HomeMy WebLinkAbout2008/05/01 Item 2
CITY COUNCIL
AGENDA STATEMENT
;$\ljf::. CllY OF
- CHULA VISTA
MA Y 1,2008, ltemL
SUBMITTED BY:
REVIEWED BY:
POST EMPLOYMENT BENEFITS OTHER THAN PENSIONS
AND THE GOVERNMENTAL ACCOUNTlNG STANDARDS
BOARD STATEMENT NO. 45
DIRECTOR OF FlNANCE/TREASURE~
CITY MANAGER
4/5THS VOTE: YES i ! NO I Xi
ITEM TITLE:
SlJM1\1ARY
In June 2004. the Governmental Accounting Standards Board (GASB) issued Statement 45,
"Accounting and Financial Reporting by Employers for Post-Employment Benefits Other Than
Pensions," which requires public agencies to rep0l1 their costs and obligations pertaining to
health and other benefits of current and future retired employees much like they now report
pension plan obligations. This is a significant change in accounting, reporting and disclosure for
Other Post Employment Benefits (OPEB), which is currently accounted for on a pay-as-you-go
basis. The most common types of post-employment benefits include health care insurance, life
insurance, long-tenn care and dental insurance for retirees.
ENVIRONMENTAL REVIEW
Not Applicable
RECOMMENDATION
Council accepts the report.
BOARDS/COMMISSION RECOMMENDATION
Not Applicable
DISCUSSION
The City of Chula Vista is required to disclose their OPEB liability in the financial statements
ending June 30, 2008. This new accounting requirement is based on a rule that has been applied
to the private sector for about ten years. Governmental entities that offer OPEBs will be required
to disclose the financial liabilities in their annual financial statements resulting from these
2-1
MAY L 2008, Item~
Page 2 of 5
benefits similar to those of pension plan obligations. Actuarial reports will be required to
detelmine unfunded liabilities.
The City of Chula Vista does not directly pay for post employment benefits but does subsidize
the health care insurance premiums paid by retirees who opt to continue to participate in the
City's retiree health care program. The costs associated with the retirees are pooled with the
active members; this pooling creates an artificially low rate for the retirees. GASB believes that
retirees who are allowed to pay the same health care benefit rate as active employees are being
subsidized and the indirect cost of this "implicit rate subsidy" needs to be recognized as an
OPEB liability by the governmental entity. 1
Estimated Unfunded OPEB Liabilitv and Annual Required Contribution (ARC)
The city's actuary John Bartel of Bartel Associates, LLC has detennined that the unfunded
liability or the Unfunded Actuarial Accrued Liability (UAA.L) created by the implicit subsidy is
approximately $8.6 million. The atmual book accrual (called Annual OPEB Cost) using the pay-
as-you-go method would require an estimated atlliual required cash contribution amount of
$1.149 million. To consider a retiree healthcare plan funded for GASB 45 purposes, assets must
be set-aside in a trust that Catlliot legally be used for any purpose other than to pay retiree
healthcare benefits. Thus the City" s retiree healthcare plat1 is not currently funded. A copy of
the Executive Summary - Retiree Health Plan prepared by our actuary is included as an
attacllli1ent to this memo.
GASB 45 doesn't require an agency make up any shortfall (UAA.L) inm1ediately. Instead. the
difference is amortized over time. An agency's Annual Required Contribution (ARC) is the
CutTent employer Normal Cost, plus the atllortized UAAL. Simply put, this contribution is the
value of benefits earned during the year by active employees plus the atnount contributed toward
paying down the unfunded liability (UAAL). For the City's valuation Bartel Associates
calculated the 2007/08 ARC as the Normal Cost plus a 30-year amoliization of the UAAL.
Calculation of Amiual Required Contribution
i Assumed Rate of Return
Nonnal Cost (FUl1ded Part of Plan)
UAAL Amortization (Unfunded Liability)
2007-08 Annual Required Contribution
Nol're- Funding
(payasYouGo)
4.50%
$795,000
$354,000
$1,149,000
I're- Funding
7.75%'
$490,000
$407,000
$897,000
Over the long telm, the failure to address the outstanding OPEB unfunded liabilities could have
an adverse effect on the agencies credit standing. As stated in Standat'ds & Poors OPEB Report
"S & P expects most state and local governments to eventually come up >vith workable strategies
I Government Finance RevieVl;- August 2006
1 Implied subsidy "benefits" paid from the City's General Fund is assumed to earn a 4.5% long term rate ofretum
3 Contributions made to an irrevocable trust through CalPERS "dth diversified assets, which are assumed to eam a
7.75% long-tenn rate ofretun1.
2-2
MAY 1,2008, ItemL
Page 3 of 5
for other post employment benefits without adversely affecting their credit quality. While near
term fiscal stress is unlikely. there could be some intermediate-term credit pressures."
