Successfully navigating OPEB: new standards cast light on governments' post-employment...

EXECUTIVE SUMMARY

* GASB released two important standards intended to disclose the nature and extent of non-pension post-employment benefit liabilities largely related to health care. Governments are not required to fund the liability, but will face disclosure requirements and operational

* GASB Statement no. 45, Accounting and Financial Reporting by Employers for Postemployment Benefits Other Than Pensions, and its companion, Statement no. 43, Financial Reporting for Postemployment Benefit Plans Other Than Pension Plans, have significant implications for both financial statement preparers and their auditors.

* The general practice has been to report OPEB costs on a pay-as-you-go basis. The new standards generally require pension-type accounting for post-employment benefits. Most governments need to use actuaries to project future benefit costs, discount these costs to present value and assign these costs to the appropriate period.

* GAS B designed the new statements to resemble the previously issued pension statements no. 25 and 27. Because of the similarity in the disclosures and processes, preparers should find that disclosures are fairly straightforward. Many preparers may merge OPEB data in the same note in basic financial statements with existing pension data.

* One of the statements' more controversial aspects is the inclusion of any implicit rate subsidies afforded to retirees in the measurement of the liability and the annual required contribution.

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Two GASB statements are sending ripples through American governmental finance. The statements establish clear, stringent standards for measuring and disclosing non-pension post-employment benefits provided---employee benefits that are largely related to health care.

Statement no. 45, Accounting, and Financial Reporting, by Employers for Postemployment Benefits Other Than Pensions, and its companion Statement no. 43, Financial Reporting, for Postemployment Benefit Plans Other Than Pension Plans, demand budgetary transparency of state and local governments. The picture will be stark for the vast majority of governments. The total unfunded OPEB (other post-employment benefit) liability for the nation's state and local governments has been estimated at $1 trillion, GASB board member Girard Miller wrote in a 2007 column in Governing, Management Letter

Governments are not required to fund this liability, though some governments may operate under either a legal, contractual or moral obligation to do so. Opting not to fund the liability will mean disclosure requirements and operational hurdles. Bond rating agencies have indicated that a government's decision not to fund OPEB indicates a lack of management recognition of a major liability. This lack of recognition may weigh heavily in a rating decision and eventually may cost the government additional funds in extra interest costs.

The Pew Center on the States reported in 2007 that the combined OPEB and defined benefit pension unfunded actuarially accrued liabilities (UAAL) over the next 30 years "can be conservatively estimated at $2.73 trillion" nationwide. The report, Promises with a Price: Public Sector Retirement Benefits, continues, "Today, the need to intelligently control and manage the cost of post-retirement benefits is integral to states' capacity to fund competing needs, such as adequate roads, bridges, water systems and high-quality public education."

By measuring and disclosing OPEB liabilities, decision makers are equipped with better information about the present value of the cost of the future benefits-information that will allow them to make educated decisions about the post-employment health care benefits to be provided to employees.

AN OVERVIEW OF THE STANDARDS

GASB designed the new OPEB statements to resemble the previously issued pension requirements in Statement no. 25 and Statement no. 27. Because of the similarity in the disclosures and processes, preparers should find that disclosures related to the new statements are fairly straightforward. In fact, many preparers may merge OPEB data into the same note in the basic financial statements with the existing pension data.

Many actuaries assisting state and local governments with the new requirements may look to standards that they are familiar with in the for-profit world--namely FASB Statement no. 106, Employers' Accounting for Postretirement Benefits Other Than Pensions. However, there are dramatic differences between the standards, as illustrated in Exhibit 1.

Recently, FASB issued Statement no. 158, Employers' Accounting for Defined Benefit Pension and Other Postretirement Plans, which primarily recognizes in statements of financial position the funded status of plans. This status is the difference between plan assets and accumulated liabilities. GASB Statement no. 45 requires the presentation of these amounts as required supplementary information.

