes sense because you are paying now
for costs you are incurring now (benefits are earned by
employees while they work), instead of putting off those
costs for future taxpayers to have to pay.
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But in these tough fiscal times, why
are we setting aside money for Retiree Health Benefits?
Good fiscal management means addressing your obligations
even when times are tough. The County needs to show that
it is committed to addressing this long term obligation,
just as it addresses other long term obligations such as
pension funding.
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Why are we changing from a five-year
phase-in to eight-years?
During the Fiscal Year 2008 budget process, the County
Executive recommended, and the County Council approved,
a resolution calling for a five-year phase-in to the
full annual pre-funding level required to fund our OPEB
obligations. However, in developing the FY09 budget, and
facing a $401 million budget gap, the County Executive
had to make some tough choices. While committed to
addressing the unfunded Retiree Health Benefit
obligation, the Executive determined that we could not
afford, in current fiscal circumstances, the previous
five-year phase-in plan. The FY09 budget calls instead
for an eight-year phase-in, or seven additional years
after taking into account the funding already set aside
in FY08.
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I have heard that we need to do this
for the bond rating agencies. What do the rating
agencies have to do with retiree health benefits?
Remember that the rating agencies are rating the County
on its willingness and ability to make debt service
payments on its bonds. Among other things, the rating
agencies consider unfunded pension and OPEB liabilities
in the rating analysis and quantify them similarly to
debt. They are interested in how the County is managing
all of its long term obligations, and according to one
agency, “a large and growing unfunded pension liability
combined with a sizeable OPEB obligation would
negatively affect an otherwise strong debt profile.”
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What is the new accounting
requirement?
It’s an accounting requirement that says you have to
estimate what the cost for retiree benefits will be, and
report that cost in your financial statements. You not
only have to report the cost, but also how you are
managing and addressing it – how much of it you have
funded already and how much of it is still an unfunded
liability. We are already doing this for pension
benefits, now we have to do it for other benefits for
retirees, such as health, life, vision, etc.
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Why does it cost so much?
The revised total estimated OPEB liability of $3.2
billion represents an estimate of all the future
payments that will have to be made for retirees of the
County – both current retirees and current active
employees. For current active employees, estimated
future payments represent benefits in retirement that
active employees have earned to date.
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How are we going to pay for it?
We have come up with a plan that calls for setting aside
a certain amount of money each year and investing it, so
that it will grow to the point where we will have enough
money to pay the bills when they come due. The amount we
are setting aside will be higher each year for the first
eight years and then it will level out, but continue on
an annual basis. The annual amount we will need to set
aside is estimated to level out at about $270 million a
year. That is a large amount of money, but it is needed
to move towards funding the total current estimated
liability, which is approximately $3.2 billion.
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What is the affect on me?
Setting aside the money for Retiree Health Benefits is
going to be tough when the County is already facing many
other budget challenges. Because some of the County’s
resources, including taxes, fees and other revenues will
have to go to this, that revenue won’t be available for
other uses such as services to residents. But we can all
appreciate that the County is acting in a fiscally
prudent manner by doing this, and that saves everyone
money in the long term.
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What’s new and changed?
Starting with last fiscal year (FY2008), the value of
retiree benefits provided such as health and life
coverage must be calculated and recognized as a
financial obligation to each County agency. For many
years, this has been the case with pension benefits, but
up until now, other types of post employment benefits
such as health and life coverage were simply considered
expenses when they were paid.
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What does all of this mean?
For the County agencies, this means that a rather large
financial commitment must be both recognized and
managed. One way to manage this liability is to “fund”
it on an annual basis. This means setting aside money
today while an employee is in active service to cover
the cost of the employee’s health and life benefits
after they retire and leave active service. We can do
this for current active employees. But we also need to
set money aside for current retirees, who already
provided their service. Since no money was set aside
while they were in active service, the amounts we now
need to fund, whether focusing on the total $3.2 billion
liability or the $305 million on-going annual
contribution, include this retiree portion also.
Therefore, beginning in fiscal year 2008, the County
agencies are funding this liability on an on-going
basis, with a portion of the money set aside each year
until we reach the annual contribution level calculated
by the actuary.
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Why is this important to me as a
County employee or retiree?
