New financial accounting and disclosure rules issued by the Government Accounting Standards Board (GASB) as Statements 43 and 45 will have far-reaching significance for public entity employers. The following Q&As are meant to serve as a "quick start" reference guide, focusing less on the details of the statements and more on the important planning and employee benefits implications that you'll need to begin understanding.
1. What is GASB?
GASB is the independent body that establishes standards of financial accounting and reporting for state and local government entities (public entities). Public entities include: state, county, and local governments, public universities, colleges and school districts, and the multitude of related public agencies that are recognized as governmental.
2. What are the consequences of not following GASB rules?
Adherence to GASB-approved standards ensures a public entity's compliance with generally accepted accounting principles. Failure to comply with these rules could result in "less-than-clean" audit reports, lower bond agency ratings, increased borrowing costs, and credibility/confidence issues with respect to the public and the media. Practically all public entities comply or strive to comply with the GASB rules.
3. Why are these new disclosure rules needed?
According to the GASB, most public entities have not been reporting the "nature and size of their long-term financial obligations and commitments" with respect to "Other Postemployment Benefits" (OPEBs). OPEBs consist of the various employee benefits that employers provide to their retirees (and, in some cases, their dependents) – other than pension benefits.
These include: retiree health insurance and dental, vision, prescription, or other healthcare benefits provided to retirees and their dependents. OPEB can also include retiree life insurance, legal services and other miscellaneous benefits.
For the most part, public entities only have been reporting their current cash payments for providing OPEB each year. For example, this might consist of the premiums, or the agreed to portion of premiums, paid for eligible retirees' health insurance coverage. What they have NOT been reporting is the cost to the entity of OPEB earned by employees in that year or in prior years. As a result, public entities have been significantly understating the actual and potential liabilities associated with these obligations – a bit like filling out a personal financial statement that mentions the amount of your annual mortgage payments without mentioning the size of your mortgage obligation. Greater transparency is particularly critical in an environment where healthcare costs are growing much faster than all other forms of employee benefits.
4. What do GASB Statements 43 and 45 require?
Generally, the purpose of these two statements is to encourage public entities to more accurately measure, recognize and report the costs and liabilities associated with providing OPEB.
Statement 45, which has the broader application of the two, requires all public entities that provide OPEB to measure, recognize and report their OPEB expenses, expenditures and liabilities in a new manner. In particular, public entities that have been "reporting" the cost of their OPEB on a "pay as you go basis" no longer will be able to do this.
Statement 43 requires the trustee or administrator of a "separately funded arrangement" to provide certain financial reports that describe the plan's assets, liabilities and net assets at the end of the fiscal year, as well as the additions to, deductions from and changes in net assets from year to year. In order to be treated as a separately funded OPEB plan, the assets of the plan must be segregated, in a trust or a trust equivalent, from the general assets of the participating employer(s).
Therefore, a public entity would only need to comply with Statement 43 if it established or sponsored a separately funded OPEB plan.
5. When are these new GASB requirements effective?
Statement 45 becomes effective for public entities in three phases, depending on the amount of an entity's total revenues in its first fiscal year ending after June 15, 1999, as follows:
Public Entity Revenue
Effective (Fiscal Year)
$100 million or more
Fiscal years beginning after December 15, 2006 (that means fiscal year July 1, 2007 through June 30, 2008 for most large California public entities).
$10 million or more, but less than $100 million
Fiscal years beginning after December 15, 2007 (that means fiscal year July 1, 2008 through June 30, 2009 for most medium-sized California public entities).
Less than $10 million
Fiscal years beginning after December 15, 2008 (that means fiscal year July 1, 2009 through June 30, 2010 for most small California public entities).
Plans are required to implement Statement 43 one year prior to the effective date of Statement 45 based upon the size of the largest employer participating in the plan.
6. What is the difference between defined benefit and defined contribution OPEB, and why does it matter?
In order to appreciate some of the complexity of the new accounting and disclosure rules, including the requirement to obtain various actuarial determinations, it is important to understand the differences between defined benefit and defined contribution OPEB.
- Defined Benefit. A defined benefit OPEB plan obligates the employer or plan to pay or provide certain specified benefits following an eligible employee's retirement. The promised benefits can be described as a level of coverage (for example, 100% or 50% of the cost of health insurance for you and your dependents for the rest of your life), a specified dollar amount to be applied to retiree health insurance premiums (for example, $250 for category A employees and $300 for category B employees each month towards the payment of their monthly retiree health insurance premiums), or a formula-derived amount (for example, a monthly payment by the plan towards the retiree's medical insurance premium in an amount equal to $10 for every year of service completed prior to retirement, up to 30).
- Defined Contribution. A defined contribution OPEB plan does not promise a specific benefit, or benefit amount, when an eligible employee retires. Instead, a defined contribution OPEB plan works much like a savings account that accumulates while the employee is still working. Generally, the employer commits to contribute a dollar amount, or percentage of pay, into an employee's account. The employee's benefit upon retirement is the value of the account, which usually will include earnings and losses on amounts contributed that have been invested. For example, a typical defined contribution OPEB plan might provide that the employer will contribute $500 dollars a year into each eligible employee's post-retirement health insurance reimbursement account. Since a defined contribution OPEB plan works like a savings account, the employer or plan is not guaranteeing the amount of the employee's benefit when the employee retires.