Two-Tier Post Employment Health Benefit
In order to prevent the liability from growing to a level that would impact the City's financial
condition, effective July I, 2008, any new hire will not be allowed to paliicipate in the
subsidized post employment health program. In other words, anyone hired after this date will
have to pay 100% of the unsubsidized cost of pa11icipating in the City's health program when
they retire from the City.
Employee funded Health Savings Plans are offered through our deferred contribution providers,
Nationwide alld ICMA. City staff is cUlTently working with our providers to identify progranls
that employees can use to save for post employment health care costs on an ongoing basis.
These plans provide employees some options to consider which will help alleviate the long-tenn
financial challenges related to health care coverage.
Subsidized Health Premiums - Current Retirees
As discussed previously, the City of Chula Vista does not directly pay for post employment
benefits but does subsidize the health care insurance premiums paid by retirees who opt in to the
City's retiree health care program. Based on the most recent calculations provided by our health
care broker Bal'11ey & Barney, the al1l1ual cost of the subsidy is estimated at $387,983. That
translates to an annual "discount'" of approximately $4311 per retiree (monthly discount of
$359). There are culTently 90 retirees. including 5 surviving spouses, who participate in the post
employment health insurance program at an average out of pocket cost of $479 per month.
Retiree Health Plan Data
Blended Unblended
Retiree Health Plan Enrollment Rate Rate Subsid
,Kaiser-Early Retirees 43 $231,648 $449.230 $217,582
IpacifiCare HMO-Early Retirees 45 $264,9961 $435,3971 $170,401:
IPacifiCare PPO-Earlv Retirees 2 $20,620 $20.6201 $0'
Totals 90 $517.264 $905,247 $387.983
Avera $5,7471 510,058 54.311
IAveraqe Monthlv Payment er Retiree $479 5838 5359
Note: Does not include data for retirees age 65 and older because their health plan is not subsidized.
Reducing the Liability
The policy decision on whether the City should continue offering post employment benefits to
current and future retirees will continue to be reviewed. Some of the options to be fmiher
analyzed and discussed include the following:
. The City could continue to subsidize the health insurance premiums for all current retirees
and future retirees (employees hired prior to July L 2008). Due to anticipated increases in
2-3
MAY 1. 2008, Item 2-
. -
Page 4 of 5
health care premiums, the unfunded liability would continue to grow over time but eventually
phase out as retirees reach age 65 and become eligible for Medicare.
. The City could consider continuing to subsidize the current retirees and future retirees
(employees hired prior to July I, 2008) but at a lower rate. The following chart provides
some examples, which could be considered during the 2009 review of the City's health
premiums. (The figures reflected below are estimates based on the 2008 health care
premiums and are provided for comparison purposes only. Further analysis ""ill be done
when the 2009 premiums are determined)
Retiree Health Plan (Under A e 65
Kaiser-Early Retirees
PacifiCare HMO-Early Retirees
PacifiCare PPO-Ear]y Retirees
Tota]s
IAveraO"e Subsidy er Retiree
iMollthlv Estimated Illcrease to Retiree
lVlontIIlyPremium'lVl()llthly P~eI11iumslVlonthly pr~mium6
(100% Subsid ) (75% Subsid 50% Subsid )
$2]7,5821 $]63,1871 $108,926j
$170,4011 $127,8011 $85.201
$0 $01 $0
$387,983j $290.9881 $194,127
, ,
$4,3 II $3,233 $2,1561
$0 $90' $1801
. The City could consider not subsidizing the retiree health insurance premiums immediately
for all CUlTent and future retirees with the exception of those retirees that accepted the early
retirement program, which expires in December 2009. Based on CUlTent health insurance
premium rates, the average monthly out of pocket cost to existing retirees would increase
from $479 per month to $838 per month.
Funding Options
If the policy decision is to continue to subsidize the health insurance premiums for all current
and retired employees hired prior to July 1,2008, some options in addressing the requirements of
GASB 45 will include the following:
. Continue on a pay-as-you go basis and only record the OPEB liability. The new standard
does not require advance funding but if the benefits are not funded, the liability will
continue to grow due to health care cost inflation and the impending retirement of baby
boomers. Not funding the liability could lead to a downgrading of credit ratings
depending on the materiality of the liability and the approach taken by the City to
mitigate the fiscal impacts.
. Undertake a funding program using an ilTevocable OPEB trust. The advantage of this is
that higher investment return assumptions can be used to calculate the OPEB liability,
~ Assumes City would continue funding the retiree health at the blended (subsidized) rate.
5 Assumes the retiree paid health care premium subsidy will decrease by 25%. The City would continue to paJ.1ially
subsidize (75%) the health care premium.
6 Assumes the retiree paid health care premium subsidy win decrease by 50%. The City would continue to partially
subsidize (:50%) the health care premium.
2-4
MAY I,2008,Item~
Page 5 of 5
which would result in lower .A..1mual Required Contributions. For example, CalPERS
offers the California Employers' Retiree Benefit Trust (CERBT) Fund that has an
assumed rate of return of 7.75%.
