City Manager
FROM: / Louie DePasquale
Assistant City Manger for Finance
Michael P. Gardner
Personnel Director
James Monagle
City Auditor
DATE: / October 13, 2004
RE: / Council Order #16 May 24, 2004, RE: report on establishing a reserve account to fund retirement health care benefits particularly in light of GASB
The Government Accounting Standards Board has issued two Statements concerning how to account for post retirement benefits (other that pension) for retirees. Statement 43 (issued in April 2004) applies to trust funds included in the reports of plan sponsors or employers. Statement No. 45 (issued in June 2004) addresses the same issues for sole employers. Although there may be additional modifications in the future that may affect our planning, this response assumes that Statement 45, as currently issued, is most applicable.
Statement 45 identifies a problem with the current financial reporting of non-pension post employment benefits (such as retiree health care and life insurance expenses) in the following way:
From an accrual accounting perspective, the cost of OPEB [Other Post Employment Benefits such as retiree healthcare and life insurance] like the cost of pension benefits, generally should be associated with the periods in which the exchange occurs, rather than with the periods (often many years later) when benefits are paid or provided. However, in current practice, most OPEB plans are financed on a pay as you go basis, and financial statements generally do not report the financial effects of OPEB until the promised benefits are paid. As a result, current financial reporting generally fails to:
· Recognize the cost of benefits in the periods when the related services are received by the employer
· Provide information about the actuarial accrued liabilities for promised benefits associated with past services and whether and to what extent those benefits have been funded
· Provide information useful in assessing potential demands on the employer’s future cash flows.
GASB Statement No. 45 attempts to address these problems by:
improv[ing] the relevance and usefulness of financial reporting by (a) requiring systematic, accrual-basis measurement and recognition of OPEB cost (expense) over a period that approximates employee’s years of service and (b) providing information about actuarial accrued liabilities associated with OPEB and whether and to what extent progress is being made in funding the plan.
As presently promulgated, Statement 45 requires that, for governments the size of the City of Cambridge, and beginning for periods after December 15, 2006, (i.e. FY08) financial statements must include the annual cost of these expenses on an accrual basis. The cost is the “(a) normal cost for the year and (b) a component for amortization of the total unfunded actuarial liabilities (or funding excess) of the plan over a period not to exceed thirty years.”
The City will be required to do an actuarial study of this liability for inclusion in its financial statements.
There is no actual requirement in the Statement (as currently promulgated) that mandates that a governmental unit must establish a trust fund or funding plan, but the net obligation (cumulative difference between annual OPEB cost and the employer’s contributions to the plan, if any) are to be displayed as liabilities in government-wide financial statements. Employers are also required to disclose descriptive information about each defined benefit OPEB plan in which they participate, including the funding policy followed (which can be pay-as–you-go).
There currently is no General Law in the Commonwealth that authorizes cities and towns to appropriate monies to fund such future expenses. The Massachusetts Municipal Association has filed legislation to authorize establishing such funds and making appropriations to them that has not yet been enacted. The MMA plans to refile similar legislation next year. A handful of communities have filed their own special legislation that has been enacted.
Among the possible sources of revenue to begin a funding plan for this liability are reductions in transfers to the Retirement Board once the pension system is fully funded (currently projected for 2014); and potential savings to the City through the new Medicare Part D employer drug coverage (due to begin in 2006 although many aspects of the plan and regulations have yet to be finalized).
Several years ago the City commissioned Watson Wyatt & Company to estimate the City’s liability for retiree medical benefits as of January 1, 2000. This was an “order of magnitude” estimate developed so the City could have a sense of its emerging liabilities. It was not an actuarial valuation. At that time the estimated accrued liability was between $139, 000,000 and $181,000,000 with an annual contribution required for a 30-year amortization of the unfunded actuarial liability then estimated at between $12,000,000 and $18,000,000[1]. This is in addition to our pay-as-you-go cost, which currently totals about $11,000,000 per year.
[1] The Statement does not require retroactive application. Thus, in the first year the prior liability will be listed as zero, and cumulate from that point forward.