KEY HIGHLIGHTS

Similarities between Statement no. 4-3 and Statement no. 45 should help ease implementation. Key highlights shared by both statements are:

Presentation of Accrued Amounts. Both statements require measuring UAAL using accrual accounting, rather than pay-as-you-go accounting OPEB liabilities increase based on normal costs and decrease based on contributions and changes in investments that are used to finance the liability. Accrual accounting is required because an exchange of compensation occurs between employer and employee with each pay period due to the promises of these future benefits or laws that require these benefits to be paid upon retirement.

Annual Required Contribution (ARC). Both statements require the measurement of an actuarially required contribution. This amount is the normal cost for the fiscal period, computed in a similar manner to normal pension cost, plus any amortization el the UAAL (or funding excess.)

Any amount of the ARC that is unfunded in a year is shown as a liability on the statement of net assets at fiscal year-end and is used in computing the ARC for the next fiscal year as an adjustment. A net OPEB obligation is arrived at, which is the cumulative difference between annual costs, including the UAAL (or asset) and contributions. Six actuarial methods are allowed; however, special disclosure is needed it the aggregate actuarial cost method is used.

Net OPEB obligation. The employer's net OPEB obligation represents the difference between the annual OPEB cost and the employer's contributions to the plan. The obligation is set at zero at the beginning of the transition year.

Inclusion of an array of costs. OPEB includes all other post-employment benefits, other than pensions, contained within a substantive plan (the terms understood by the employee and employer) and is updated with each valuation. OPEB may include dental, vision, long-term care. disability, life insurance or other costs that are borne in any part by the employer. OPEB may include spousal and dependent coverage. If the employee pays 100% of these costs, they are not included in the OPEB calculations. All of this is disclosed as part of the OPEB substantive plan. GASB, however, specifically exempts vacation, sick leave and termination benefits, as they are addressed elsewhere in standards.

Valuation frequency Calculation of the liability must be done at least biennially, while the smallest governments (200 plan participants or less) have an exemption affording triennial valuations. Valuation of assets within a plan must be done annually. Because of this frequency mismatch, many governments may choose to value both the assets and liabilities annually.

Actuary Exemption. Governments with fewer than 100 members are permitted to use an arithmetic calculation, rather than an actuarial calculation. The standards refer to this as the "alternative measurement method."

Implicit rate subsidies. One of the more controversial pieces of the statements is fine inclusion of any implicit rate subsidies afforded to retirees in measuring the liability and the annual required contribution. These subsidies are generated as a result of the basic nature of insurance--one risk group subsidizes another to arrive at a blended premium. In all likelihood, current employees who are young and healthy subsidize older retirees.

Staggered implementation Both statements afford an implementation schedule based on revenues, as illustrated in Exhibit 2. Component units of a primary government must implement the standards at the same time as the primary government, irrespective of their revenue base.

AUDIT CONSIDERATIONS

Most governments use actuaries to assist with computing information about their OPEB that will be used in preparing the financial statements and OPEB-related footnote disclosures and required supplementary information. Actuaries are specialists as defined in AU Section 336, which states that the auditor "should consider" various factors to evaluate the professional qualifications of the specialist, including professional certification, licensing, reputation and experience.

In addition, the auditor must understand the nature of the specialist's work. That understanding should include the objectives and scope of the specialist's work; the specialist's relationship to the client; the methods or assumptions used; a comparison of the methods or assumptions with the prior period; the appropriateness of the specialist's work; and the specialist's findings that will enable the auditor to conclude that the related financial statement assertions are supported.

Finally, for the auditor to conclude that the specialist's findings support the related financial statement assertions, the auditor must make appropriate tests of data provided to the specialist (for example, the payroll database) and evaluate whether the specialist's findings support the relevant financial statement assertions.

Timing can be an issue. Auditors should ask for the actuarial report early in the planning phases of the audit whenever possible. The report should provide the ARC by function (for the governmentwide statements) and fund (for full accrual funds). Auditors should confirm that the actuary is using GASB standards for the calculations instead of FASB standards.

Other audit considerations include whether the investment rate of return assumption is guided by paragraph 13c of Statement no. 45. That is, if there are no plan assets, the actuary cannot use a rate of return higher than the entities' own internal earnings rate on liquid investments. In addition, the health care cost trend needs to be reasonable. Auditors should find out the source of the trend used by the actuary.