. Issuance of OPEB obligation bonds (similar to Pension Obligation Bonds) IS being
marketed to governmental agencies as a way to fund the unfunded liability.
DECISION MAKER CONFLICT
Staff has reviewed the decision contemplated by this action and has detelmined that it is not site
specific and consequently the 500 foot rule found in California Code of Regulations section
1 8704.2(a)(1 ) is not applicable to this decision.
FISCAL IMPACT
The net fiscal impact of recording the liability in the City's financial records will reduce total
Governmental Activities Net Assets from $910.6 million to $902.0 million, which equates to a
reduction of 0.994% as of June 30, 2007 (City of Chula Vista CAFR dated June 30, 2007, Page
17).
Recording of the liability does not affect cash or reserves of the City's Governmental Funds.
ATTACHMENTS
1. Bartel and Associates, Executive Summary - Retiree Healthcare Plan
2. Standard and POOl'S Report, OPEB Liabilities Pose Some Risk/or State and Local
Governments
Prepared b)': filaria Kachadoorial1, Director of Finance-Treasurer, Finance Department
2-5
D 1[)T.l=!
Ue-! L-, 1- L
1 -, ('1(-;:\! E (~ L L\_
A~c}-,'('r)e.nt- (
~ 'It.-
~Lb:~
~~~~
----
OW OF
CHULA VISfA
Retiree Healthcare Plan
June 30, 2007 Actuarial Valuation
Executive Summary
October 2007
2-6
o:\cJients\city of chula vista\opeb\6-30-07\reports\ba 08~04.23 chula vista opeb exec summary.doc
2-7
Executive Summary
City of Chula Vista
Retiree Healthcare Plan
June 30, 2007 Actuarial Valuation
On June 21, 2004, the Govemmental Accounting Standards Board approved Statement No. 45
(GASB 45), Accounting Standards for Other (than pensions) Post Employment Benefits (OPEB).
This report is based on the financial reporting standards established under GASB 45, and assumes
the City will implement GASB 45 for its 2007/08 fiscal year.
The City allows retirees to purchase healthcare coverage under the City's medical plan. Retirees
pay 100% of the premiums. Retirees not eligible for Medicare pay the same healthcare premiums as
active employees, even though retiree's healthcare costs are greater than that of active employee's.
This results in an implied subsidy of retiree's healthcare costs by the City. GASB 45 will require
the City account for this implied subsidy on an accrual basis (as benefits are eamed).
STUDY RES{]L TS
Funded Status: The plan funded status is equal to the Actuarial Accrued Liability (see definitions
and assumptions section below) less plan assets. When assets equal liabilities, a plan is considered
on track for funding.
To consider a retiree healthcare plan funded for GASB 45 purposes, assets must be set aside in a
trust that cannot legally be used for any purpose other than to pay retiree healthcare benefits. The
City's retiree healthcare plan is not currently funded. This has important implications on the
discount rate assumption used to calculate plan liabilities (see definitions and assumptions section
below). We have prepared valuation results under 2 scenarios:
II No Pre-Funding - Implied subsidy "benefits" paid ll'om the City's general fund which is
assumed to eam a 4.50% long term rate of return.
II Pre-Funding - Contributions made to an iITevocable trust through CalPERS with diversified
assets which are assumed to earn a 7.75% long term retull1.
The following table summarizes the plan's June 30, 2007 funded status (OOOs omitted):
No
Pre-Funding Pre-Funding
4.50% 7.75%
II Actuarial Accrued Liability (AAL)
. Actives S 6.584 S 4,868
. Retirees 2.002 1.669
. Total S 8,586 S 6,537
II Plan Assets ~ ~
II Unfunded AAL (UAAL) S 8,586 S 6,537
~
\D"1 )
~l~
- -
~
October 9, 2007
2-8
CrTYOf
CHUlA VISrA
Executive Summary
City of Chula Vista Retiree Healthcare Plan
June 30, 2007 Actuarial Valuation
Page 2
Annual Required Contrihution (ARC): GASB 45 doesn't require an agency make up any shortfall
(unfunded liability) immediately, nor does it allow an immediate credit for any excess assets,
Instead, the difference is amortized over time, An agency's AlUmal Required Contribution is
nothing more than the CU1Tent employer Normal Cost, plus the amortized unfunded liability or less
tbe amortized excess assets. Simply put, this contribution is tbe value of benefits earned during tbe
year plus something to move tbe plan toward being on track for funding. For the City's valuation
we calculated tbe 2007/08 ARC as the Normal Cost plus a 30-year1 amortization (as a level percent
of pay) of the Unfunded Actuarial Accrued Liability (OOOs omitted):
No
Pre-Funding Pre-Funding
4,50% 7,75%
. Normal Cost $ 795 $ 490
. UAAL Amortization 354 407
. 2007/08 AlUmal Required Contribution $ 1.149 $ 897
. Annual Required Contribution as a
percentage of estimated 2007/08 Payroll l.4~o 1.1%
. Estimated 2007/08 Payroll $ 82,]44 $ 82, ]44
Net OPEB Obligation (NOO): An agency's Net OPEB Obligation is tbe bistorical difference (from
implementation)' between actual contributions made and tbe Annual Required Contributions'. If an
agency has always contributed the required contribution, tben tbe Net OPEB Obligation equals zero.
