Sizing Up Your Other Postemployment Benefits (OPEB) Plan

The combined impact of the Affordable Care Act, changes to accounting rules, and a challenging economy have introduced significant financial obstacles for virtually all governmental organizations and their ability to offer a sustainable postretirement healthcare program. As employers assess the combined impact of these changes, they are faced with the prospect of choosing the right program for their organization.

In order to assist governmental employers with their forward-looking strategy, Aon is developing a white paper series to provide insights and strategies in the midst of these dramatic changes. Experts from around our firm will be weighing in on how to navigate this landscape.

The first installment of our white paper series focuses on sizing up your OPEB plan to understand the prevalence of such programs, the financial reporting changes brought forth by the Government Accounting Standards Board (GASB), and how these OPEB benefits are viewed by the rating agencies.

Continue reading the whitepaper above to learn more.

Current Offerings in the Public Sector

OPEB plans have been, and continue to be, a prominent part of the benefit packages for many public sector employers. A 2016 survey by the Pew Charitable Trusts (Pew)¹showed that 49 states offered some form of retiree healthcare to their current employees. Local coverage is also strong (according the 2010 U.S. Bureau of Labor Statistics, over 60% of local government workers have access). Reviewing a cross section of public sector employers Aon works with, we found that most of the programs offered were open and ongoing.

Plan designs can range from traditional coverage with no retiree premiums to partial employer subsidies to access-only coverage (i.e., no direct employer spend). The 2016 Pew survey indicates that over 75% of states subsidize the costs for retirees either through a fixed contribution each year or as a percentage of the premium.

Aon’s internal survey of public sector employers who sponsor OPEB plans illustrates that approximately half of employers surveyed subsidize at least 50% of the cost of OPEB plan, whether it be pre-65 or post-65 coverage.

Changes to Accounting Rules

Background

The Government Accounting Standards Board (GASB) issued statements 74 and 75 in order to make accounting and financial reporting for OPEB consistent with the pension standards set by the GASB (statements 67 and 68).

The purpose of the new standards (replacing the prior statements 43 and 45) is to:

Establish a consistent set of standards for all postemployment benefits;
Provide more transparent reporting of the liability; and
Provide more useful information about the liability and costs of benefits.

Statement 74 covers the reporting required by the plan itself and will not necessarily apply in all situations. Typically, it would apply if the plan was issuing a standalone statement of its assets and liabilities separate from the plan sponsor’s financial statements. This is often, though not exclusively, the case when the plan is funded through a Trust fund.

Statement 75 is for purposes of determining the liability disclosures and plan accounting expense that will be reported as plan costs and liabilities on the employer’s audited financial statements. Typically, all employers would have this reporting.

What is Required?

The objective of the Standard is to more clearly and uniformly reflect the financial effects of OPEB, including the amounts paid or contributed by the government. In general the Standard requires:

Measurement and recognition of an annual expense due to OPEB on an accrual accounting basis;
Disclosure information regarding the funding, costs and provisions of the OPEB plans.

The resulting information will achieve the following objectives:

Reporting of the estimated cost of the benefits as an expense and as a liability on the balance sheet of the employer during the years the employees are providing services to the government and its constituents in exchange for those benefit promises
Availability of more consistent and detailed information on the government’s financial statements about the total cost of services that the government provides to its constituents
Clarifies whether the amount a government has paid or contributed for OPEB during the reporting year (and on a historical basis) has covered its annual OPEB costs
Provides better information to report users about a government’s unfunded liabilities and the funded status of the benefit promises over time

Impact on Employer

It is important to note that while the new accounting standards require reporting of OPEB liabilities and costs in a specific manner, they do not impact the underlying economic value (or cost) of providing the OPEB benefit.

The accounting changes could affect employers in many different ways. We have identified three impacts that we believe are relevant to employers:

Visibility: The reported level of OPEB liability is likely to be larger than most employers have been reporting.
Labor Costs: The annual expense charge under GASB 75 will include the cost of benefits being earned (i.e., the cost of today’s labor) as well as interest on the outstanding liability. In this way, employers can see the actual cost of current workers and not assign an artificially high cost to the current and future workers. This detail will allow interested parties to see the actual cost of the benefits.
Borrowing Costs: Many public sector employers raise capital by using general obligation bonds. A weaker financial analysis could result in a downgrade to an employer’s bond rating, which would likely result in increased borrowing costs to the employer. The next section discusses what employers can expect from the major rating agencies in this regard.