As noted earlier, governments with fewer than 100 members are permitted to use an alternative measurement method in lieu of an actuary. However, we believe that because of the complexity of the calculation, the data elements that are needed and the audit risk involved in the calculation, it is likely that even the smallest governments may seek out an actuary to produce a report of these liabilities.

The standards also require significant footnote disclosures. Most, if not all, of the disclosure information will be taken directly from the actuary's report. Since the footnotes are part of the basic statements, the auditor should evaluate whether the footnote information is supported by the actuary's report.

GASB Statement no. 45 also requires the presentation, as required supplementary information, of various trend information behind the footnotes. The auditor's responsibility for such information is described in AU Section 558.

An OPEB valuation is the beginning of a government's journey into finally realizing the full costs of compensation promises made. With this information, governments are better equipped to make decisions and plan for the future. There are many facets of the new rules that both governmental financial statement preparers and their auditors will need to consider.

For a discussion of how the OPEB standards may affect government budgetary and other policy decisions, visit www.journalofaccountancy.com.

AICPA RESOURCES

Conferences

* National Governmental Accounting and Auditing Update East, Aug. 18-19, Washington

* National Governmental Accounting and Auditing Update West, Sept. 22-23, Denver

* National Governmental and Not-for-Profit Training Program, Oct. 27-29, Las Vegas

Publications

* State and Local Governments--Audit and Accounting Guide (#012668)

* State and Local Governmental Developments--Audit Risk Alert (#022438)

* State and Local Governments: Checklists and Illustrative Financial Statements (#009038)

For more information or to register or place an order, go to www.cpa2biz.com or call the Institute at 888-777-7077.

Web sites

* AICPA Government Resource Center http://fmcenter.aicpa.org/Resources/Government+Resource+Center/

* Governmental Audit Quality Center, www.aicpa.org/GAQC

OTHER RESOURCE

Web site

GASB's Statements 43145 Resource Center, www.gasb.org/gasb43_45/index.html

Keys for Management to Have a Successful OPEB Implementation

* Gather data on demographics and participants at or as close as possible to the valuation date. If spouses and other beneficiaries are involved in the plan, a full count of participants is needed.

* Gather information on participants in cost-sharing arrangements and assess which government holds the risk of paying health care costs.

* Gather claims data for the year previous to the valuation date.

* Gather investment returns (if any) of assets held in an irrevocable trust to pay for OPEB. Statement no. 43 and Statement no. 45 require that the investment return used for a discount rate mirror the investments that are held in the portfolio to pay benefits. If no investments are held in an irrevocable trust to pay for OPEB, then gather a long-term series of investment returns of the government's cash investments. A typical view would be monthly returns over five to 10 years, or more if available. Statement no. 43 and Statement no. 45 require a "long-term view of short-term interest rates."

* Document and locate all plan information including contributions, vesting, insured status, eligibility, deductibles, types of coverage, co-pays and spousal/dependent benefits. Make a table of each element by plan.

* Don't forget about non-health OPEB, including dental, vision, life insurance and other benefits.

* Engage an actuary, preferably a health care actuary or one who has access to that expertise.

* Talk to your auditor early about information such as trend rates and returns for a "reasonableness" check.

* Engage the government's bond disclosure counsel to assure proper and timely reporting to bondholders and other interested parties.

Survey: Approaches Vary Among Virginia Governments

by Bruce W. Chase and Vivian Calkins-McGettigan

A study of counties and cities in Virginia found significant differences in responses from governments that had performed an actuarial study of other post-employment benefit liabilities and those that had not. The finding suggests that as governments measure their actuarial liability and annual required contributions, they are more likely to consider options that will reduce these costs, such as making changes to benefits or funding future costs. The survey also found a significant impact related to using a trust fund to provide for future OPEB costs.