HO\veveL an agency has not ;'made" the contribution unless it has been set aside and cannot legally
be used for any other purpose.
Annual OPEB Cost (AOC): GASB 45 requires tbe Annual OPEB Cost equal tbe Annual Required
Contribution, except wben an agency bas a Net OPEB Obligation at the beginning of the year.
When tbat bappens an agency's Alliual OPEB Cost will equal the ARC, adjusted for expected
interest on the Net OPEB Obligation and reduced by an amortization of tbe Net OPEB Obligation
(OOOs omitted):
No
Pre-Funding Pre-Funding
4.50% 7.75%
1/1 2007/08 Annual Required Contribution $ 1.149 $ 897
II Interest on Net OPEB Obligation 0 0
II Amortization of Net OPEB Obligation -----2 ---.J2
1/1 Total 2007/08 Annual OPEB Cost $ 1,149 $ 897
Maximum amortization period allowed under GASB 45.
GASB 45 specifies the initial Net OPEB Obligation (at implementation) be set to zero.
Benefits paid for current retirees are considered contributions.
~
~.D-1 )
~!I?-
- -
-
October 9, 2007
2-9
mY 0'
CHULA VISfA
Executive Summary
City of Chula Vista Retiree Healthcare Plan
Jnne 30. 2007 Actuarial Valnation
Page 3
The following illustrates the City's June 30, 2007 Net OPEB Obligation if the City adopts GASB 45
for the 2007/08 fiscal year (OOOs omitted):
No
Pre-Funding
4,50%
Pre-Funding
7.75%
. June 30, 2007 Net OPEB Obligation
. 2007/08 AIIDual OPEB Cost
. 2007/08 Contributions
. June 30, 2008 Net OPEB Obligation
$ 0 $ 0
1,149 897
(367)' ..ffi2l) 5
$ 782 $ 0
The City's actual June 30,2008 Net OPEB Obligation may differ slightly from the above because
actual implied subsidy benefit payments may be different from estimated.
Projected Benefit Payments: Following are 10-year open group benefit payout projections,
assuming the number of active City employees remains constant (OOO's omitted):
Implied Subsidy Implied Subsidy
Year Benefit Pavment Year Benefit PaYment
2007/08 $ 367 2012/13 $ 547
2008/09 355 2013/14 593
2009/1 0 395 2014/15 671
2010/11 440 2015/16 760
2011/12 492 2016/17 842
Sensitivity: The above results are based on a 30-year amonization of the unfunded liability.
Following illustrates the impact of changing the amonization to 20 years (OOOs omitted):
No
Pre-Funding - Pre-Funding
4.50% 7.75%
. 20-year amortization
. Total 2007/08 ARC $ $ 1,297 $ 1.003
. Total 2007/08 ARC % 1.6% 1.2%
II 30-year amortization
. Total 2007/08 ARC $ $ 1,149 $ 897
. Total 2007/08 ARC % 1.4% 1.1%
Estimated 2007/08 implied subsidy benefit payments.
Assumes full ARC is contributed.
(&0' .
t"/ I
H
J
October 9, 2007
2-10
~!f?
-n-
"'---
CIlYOF
CHUIA VISTA
Executive Summary
Cit)' of Cbula Vista Retiree Healtbcare Plan
June 30, 2007 Actuarial Valuation
Page 4
EARLY RETIRE.l\1ENT WINDOW STUDY RESULTS
Eligibility: The early retirement window being considered would be offered to employees of all
City departments and bargaining groups who are eligible to retire, with a 90-day opt-in window.
Benefit: The City would pay the single premium through December 31, 2009 for those who retire
prior to January 1. 2008, and through December 31. 2008 for those who retire during 2008.
Scenarios: Estimating the impact of an Early Retirement Window on the City.s GASB 45 liability
requires an assumption of how many employees will opt into the window. We calculated results
under two retirement assumption scenarios as follo\vs:
. Scenario 1 - An additional 10% of eligible employees over those already expected to retire
will opt to retire prior to 2008 and an additional 2.5% of eligible employees over those
already expected to retire will opt to retire during 20086
. Scenario 2 - An additional 20% of eligible employees over those already expected to retire
will opt to retire prior to 2008 and an additional 5.0% of eligible employees over those
already expected to retire will opt to retire during 2008.7
The follO\ving table summarizes results under the two scenarios. based on a 4.500/0 discount rate
($OOOs omitted):
Scenario 1
10% / 2.5%
Scenario 2
20% / 5%
. Funded Status
. Actuarial Accrued Liability (AAL)
;;... Actives
~ Retirees
~ Total
. Plan Assets
$ 7,606 $ 8.198
2.002 2.002
$ 9.608 $ 10,200
---1! ~
$ 9,608 $ 10.200
. Unfunded AAL (UAAL)
. 2007/08 Annual Required Contribution (ARC)
