Q&A: Why Should Government Employers be Thinking About OPEB Trusts?

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Insights  <  Q&A: Why Should Governmental Employers be Thinking About OPEB Trusts?

We’ll cut to the chase and then fill in the blanks: Any governmental entity, city, or town or that hasn’t yet considered creating and funding an OPEB trust should start thinking about it – right now.

With that said, let’s take a step back and answer a few questions.

What’s OPEB – and why is it important?

OPEB refers to “other post-employment benefits.” Put simply, these are any retirement benefits a public employee is promised other than his or her pension. Benefits under the OPEB umbrella include anything from life insurance premiums to post-retirement healthcare costs to deferred-compensation arrangements.

These benefits are typically paid using one of two methods: A so-called pay-as-you-go method, in which a public employer annually allocates a certain percentage of its annual operating budget (or general fund) to disburse to its retirees; or an OPEB trust method, in which an employer annually transfers a set amount of earmarked cash into a dedicated trust fund, and invests it.

Up until the mid-2000s, most governmental employers created dedicated trusts for their employee pension plans, but opted for the pay-as-you-go method for any benefits falling under OPEB. At the time, there were several good reasons for government leaders to take that route.

For one, creating an OPEB trust isn’t cheap. It can require a significant up-front investment, which-remember, we’re talking about governing bodies-typically means raising taxes. If you’re a governor, a mayor, or a town administrator, hiking taxes for any reason is always going to be a tough sell. If the result is a freshly paved highway or noticeable improvements in the school system, the tax increase may go over smoothly. When the result is something your constituents can’t see, like the creation of a dedicated trust fund, the sell becomes even tougher.

Many public employers opted for the pay-as-you-go method simply because there wasn’t a clear, objective, accounting-based reason to do anything else. That changed in 2004, when the Governmental Accounting Standards Board (GASB) issued Statement No. 45.

GASB 45-Accounting and Financial Reporting by Employers for Postemployment Benefits Other Than Pensions-was the first standard that required employers to measure and recognize their OPEB obligations as liabilities (or, in rare cases, assets) in the government-wide financial statements and disclose in the footnotes of their financial statements.

By introducing OPEB obligations to the balance sheet, GASB 45 forced public employers to seriously consider the magnitude of the actuarial liabilities that came with their OPEB benefit plans, and come up with long-term solutions to manage those costs.

One of those solutions, of course, is to create and pre-fund an OPEB trust.

If GASB 45 was issued in 2004, why is this important now?

GASB 45 was fully implemented by 2008. In 2015, GASB 75 was issued, and with it came several significant changes-changes that are set to take effect this June as implementation is required for fiscal years beginning after June 30, 2017.

Setting up a trust also allows employers to utilize higher discount rates (or, investment return assumptions), which are used by actuaries when determining the long-term rate of return on the assets being used to eventually pay the benefits. Those without a trust are forced to use the municipal bond index, which is currently around 2.85%.

How can establishing an OPEB trust benefit your government?

OPEB trusts can help public employers in several ways.

Improved Financial Reporting:

A well-funded OPEB trust can significantly reduce-or, in some cases, eliminate-the employer’s net OPEB liability. GASB 75 defines net OPEB liability as “the portion of the present value of projected benefit payments to be provided to current active and inactive employees that is attributed to those employees’ past periods of service, less the amount of the OPEB plan’s fiduciary net position.”

In much, much simpler terms: A public employer’s net OPEB liability is the dollar amount of what that employer currently owes – minus what assets it already has stowed away.

If an employer consistently contributes to a trust, it will likely have the ability to annually offset its OPEB liabilities with its on-hand, pre-funded assets. This helps public employers avoid having to explain to a credit-rating agency why they’re not working towards reducing significant long-term liabilities on their balance sheet.

Establishing an OPEB trust gives public employers the ability to realize investment returns:

Pay-as-you-go OPEB benefit plans are typically paid annually out of the public employer’s general fund. In other words, every year, a slice of a public employer’s total budget is set aside and immediately paid out to the employer’s retirees.

When an OPEB trust is created, annual appropriation of funds are transferred into the trust and invested. Through the simple power of compounding interest, public employers can watch their annual appropriations grow year after year. This ultimately leads to a reduction in required contributions, potentially saving public employers millions of dollars over the years in the long run.

Finally, establishing an OPEB trust protects employers’ assets:

OPEB trust fund are irrevocable. Plan assets are legally protected from creditors of the employer or the plan administrator, and they are dedicated solely to providing retiree benefits in accordance with plan terms. In other words, a pre-funded OPEB trust will ensure all retirees ultimately receive the benefits they’ve earned.

What first steps do public employers need to take to create an OPEB trust?

The process is complex, and involves a number of IRS-related issues. The first step public sector leaders will need to take is to consult with their financial team and bring in qualified legal counsel.

From there, public employers will need to identify the legal form of the trust they’re creating; create an independent board of trustees to control and administer the trust; and assign various fiduciary roles and responsibilities to the people in charge of managing the trust.

Again, it’s a complicated process – but, with the new GASB standards taking effect in a few short months, it’s a process we strongly recommend considering.

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