A Guide to Dealing with Other Post Employment Benefit OPEB Liabilities

1. A Guide to Dealing with Other Post Employment Benefit(OPEB) Liabilities November 13, 2006 By The PFM Group for the Florida Government Finance Officers Association

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3. 3 OPEB Reporting Requirements Failure to comply with Governmental Accounting Standards Board (GASB) requirements could prevent auditors from providing a “clean” audit opinion on financial statements Public entities must recognize OPEB costs over active service life of employees rather than on pay-as-you-go basis (GASB 45) Phase 1: Revenues > $100M 1st FY after 12/15/06 Phase 2: Revenues $10M - $100M 1st FY after 12/15/07 Phase 3: Revenues < $10M 1st FY after 12/15/08 New line item on balance sheet – Net OPEB Obligation

4. 4 OPEB Key Terms Pay-as-you-go (PAYGO): current year out of pocket claims and insurance premiums payable. Normal cost: portion of future benefits accrued in current year. Actuarial Accrued Liability (AAL): Present Value (PV) of future benefits attributable to prior years of service. Amortized AAL: Portion allocated to a given year to pay off AAL in a specified time frame at an assumed earnings rate. Annual Required Contribution (ARC): Normal cost plus amortized accrued liability. Present Value of Benefits (PVB): PV of all future benefits for past and future service. Net OPEB Obligation (NOO): Amount stated on balance sheet to extent aggregate OPEB contributions are less than cumulative OPEB costs (i.e. ARCs).

5. 5 Rating Agency Perspective on Unfunded Liabilities “We don’t expect any immediate rating adjustments on a broad scale”1 “The key is how these liabilities are managed”2 OPEB Rating Factors as articulated by Standard & Poor’s (representative list) Are consequences of OPEB obligations fully understood? Where does OPEB rank in relation to other planning priorities? How conservative or aggressive are planning assumptions? Is budget able to afford the OPEB ARC? What are the legal obligations of the employer to meet retiree healthcare obligations? How does the OPEB alter the competitive landscape regarding long-term liabilities? 1 Dow Jones & Reuters Factiva, 3 April 2006, Raters Don’t Expect Immediate OPEB Effects, Yvette Shields – Attributed to Douglas Benton, Analyst and Vice President, Moody’s Investor Services 2 Dow Jones & Reuters Factiva, 3 April 2006, Raters Don’t Expect Immediate OPEB Effects, Yvette Shields – Attributed to Parry Young, Director, Standard & Poors

6. 6 OPEB is a multi-dimensional, interdisciplinary challenge Actuarial approach Benefits / workforce strategy Plan redesign / Medicare integration Employee relations / bargaining Recruitment / retention impacts Trust establishment / funding Trust policy development Structure / legal authorization / investment policy OPEB obligation bond evaluation Budget policy Cost recovery User charges / grant reimbursements Medicare Financial impact / affordability Options quantified, balanced, and linked to government’s overall fiscal strategy Plan formalization / communications Elected officials / taxpayers Workforce Rating agencies / disclosure

7. 7 Steps to Addressing the OPEB Liability

8. 8 OPEB Decision-Making Framework

9. Decision Points

10. 10 Public sector: Workforce strategies still emerging A few governments are eliminating retiree medical benefits (prospectively)… Pittsburgh, PA eliminated retiree medical coverage altogether for new hires State of Utah ended policy of one month retiree medical coverage for every day of unused sick leave City of Easton, PA has ceased all coverage for new police hires Some are redesigning D/B plans to contain costs… Commonwealth of Pennsylvania negotiated with largest state employee unions to change eligibility requirements from 15 to 20 years, to redesign plan for cost containment (with future changes to parallel active employee plan), and to add retiree premium cost-sharing based on 1.0% of final gross salary State of Ohio reduced coverage for shorter tenured retirees and increased cost-sharing for actives Alternative approaches are also emerging… City of Anaheim, CA is among governments establishing a D/C program (integral part trust) for newer hires instead of guaranteeing a defined benefit Multiple governments are evaluating alternative strategies for creatively integrating their programs with Medicare Part D

11. 11 Funding Strategy

12. 12 Funding Strategy

13. 13 Economics of an OPEB Obligation Bond OPEB Obligation Bonds constitute a market arbitrage The Issuer would borrow in the taxable municipal fixed income market The Issuer would invest the OPEB Obligation Bond proceeds, less financing expenses, in other markets (an allocated investment portfolio that meets defined criteria) On a risk adjusted basis, all markets are theoretically in equilibrium, making this trade a risk-bearing arbitrage To be economically viable, the invested proceeds must earn more than the all-in (effective) interest cost on the OPEB Obligation Bonds Debt service on the OPEB Obligations Bonds may be structured to achieve “savings” relative to the UAAL The OPEB Obligation Bonds may be issued as taxable fixed- or variable-rate obligations Projected hurdle rates are different Appropriate levels of variable rate debt should consider the Issuer’s overall debt and risk profiles

14. 14 OPEB Obligation Bond Analysis Analyze the contemplated OPEB Obligation Bond transaction using a two-step approach Determine the estimated borrowing rate(s) for the OPEB Obligation Bond transactions Estimate the likelihood these hurdle rates may be earned in the investment portfolio

15. 15 Hurdle Rate Analysis

16. 16 Account Structure Continue with PAYGO mode Least disruptive for staff; Provides no balance sheet offset against OPEB liability May be seen by rating agencies as “sticking head in the sand” Create a separate account within Operating Budget While earmarking funds for OPEB liability, provides most flexibility in handling cash flow and assets Provides no balance sheet offset against OPEB liability Can be used to create a story regarding understanding of OPEB liabilities Create an irrevocable trust Requires some work to set up trust Provides direct balance sheet offset against OPEB liability Demonstrates knowledge of OPEB liabilities Removes assets from control of government

17. 17 Individual versus Group Trust Retain a level of autonomy with respect to trust provisions during setup Manage your own funding relative to potential contribution limitations Depending upon trust type, eliminate the need for any kind of IRS approval Limit reliance on unknown service providers and investment managers

18. 18 Trust Structures In order to offset OPEB liabilities on the balance sheet, assets must be invested in an irrevocable trust Three types of trusts that can generally qualify . . .

19. 19 Alternatives for Investing OPEB Assets Typical state investment guidelines Fixed income securities allowed under including: Treasuries Federal Agencies High-quality corporate securities Municipal notes Money market funds Pools Typical trust investment guidelines Fixed income securities Equities Real Estate Foreign securities Hedge funds Other investment alternatives

20. 20 Investment Program or Consultant Characteristics No conflict of interest with managers or brokers (e.g., no revenue sharing, brokerage commissions, or other fee arrangements) Structured process designed to protect employer/trustees Designed to fit the individual asset allocation needs of each client Type of Program Discretionary Non-discretionary (recommendations in writing) Reasonable cost structure (typically 1.00% or less) No significant withdrawal restrictions (e.g., 4 or 5 year minimum terms)

21. How to Address the OPEB Liability

22. 22 Comprehensive OPEB strategy Due to many different factors, there will be no “one-size-fits-all” approach Extent of existing commitments Fiscal condition, resources, and competing budget demands Workforce and retiree demographics Regional labor market characteristics Regional health benefit provider marketplace differences Evolving benefit options and products Labor-management culture Political and taxpayer culture State and local legal frameworks In almost every circumstance, however, comprehensive, interdisciplinary, multi-year planning will be worthwhile

23. 23 OPEB Liability Program Management

24. Questions?