. Normal Cost $ 967 $ 1,042
. UAAL Amortization 396 421
. 2007/08 ARC $ 1,363 $ 1.463
. ARC as a % of estimated 2007/08 payroll 1,7% 1.8%
6 Scenario 1 anticipates ;::.57 retirements before January 1,2008 and ::::38 retirements during 2008.
7 Scenario:2 anticipates;::.81 retirements before January 1,2008 and :::45 retirements during 2008.
(iQ)n ,
j.-O, j
L}"-i
October 9. 2007
2-11
~If?.
-~-
-
CTlYOf
CHULA VISTA
Executive Summary
City of Chula Vista Retiree Healthcare Plan
June 30, 2007 Actuarial Valuation
Page 5
BASIC DEFINITIONS AND AsSUMFTIONS
Present Value of Benefits: When an actuary prepares an actuarial valuation, (s)he first gathers
participant data (including active employees, former employees not in payment status, participants
and beneficiaries in payment status) at the valuation date (for example June 30, 2007). Using this
data and actuarial assumptions. (s)he projects future benefit payments. (The assumptions predict,
among other things, when people will retire, tenninate, die or become disabled, as well as what
salary increases, general (and healthcare) inflation and investment return might be.) Those future
benefit payments are discounted, using expected future investment retum, back to the valuation date.
This discounted present value is the plan's present value of benefits. It represents the amount the
plan needs as of the valuation date to pay all future benefits - if all assumptions are met and no
future contributions (employee or employer) are made. The City's June 30, 2007 retiree heaJthcare
Present Value of Benefits is $18 million using a 4.50% discount rate ($10.8 million using a 7.75%
discount rate). with $2 million of this for fonner employees who have already retired ($1.7 million
using a 7.75% discount rate).
Actuarial Accrued Liability: This represents the portion of the present value of benefits that
participants have earned (on an actuarial, not actual, basis) through the valuation date. The City..s
June 30. 2007 retiree healthcare Actuarial Accrued Liability is $8.6 million using a 4.50% discount
rate ($6.5 million using a 7.75% discount rate), with $2 miliion of this for fonner employees who
have already retired ($1.7 million using a 7.75% discount rate).
Normal Cost: The Normal Cost represents the portion of the present value of benefits expected to
be earned (on an actuarial, not actual, basis) in the coming year. The City's 2007/08 retiree
healthcare Nom1al Cost is SO.8 million (1.0% of base payroll) using a 4.50% discount rate and SO.5
million using a 7.75% discount rate (0.6% of base payroll).
Actuarial Cost Method: This detennines the method in which benefits are actuarially earned
(allocated) to each year of service. lt has no effect on the Present Value of Benefits, but has
significant effect on the Actuarial Accrued Liability and Normal Cost. The City's June 30, 2007
retiree healthcare valuation was prepared using the Entry Age Normal cost method.
Implied Subsidy: GASB 45 requires that the implied subsidy for retirees be included in the AAL
and the ARC for plans that are not community rated. An implied subsidy exists when the premium
for a group of employees is determined by aggregating the experience of the group. For example.
assume the premium for actives and non-Medicare eligible retirees is $600 per month. The
underlying medical cost varies by age and gender and might actually be $300 per month for a 40
year-old active employee and $900 per month for a 60 year-old retiree. In this case, the premium for
the younger employee is subsidizing $300 of the older retiree's cost. We have valued the implied
subsidy for the City's retiree healthcare plan. There is no cash subsidy because the retirees pay
100% oftheir medical premiums.
Actuarial Assumptions: Under GASB 45, an actuary must follow cunent actuarial standards of
practice~ \vhich generally call for explicit assumptions - meaning each individual assumption represents
the actuary's best estimate.
C"'\
~. \~:'--_.~ )
October 9, 2007
2-12
~!~
-
CnYOF
CHUlA V1SfA
Executive Summary
City of Chula Vista Retiree Healthcare Plan
June 30, 2007 Actuarial Valuation
Page 6
GASB 45 requires that the discount rate is based on the source of funds used to pay benefits. This
means the underlying expected Jong-tenn rate of return on plan assets for funded plans. Furthennore,
since the source of funds for an unfunded plan is usually the general fund and California law restricts
agencies' investment vehicles. this valuation uses a relatively low, 4.50%, discount rate. If the City
sets up a Trust (that could only be used to pay plan benefits), using CalPERS Section 115 Trust then
the discount rate would be based on the Trust's expected long-tenn investment return (established by
CalPERS at 7.75%).
