Under Governmental Accounting Standards Board (“GASB”) Statement 45, public employers must soon account differently for “other post-employment benefits” (“OPEB Benefits”). Based upon the public employer’s phase for purposes of implementing the related GASB Statement 43, implementation of GASB Statement 45 is required for fiscal periods beginning after December 15, 2006 for phase 1 employers, December 15, 2007 for phase 2 employers and December 15, 2008 for phase 3 employers. OPEB Benefits include various non-pension benefits, such as health care and life insurance, which are provided to retirees. Historically, public employers have used a pay-as-yougo method of accounting for OPEB Benefits, resulting in recognition of the cost for these benefits occurring only when premiums or benefit claims for these retirees were paid. GASB issued Statement 45 to require more complete, reliable, and decisionuseful financial reporting regarding the costs and financial obligations that governments incur when they provide OPEB Benefits. Thus, Statement 45 requires that public employers annually expense OPEB Benefits that are earned today by active employees, but that will be paid only when the employee retires. If a public employer does not fund its OPEB Benefits liability, then the employer must report an OPEB Benefits obligation on its balance sheets and disclose any unfunded liability in the notes to its financial statements.
While there is no obligation to fund for OPEB Benefits, it is likely that most public employers will do so for a number of reasons, including credit rating concerns and the ability to use investment returns to reduce the liability. If an employer decides to fund for OPEB Benefits, it has some choices with respect to the funding vehicle, but it is anticipated that most will adopt an Internal Revenue Code Section 115 trust. Funding of OPEB Benefits liability through a trust meeting the GASB requirements allows the public employer to use a higher discount rate in calculating its unfunded liability, which results in a reduction in the amount reported as the OPEB Benefits liability in its financial statements. This Alert addresses the steps that a public employer should take to adopt a Section 115 trust.
A public employer must understand that GASB has prescribed certain requirements for a trust intended to fund OPEB Benefits. To avail itself of the advantageous discount rate permitted for trust funded OPEB Benefits, an employer must irrevocably transfer assets to a trust which is dedicated to providing benefits to retirees and their beneficiaries and is legally protected from the employer’s creditors. According to the GASB Implementation Guide—2006, the plan structure and the manner in which trust assets are held, invested, and disbursed must be compatible with holding and managing plan assets as assets held in trust for the exclusive benefit of retirees and their beneficiaries, not as assets of the employer, and with the specific criteria of irrevocability of contributions, dedication of plan assets (including income from the investment of plan assets) to paying benefits in accordance with the plan, and legal protection of the plan assets from creditors. Also, all entities and persons involved in the disbursement and application of trust assets must act in a manner consistent with their fiduciary responsibility with regard to their respective involvements.
Steps to Consider When Adopting Trust Arrangement
When adopting a trust arrangement, employers must consider the following:
• Who will serve as trustee(s) (and have fiduciary responsibility)
• Who will provide investment advice (including the preparation of an investment policy statement)
• Who will custody the assets
• Who will be responsible for distributing benefits
In order to effectuate the adoption of the trust, certain documentation is required, including:
• Resolutions/authorizations from appropriate entity to adopt trust and retain service providers
• Trust document
• Investment Policy Statement
• Custodial Agreement(s)
• Service Agreements (with investment managers, third party administrators, etc.)
Many public employers already have systems in place for investing pension plan assets. While we anticipate that much of those systems may be duplicated with respect to the management and oversight of OPEB Trusts, there are some differences that must be taken into consideration when implementing an OPEB Trust. Specifically, the volatility of health care expenses and the lack of predictability in estimating costs, presents a significant challenge in determining a funding plan that will satisfy future needs. As a result, frequent review of investment performance of trust assets with an investment advisor and actuary is advisable to determine whether the public employer is on track to meet its funding goals. Also, while it is not clear at this time what action, if any, the rating agencies will take with respect to the funding of OPEB Benefits, it is advisable to discuss with representatives of those agencies funding plans and progress to prevent any potential rating concerns.