Radford University in July 2007 sent a survey to 134 counties and independent cities in Virginia to gauge plans for implementing GASB Statement no. 45. Fifty-nine surveys, or 44%, were returned. Of the responding governments, 13 (22%) had completed an actuarial study. All six localities with a population of more than 90,000 had done an actuarial study, while only 13% of localities with populations under 90,000 had completed such a study.

The survey also found:

* For governments that had performed an actuarial study, 16% were considering a pay-as-you-go approach, paying for OPEB costs only as insurance and other invoices are due, and another 16% were undecided. In addition, 47% of the governments that had performed an actuarial study were considering changing the benefits they offered. Of these, 33% said they were considering changing benefits for all employees and 67% would only change benefits for new employees.

* For governments that had not performed an actuarial study, 59% were considering the pay-as-you-go approach and 39% were undecided. In addition, 11% were considering changing benefits.

* Fifty-four percent of governments that performed an actuarial study were considering using a trust fund, 16% an internal service fund, and 8% creating some type of reserve in the general fund. The remaining 22% were undecided or were not planning to fund their OPEB liability.

* If a trust fund was used, the actuarial liability was on average 46% lower than the amount computed assuming no separate investment of funds, and the annual required contribution (ARC) was on average 36% lower than the amount computed assuming no separate investment of funds. Higher discount rates and the consistent funding of the ARC through the use of a trust can cause unfunded actuarially accrued liabilities to drop 40% or more.

Bruce W. Chase, CPA, Ph.D., is an accounting professor at Radford University. His e-mail address is bchase@radford.edu. Vivian Calkins-McGettigan, CPA, MBA, CPFO, is the finance director for Fauquier County and Fauquier County Public Schools. Her e-mail address is vivian.mcgettigan@fauquiercounty.gov.

Eric S. Berman, CPA, is deputy comptroller for the commonwealth of Massachusetts. Donald L. Rahn, CPA, MBA, is a partner in the public sector practice group at Virchow, Krause & Co. LLP, Their e-mail addresses, respectively, are eric.berman@state.ma.us and drahn@virchowkrause.com.

The authors would like to thank Elizabeth K. Keating, CPA, Ph.D., a visiting assistant professor at Boston College, and Reem Samra, CPA, of Deloitte, for their contributions to this article.

Exhibit 1 Differing OPEB Standards

Element                 FASB Statement no.       GASB Statements no. 43
                        106                      and Statements no. 45

Amortization of         The lesser of 20 years   30 years or less
Unfunded Liability at   or remaining service
Transition              period of active plan
                        participants

Liability recognition   Immediate recognition    The cumulative amount
                        of liability and         of cumulative unpaid
                        expense, but             annual required
                        amortization is          contributions (ARCs)
                        straight-line over
                        average service life
                        of participants, but
                        no less than
                        pay-as-you-go-and must
                        be 20 years or less

Treatment of Medicare   Offsets liability        Not an exchange
Part D                                           transaction, therefore
                                                 no offset

Implicit rate subsidy   No separate disclosure   Disclosure

Implementation          Publicly traded          Staggered
                        employers, generally,    implementation by
                        1993, nonpublic          revenue in years
                        employers, generally,    beginning after Dec.
                        two years later          15, 2006, through Dec.
                                                 15, 2008. One year
                                                 sooner for plans (see
                                                 Exhibit 2).

Actuarial methods       Single specified         Any one of six
                        method                   acceptable methods

Sensitivity             Mandatory                Not required, but some
analysis--1%                                     governments are
increase/decrease in                             calculating for
health insurance                                 management purposes.
trend rates

Requirement to fund?    No                       No

Exhibit 2 Staggered Effective Dates

Employer revenue in     GASB 45 effective   GASB 43 effective
the first fiscal        date for plan       date for plans or
year ending after       sponsors' fiscal    trust funds fiscal
June 15, 1999, is       years beginning     years beginning
greater than:           after:              after:

$100 million            Dec. 15, 2006       Dec. 15, 2005

$10 million, but less   Dec. 15, 2007       Dec. 15, 2006
than $100 million

$0 but less than $10    Dec. 15, 2008       Dec. 15, 2007
million