Another key assumption is future healthcare inflation rates. Actual premiums for 2007 and 2008 were
used. The inflation rate for HMO's starts at 9.7% (the increase in 2009 premiums over 2008) and
grades down to 4.5% (2017 premiums over 2016) and remains at 4.5% into the future. The inflation
rate for PPO's starts at 10.5% (the increase in 2009 premiums over 2008) and grades down to 4.5%
(2017 premiums over 2016) and remains at 4.5% into the future. This assumption means healthcare is
assumed to increase. on the average, 7.1 % for HMO's and 7.5% for PPO's a year for the next 9 years
after 2008. Furthermore, since the valuation's general inflation assumption is 3%, it also means
health care is assumed to level off at 1.5% over general inflation.
o
~. _C\_\ )
~l!?-
- -
-
October 9. 2007
2-13
CllYOf
CHUIA Vl5fA
Executive Summary
City of Chula Vista Retiree Healthcare Plan
June 30, 2007 Actuarial Valuation
Page 7
BENEFIT PROMISE
The following table summarizes the City's retiree medical benefits:
. Eligibility . Service or disability retire directly from the City
. Age 50 & 5 years service under CalPERS
. Benefit . Continued participation in City medical plans
. Retiree pays 100% of premiwn
. Surviving Spouse . Based on retirement plan election
Continuation . Same benefit continues to surviving spouse
. Dental, Vision & . None
Life
. Pay-As-You-Go . None
Costs
,
. Possible Early . Eligibility:
Retirement . Offered to all City departments/bargaining groups
Window
. Must be eligible to retire
. 90 Day opt-in window
II Benefit:
. DOR < 111108 - City pays single premium through 12/31/09
I . DOR::: 111108 and DOR < 1/1/09 - City pays single premium
through 12/31/08
II Implied Subsidy III Participating retirees paying active rates vs. actual cost
. Value implied subsidy only, until age 65
([{)
October 9, 2007
2-14
~I~
_ fi
ClTYOf
CHULA VISJA
OPEB Liabilities Pose Some Risk For
State And Local Governments
Primary Credit Analyst:
Peter Block, Chicago (1) 312-233-7040; peter_block@standardandpoors,com
Secondary Credit Analysts:
Robin Prunty. New York (1) 212-438-2081; robin_prunty@standardandpoors.com
Marc Sa varia, Boston 11) 617-530-8315: marc_savaria@standardandpoors.com
Table Of Contents
.__n.n._____.__..._____..._...__.___._._____.______.__...-------...-.----.---------.-.-----------.---.---------.-
New Reporting Requirements Highlight Issue
OPEB Credit Analysis
www.standardandpoors.com/ratingsdirect
1
Standard & Poar's. All rights reserved No reprim or dissemination without S&p7s permission See Terms of
Use/Disclaimer on the last page 2 -1 5
OPEB Liabilities Pose Some Risk For State And
Local Governments
Standard & Poor's Ratings Services expects most state and local governments to eventually come up with workable
strategies for other postemployment benefits (OPEB) without adversely affecting their credit quality. While
near-term fiscal stress is unlikely, there could be some intermediate-term credit pressures - possibly as soon as three
to five years __ as governments grapple with funding solutions amid rising health care costs. If unmitigated, OPEB
costs _ which in some cases are projected to be several multiples larger than what governments currently pay to
cover retirees -- are likely to strain some" municipal budgets, potentially affecting other spending priorities and the
magnitude of reserves.
With the deadline for compliance with the new Governmental Accounting Standards Board (GASB) requirement for
OPEB looming, all state and many local governments are developing solutions to address the liability. In many
instances, state legislative action has been taken and still may be required to provide local governments and school
districts a range of options to manage their OPEB liabilities, including authorizing trust funds, reserves, and
managing benefit levels.
OPEB liabilities are just one of many credit factors Standard & Poor's evaluates during the ratings process. We
recognize that the overall effect of the liabilities will be felt over many years. How the OPEB liability is managed by
issuers, along with a government's capacity to fund these obligations on an annual basis -- either on a pay-as-you-go
or an accrual basis -- will be an important element of the credit review. The framework for evaluating the solution
includes three broad areas: finances, management, and debt.
New Reporting Requirements Highlight Issue
OPEB requirements are not new and have been a part of the cost structure of state and local governments -- as well
as not-far-profit organizations -- for a long time. GASB Statement No. 45, "Accounting and Financial Reporting by
Employers for Postemployment Benefits Other Than Pensions," established new accounting and reporting practices
for OPEB liabilities for governmental entities. This standard affects all governmental entities, including state and
local governments, school districts, transportation sector issuers (including transit agencies, airports, and roll roads),
utilities, and housing ,agencies. GASB 45 is essentially a new way to account for, and report on, these accrued
liabilities. It can also be viewed as a tool to better manage OPEBs in the long term. GASB 45 is being phased in over
three years. Governments with annual revenues in excess of $100 million must adopt the standard for fiscal years
ending after Dec. 15,2006.