Just as I care that the County has enough money to pay
out any pension payments it owes to me in my retirement
(defined benefit plan recipients), I also want to know
that the County will be able to pay for its share of my
health benefits in retirement, regardless of which
pension plan I am in. For employees and retirees of
County agencies, this means that the County is
recognizing the future cost of retiree health and life
benefits now and is setting aside money today to meet
those expenses in the future. It also means that the
County will continue to evaluate ways to manage benefit
costs. All of the retiree benefits plans are reviewed on
a continuing basis to determine if plan changes may be
appropriate for consideration. In addition to the review
of retiree benefits plans, active plans are also
reviewed on a continuing basis. Eligibility criteria for
retiree benefits may also be a subject for review as
well.
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What does this mean to me as a
taxpayer and County resident?
For residents of the County, this means that the County
is taking fiscally prudent steps to protect its overall
financial health, not only from a funding perspective,
but also from a cost management perspective. While
pre-funding places a strain on the budget now, if we
don’t pre-fund, it will cost us more in the long run,
requiring more in taxpayers’ dollars.
MORE ON THE FISCAL AND
ACCOUNTING DETAILS
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What is the new accounting requirement
and where did it come from?
This requirement comes from the Governmental Accounting
Standards Board or “GASB.” GASB establishes standards of
financial accounting and reporting for state and local
governments. These standards guide the preparation of
external financial reports. External financial reporting
demonstrates financial accountability to the public and
is the basis for investment, credit and many legislative
and regulatory decisions. In June 2004, GASB issued
Statement No. 45 which addressed Accounting and
Financial Reporting for Postemployment Benefits Other
Than Pensions. These non-pension benefits are commonly
referred to as “other post employment benefits” or OPEB.
They include health and life coverage offered to
retirees. It is this Statement No. 45 that speaks to how
state and local governments should now account for and
report their costs and financial liabilities related to
OPEB.
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Prior to this new requirement, how was
OPEB accounting and financial reporting done?
Governments usually followed an approach of
“pay-as-you-go,” meaning that the costs of retiree
benefits other than pensions were treated as an expense
when actually paid rather than as an obligation that
accumulates or “accrues” over the period of active
employment.
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What is the new requirement intended
to accomplish?
This new requirement is intended to improve the
relevance and usefulness of financial reporting for
state and local governments. When governments finance
OPEB plans on a pay-as-you-go basis, and their financial
statements do not report the financial effects of OPEB
until the benefits are actually paid, the users of these
financial reports do not have a clear understanding of
the governments’ liabilities and whether or not they are
properly funded.
In 1994, GASB had established somewhat similar standards
for how governments should account for and report the
cost associated with pension benefits. As is the case
with pension benefits, OPEB are considered part of an
employee’s total compensation during active service,
even though the benefits are not received until after
employment has ended. Therefore, the cost of these
future benefits is part of the cost of doing business
and providing service today. From an “accrual”
accounting perspective, the cost of OPEB, like the cost
of pension benefits, now will be associated with the
period of active service in which these benefits
accumulate, rather than with the periods (often many
years later) when they are actually paid. This will
provide the users of governmental financial reports more
accurate information about the total cost of services to
residents and what the government’s true financial
liabilities are.
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What do OPEB obligations have to do
with the County’s bond rating?
In addition to the interest of current and future
retirees about whether the money will be there in the
future to pay out benefits, other institutions, such as
the bond rating agencies, are interested in how the
County is managing and addressing this sizeable
financial commitment. In a fiscal sense, commitments to
pay out benefits to retirees compete with commitments to
pay debt service on bonds, so the rating agencies have
an obligation to report to the County’s investors how
well prepared the County is to meet all of its future
commitments.
This is all a part of the bond rating process. A
county’s bond rating impacts the costs associated with
borrowing money. Montgomery County currently has a AAA
Bond rating, which is the highest rating given to public
entities. But if the County is not found to be
satisfactorily addressing its liabilities, this could
impact the County’s rating.
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What are the County agencies doing to
meet the new requirement? How do we know how much we
need to set aside?
First, the County agencies estimated the dollar
liability of OPEB attributable to its current employees.