There is a tremendous difference between the way the new GASB statements treat defined benefit OPEB and defined contribution OPEB. Since, in the case of a defined benefit OPEB plan, the employer is guaranteeing the availability of certain benefits or amounts when the employee retires (and these benefits are being earned now while the employee is still working), Statement 43 requires a public entity employer to determine the current "cost" of providing OPEB by:
- Projecting the employer's future cash outlays for benefits. For example, this might involve projecting how much it would cost to provide post-retirement medical insurance coverage for an employee and the employee's spouse assuming that the employee is currently only 35 years old, but could retire with fully paid medical insurance coverage at age 60).
- Discounting the future value of the projected benefits to determine the present value of benefit. For example, the cost in today's dollars of providing a $500,000 benefit, fifteen years from now, assuming a 6% annual discount/interest rate would be approximately $208,000.
- Allocating the present value of benefits to past and future periods. Assuming that the goal is to spread the cost of providing benefits over the employee's working career, this step distinguishes between the portion of the benefit that relates to past service, current service and future service.
Using this methodology, and certain actuarial methods and assumptions, an actuary for a defined benefit OPEB plan can determine the annual required contribution of the employer, the ARC, which would normally be sufficient to fund the plan – if the plan is starting from scratch, or a fully funded position. Unfortunately, most defined benefit OPEB plans have already accumulated a substantial "unfunded" OPEB obligation with either no or insufficient assets to cover the obligation. Public entities that have significant unfunded OPEB obligations will have annual OPEB costs that are much larger than their ARCs because they will have to include an extra expense to amortize (pay down) the already accumulated, but unfunded, obligations.
By comparison, the annual OPEB cost for a defined contribution OPEB plan is simply the annual required contribution to the plan. Since defined contribution OPEB plans do not give rise to significant unfunded liabilities, they are not the true focus or concern of the new GASB statements (and do not require the services of an actuary). They are important in the sense that more and more employers, public and private, will opt to utilize defined contribution OPEB plans instead of defined benefit OPEB plans – if they continue to offer OPEB at all.
7. What is the difference between a "funded" and an "unfunded" OPEB plan? Why might a public entity create a funded, or partially funded OPEB plan?
In the case of an unfunded OPEB plan, all benefits are paid out of the general assets of the public entity. In the case of a funded or partially funded OPEB plan, all or some of the assets needed to pay OPEB have been irrevocably set aside in a trust, or trust equivalent such as a custodial arrangement or certain types of insurance arrangements.
In general, contributions to such a trust must be made on an irrevocable basis – that is, once made, the monies contributed may not go back to the employer and may only be used to provide benefits to participants and their beneficiaries.
As one can imagine, the immediate concern of public entities is to control the extent to which unfunded liabilities for OPEB must be reported on their financial statements and will have a negative impact on their credit ratings and borrowing capabilities. By creating a funded or partially funded OPEB plan, a public entity can: (a) point to specific "dedicated" assets that have been set aside for the purpose of funding its OPEB obligations and (b) take advantage of actuarial rules that generally would allow it to use a higher interest or discount rate for determining the present value of its OPEB obligations. The use of a higher interest rate (than would be available in the case of an unfunded arrangement) has the effect of lowering the size and amount of the public entity's OPEB obligation. Based on this rule, we expect to see many public entities that have previously "self-funded" their OPEB move to funded arrangements. For example, CalPERS is launching a massive effort to facilitate and support the pre-funding of OPEB. Its actuarial staff estimates that the use of a funded arrangement could reduce some agencies' OPEB liabilities by 50% or more.
8. Do agencies providing retiree medical benefits through CalPERS have to comply with these statements?
Yes. It is our understanding that each public employer participating in CalPERS that provides OPEB to its employees will be separately responsible for compliance with Statements 43 and 45. This is not something that CalPERS will do for you.
If you would like information about securing the services of an actuarial firm that can perform the necessary valuations, please contact us.
9. What are the likely consequences of these new rules?
The impending implementation of these new rules is creating a shock wave throughout the state and local government community. Any public entity that provides OPEB must begin (and hopefully already has begun) to evaluate its potential liabilities under Statement 45. If these liabilities are significant, the entity must develop a strategy for dealing with them. In response to the coming implementation of Statement 45, a number of public entities are:
- Modifying or curtailing their OPEB commitments, to the extent possible (such changes often are subject to contractual and/or constitutional restrictions).
- Funding or partially funding their OPEB in order to take advantage of the more favorable valuation rules.
- Some combination of the foregoing.
10. How can Employee Benefits Law Group help?
These challenges won't go away. Employee Benefits Law Group can help you control OPEB liability by identifying alternatives for changing plan funding mechanisms and plan design. We'll help you develop a better understanding of the requirements and their impact on your financial statements. Our governmental benefits practice group shares over 80 years of experience and expertise with respect to advising employers on a wide variety of employee benefit issues.