Rating Agency Views

Credit Rating Impact

The change in accounting standards is not a change in the underlying economics of the plan and, therefore, does not constitute a credit event.

This sentiment was universally expressed to us as Aon interviewed the Big Three rating agencies (Fitch Ratings [Fitch], Moody’s Investor Services [Moody’s], and Standard & Poor’s Financial Services [S&P]) to better understand the impact OPEB liabilities, under the new accounting standards, have on their state and local bond ratings.

In December 2017, Aon published a white paper focused on the credit rating impact of public pension plans. For that paper, similar interviews with the Big Three were conducted and a comparison to their rating methodologies was detailed with the chart on page 7, representing a high-level summary of each agency’s ratings framework. While each agency has a unique rating methodology, consistency was found across the firms with regard to the inclusion of both the current and future state of pension liabilities and plan management. Agencies are not just looking at where these plans stand today; they are also looking at the expected future trajectory of the plan based on how it is being managed.

Focusing now on OPEB benefits and their direct impact on credit ratings, the same line of thought continues. Agencies are looking at both the current state of OPEB plans as well as how they are projected to evolve into the future. Questions being asked include the following:

How large is the OPEB liability (both in size and relative to peers)?
How quickly are benefit payments increasing and does that foreshadow future budgetary concerns?
Does the entity have the ability to make benefit changes?

In our discussions, Aon found that the OPEB impact on credit ratings diverges from what we previously found on pension benefits. As we compare the handling of OPEB liabilities amongst the rating agencies, S&P is the lone agency with an explicit weighting to OPEB in its methodology – OPEB liabilities are considered with an equal weighting to pension liabilities within the Debt & Liability Profile. Fitch and Moody’s consider OPEB liabilities when making adjustments to their rating calculations but do not currently consider them to be akin to pension liabilities. The primary reason for these differences is the nature of the benefits themselves. Pension benefits represent “hard” dollar obligations with a promise from a governing body that they will be paid in the future. The rating agencies all give these benefits a full weighting in their respective methodology.

On the other hand, OPEB is considered a “soft” dollar obligation – there are instances where the benefits are promised, but greater flexibility exists (or is deemed to exist) within OPEB benefits to make changes and adjust the obligation in the future. The relatively low funding levels typically seen in OPEB plans have allowed the rating agencies to defer any push to more fully account for the economic value of these assets in making their determinations. For at least one agency (Moody’s), the assets enter into the rating only when looking at how many years of future medical costs could be covered by the current balance.

It is the view of the rating agencies that the new GASB accounting statements provide greater levels of transparency to OPEB liabilities than previously existed. Greater visibility may also lead to greater awareness and more proactive long-term management of OPEB plans. Several of the agencies mentioned they would be assessing their methodology in 2019 after they have seen the first round of reporting under Statement 75.

Summary

Retiree benefits are an important part of the benefit offerings for many public-sector employers. Subsidy approaches vary significantly across different geographies, but many employers offer at least access to a group program. Rising premium and claims costs as well as new pressures from more volatile accounting rules threaten the sustainability of OPEB plans as employers review their programs and consider their long-term impact. Due to the inherent flexibility of OPEB benefits, rating agencies have not yet uniformly incorporated these liabilities into their rating framework. Increased transparency from the new GASB standards will provide greater awareness of plan liabilities and provide an opportunity for proactive long-term management of OPEB plans.

In the next installment of our OPEB series, Aon will discuss designing an employer’s OPEB plan for success. The traditional postretirement benefit program provides subsidies that cover a portion of future premiums. Benefits are often delivered through traditional programs. Our experts discuss ways to better manage current and future health plan costs for retirees while still providing a competitive, cost-effective benefit.

^{1 Source: Pew’s “State Retiree Health Plan Spending: An examination of funding trend and plan provisions,” May 16, 2016}

^{2 Source: Survey of internal Aon public sector actuarial clients conducted as of August 2018}

^{3 Sources: Fitch’s “U.S. Public Finance Tax-Supported Rating Criteria,” May 31, 2017; Moody’s “US States Rating Methodology,” April 17, 2013; and S&P’s “U.S. State Ratings Methodology,” October 17, 2016}

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