Standard & Poor's recently reported on OPEB liabilities for state governments (see "U.S. States Are Quantifying
OPEB Liabilities And Developing Funding Strategies As The GASB Deadline Neats,", Nov. 12,2007). Based on our
research, of the 40 states that have reported to date, the scope and range of OPEB liabilities -- $400 billion in total
and counting __ underscore the enormous challenges that OPEB presents for governmental entities in the future. This
is not simply because the absolute size of the liabilities is large, but ongoing costs to cover promised health care
benefits are projected to be many multiples larger than what governments currently pay.
Not-for-profit entities, primarily health care and higher education, that follow accounting rules established by the
Standard & Poor's RatingsDirect I January 30, 2008
2
Standard & poar's, All rights reserved. No reprint or dissemination without S&P?s permission. See Terms 01 Use/Oisclaimer on the last page.
2-16
OPEB Liabilities Pose Some Risk For State And Local Governments
Financial Accounting Standards Board (FASB) have been reporting OPEB liabilities for many years under FASB's
Statement of Financial Accounting Standard (SFAS) No. 106: "Employees' Accounting for Postretirement Benefits
Other Than Pensions." On Sept. 29, 2006, FASB issued its new standard, SFAS No. 158: "Employers' Accounting
for Defined-Benefit Pension and Other Postretirement Plans." SFAS 158 amends SFAS 106, requiring employers to
recognize the overfunded or underfunded status of their defined-benefit OPEB plans as an asset or liability in their
statement of financial position for fiscal years ending after June 15,2007. Under prior accounting standards, the
funded status of an employer's OPEB plans was not always recorded in the balance sheet.
FASB 158 has had some impact on balance sheets and income statements of many not-for-profit organizations,
although to date, Standard & Poor's has not revised ratings solely because of unfunded liabilities. In many of these
cases, the new rule caused a weakening of balance sheets following an increase in liabilities and a decrease in equity.
Standard & Poor's will continue to monitor the impact of the new rule, especially the strategies used by these
organizations to absorb the cost of OPEB.
OPEB Credit Analysis
OPEB liabilities are just one of many credit factors Standard & Poorls evaluates during the ratings process. We
recognize that OPEB liabilities are likely to be more volatile than pension liabilities over time. In addition to
variation in actuarial methods and assumptions, OPEB liabilities factor in health care cost inflation assumptions,
which have varied over time and continue to increase at double-digit rates. We have already seen wide ranges of
liabilities for the same OPEB plan in subsequent actuarial valuations due to changes in assumptions. Nevertheless,
once the final OPEB liabilities and the annual required contribution (ARC) are determined, it will be up to
management and political leaders to decide how best to handle liabilities. Options include prefunding the liability
and paying the ARC, continuing with pay as you go, or some combination thereof.
Failure to fund the ARC or at least establish a workable plan to do so in an identifiable time frame may indicate that
the OPEB structure is unaffordable. If funding costs go largely unmitigated, OPEB has the potential to slowly crowd
out other spending priorities, potentially leading to credit problems. In analyzing the impact of OPEB liabilities on a
government's general credit, we focus on how OPEB affects management, finances, and debt.
Management
Management should be able to clearly discuss the details of OPEB, consequences of restructuring benefits if possible,
and demonstrate an understanding of the impacts of the results of GASB 45 actuarial valuations in terms of how
conservative (or aggressive) the methods are and the assumptions used to determine the OPEB liabilities. If OPEB
liabilities are material, Standard & Poor's is interested in the various alternatives that management is pursuing to
soften the impact on the government IS finances. Additionally, it should be clear where the OPEB problem ranks in
relation to other planning and spending priorities. If, after the OPEB liability has been agreed upon, the ultimate
solution to a governmentls OPEB liability is prefunding, additional challenges will arise, which must also be
considered.
Finances
As part of our financial review, we will analyze the effect of the OPEB liability, together with pension liabilities, on a
government's lncome statement and balance sheet. Our analysis will be enhanced when trend information for OPEB
becomes available.
www.standardandpoors.com/ratingsdirect
Standard & Poor's. All rights reserved. No reprint or dissemination without S&P?s permission. See Tenns of Use/Disclaimer on the last page.
2-17
3
i;7',L\l\l JDU,i} ','.
OPEB Liabilities Pose Some Risk For State And Local Governments
From an income statement perspective, the annual and projected costs of addressing both pension and OPEB
liabilities, along with annual debt service costs, will be analyzed as it relates to the size of the budget, the strength
and diversity of the revenue base, and other spending priorities. This analysis is similar to the way in which we have
traditionally analyzed the impact of unfunded pension liabilities. Specifically, we will measure the ARC and actual
contribution rates, along with funding progress. As with pension funding, OPEB contribution rates can lag and be
distorted by investment return assumptions, asset smoothing methodologies, and amortization periods for unfunded
actuarial accrued liabilities. Nevertheless, contribution rates and funding ratios are useful for comparison across
governmental entities because they shed light on the burden pension and OPEB liabilities and costs have on an
issuer1s budget and balance sheet. These metrics may be less significant for issuers who do not actually fund the cost
of OPEB but instead allow retirees to participate in their plans by paying for themselves.