That included, under the current level of benefits
offered, not only the estimated benefits earned by
employees in the current year, but the benefits that
employees have already earned (because the County
agencies had not been previously recognizing these
costs). The costs associated with current service are
referred to as “normal costs.” Normal costs and those
costs associated with prior service, including all
estimated costs associated with current retirees, are
referred to as an “actuarial accrued liability” or AAL.
The amount of the AAL that does not have assets set
aside towards it is known as the “unfunded actuarial
accrued liability” or UAAL. Payment of the UAAL is
spread out or “amortized” over a period of up to 30
years in level amounts (the period of time used is
usually reflective of the length of active service for
employees). This is similar to the way a mortgage is
spread out in equal amounts over a number of years. The
County agencies have completed this step through what is
known as an “actuarial valuation” that was performed by
their benefit consultants. The total AAL across all
County agencies was estimated to be approximately $3.2
billion as of the latest actuarial update.
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What information and assumptions did
the consultant use in the valuation?
Looking at the current level of benefits offered, the
consultant or “actuary” used information such as
turnover and retirement assumptions, medical inflation
and claims cost assumptions, mortality assumptions, and
discount rate assumptions (the present value of the
future benefit payments in terms of today’s dollars).
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What impacts this liability?
This liability is impacted by the number of retirees
receiving benefits, the number of active employees who
will be eligible for benefits under current policies,
the costs of the retiree benefits for the current
benefit levels, and the investment return on any funds
set aside.
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Is there a legal requirement for the
County to set funds aside toward this liability? If
not, why are we doing this?
No, this is not a legal requirement, nor is it even a
specific accounting requirement to set aside the funds.
What changed is the new accounting requirement to report
the amount of unfunded liability, and due to that
reporting requirement, there is more attention on the
liability and what the County is doing to address it. As
described in the General section of these FAQ’s, we are
setting funds aside since it wouldn’t be fair to leave
that bill for future taxpayers to deal with, and,
because by putting aside the money now and investing it,
it will cost us less over the long run.
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How much money is required to fund
OPEB?
The amount required annually to fund the OPEB liability
is called the Annual Contribution. This amount consists
of several pieces – (1) the normal costs earned by
active employees during the year, (2) the portion of the
Unfunded Actuarial Accrued Liability or the UAAL
attributable to that year, and (3) interest on the
unpaid UAAL. The normal costs and the UAAL pieces were
discussed above. The total UAAL estimated for FY09 is
$3.2 billion.
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That is a large amount of money. Will
the County agencies be contributing this amount in
fiscal year 2009?
No. The County agencies will phase-in this contribution
over an 8-year period, starting with the money already
set aside in FY2008. This means that 7 years from now,
the annual contribution will be at the full Annual
Contribution amount. The Annual Contribution will then
be set aside on an ongoing basis each fiscal year. For
the County agencies, a total of $32 million was set
aside in fiscal year 2008. Under the current plan, an
increasing amount will be set aside each year until the
full Annual Contribution is reached in fiscal year 2015.
The revised 8-year phase-in was determined by the County
Executive to be the most fiscally prudent method to
manage the OPEB liability in the current fiscal
situation, and the $55.15 million to be set aside in
FY2009 was part of the County Executive’s recommended
fiscal year 2009 budget submitted to the County Council.
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What is good about GASB 45 and this
new reporting requirement?
GASB 45 gives us an understanding of the magnitude of
the liabilities of retiree health and life coverage. We
will be better able to plan for the cash flow in coming
years to pay for these benefits. We will also be in a
position to better evaluate the full cost impact of
proposed benefit changes.
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GLOSSARY OF ACRONYMS
OPEB – Other Post Employment Benefits
GASB – Governmental Accounting Standards Board
GASB 45 – a specific set of accounting rules on OPEB put
out by the GASB including when those new rules must be
implemented
AAL – Actuarial Accrued Liability, or total cost of
retiree benefits for current retirees and actives that
is associated with prior service as an employee
UAAL – Unfunded AAL, or the portion of the AAL that does
not have assets set aside towards it
AC – Annual Contribution, or the amount required
annually to fund the OPEB liability
Pay-As-You-Go Costs – The amount of retiree benefits
actually paid out during the year
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Seniors