From a balance sheet perspective, we will focus on the impact of unfunded pension and OPEB liabilities on reserves,
the ability to fund capital improvements, and retire debt obligations within a reasonable time frame.
Debt
Pension and OPEB liabilities are debt-like in nature, although the annual costs to service the obligations differ. Debt
costs are traditionallytixed and must be paid on time, whereas ARC payments for pension and OPEB can be
deferred or only partially paid. Further, OPEB ARCs are subject to significant variation based on the actuarial
methods and assumptions used to calculate the OPEB liability as well as the performance of any fund assets.
If pension obligation bonds or OPEB obligation bonds have been issued, we are concerned with the source of
funding for these obligations and the additional fixed costs associated with this prefunding solution. (For further
information about the risks and benefits of issuing bonds to prefund pension and OPEB liabilities, see "Time May
Be Ripe For A POB Revival," dated Jan. 23,2008, and "OPEB Obligation Bond Funding Strategies Offer Risks And
Rewards," dated Nov. 19,2007.)
Prefunding challenges
While there is no requirement under GASB 45 to prefund benefits, significant attention is placed on future funding
requirements due mainly to the rapidly escalating costs of health care and the implicit penalty of not prefunding
liabilities. Under GASB 45, governments are permitted to use the typically higher discount rate (about 8%) of the
OPEB trust fund assets, rather than the government's own rate of return (about 3%), for prefunding purposes. This
serves to reduce the government's overall OPEB liability and future cost requirements.
If governments try to prefund OPEB liabilities through bonds and achieve funding ratios consistent with or
exceeding pension plans, they will face several new challenges related to maintenance of adequate funding ratios.
Indeed, the annual process of balancing affordable and predictable contribution rates for the government while
maintaining adequate funding ratios for beneficiaries will likely become the government's priority in dealing with
the OPEB issue, similar to the situation faced currently with pension plans.
As government investment strategies became more diversified (away from fixed-income) in the 19805 toward equity
investments, pension funding ratios increased markedly in the latter part of the 1990s. However, as of the early part
of this decade, investment returns fell precipitously, depressing pension funding ratios. It is almost inevitable that
OPEB trust funds will face similar pressure over time. Therefore, if a government chooses to ]?refund OPEB
liabilities, management must be cognizant of the pressure to achieve outsized investment returns to stabilize and
reduce contribution rates. For these reasons, Standard & Poor's will also focus on the OPEB fund's structure,
Standard & Poor's RatingsDirect I January 30. 2008
4
Standard & Poor's. All rights reserved. No reprint or dissemination without S&P?s permission_ See Terms of Use/Disclaimer on the last page
2-18
OPEB Liabilities Pose Some Risk For State And Local Governments
governance, investment allocation, and return assumptions. This analysis is identical to the way in which we view a
government's pension plan and its impact on a government's general credit.
www.standardandpoors.com/ratingsdirect
Standard & Poor's An rights reserved. No reprint or dissemination without S&P?s permission. See Terms of Use/DiSClaimer on the last page.
. 2-19
5
:""l3'1G:'mlA!i
Copyright@2008, Standard & Poors, a division of The McGraw-Hili Companies, Inc.l?S&P?l. S&P and/or its third party licensors have exclusive proprietary rights in the data
or information provided herein, This data/information may only be used internally for business purposes and shall not be used for any unlawful or unauthorized purposes.
Dissemination, distribution or reproduction of this data/information in any form is strictly prohibited except with the prior written permission of S&P, Because of the
possibility of human or mechanical error by S&P, its affiliates or its third party licensors, S&P, its affiliates and its third party licensors do not guarantee the accuracy,
adequacy, completeness or availability of any information and is not responsible for any errors or omissions or for the results obtained from the use of such information, S&P
GIVES NO EXPRESS OR IMPLIED WARRANTIES, INCLUDING, BUT NOT LIMITED TO, ANY WARRANTIES OF MERCHANTABILITY OR FITNESS FOR A PARTICULAR PURPOSE
OR USE. In no event shall S&P, its affiliates and its third party licensors be liable for any direct indirect special or consequential damages in connection with subscriber?s or
others? use of the data/information contained herein. Access to the data or information contained herein is subject to termination in the event any agreement with a third-
party of information or software is terminated.
Analytic services provided by Standard & Poor's Ratings Services (Ratings Services) are the result of separate activities designed to preserve the independence and objectivity
of ratings opinions. The credit ratings and observations contained herein are solely statements of opinion and not statements of fact or recommendations to purchase, hold, or
sell any securities or make any other investment decisions. Acco rdingly, any user of the information contained herein should no trelyonanycreditratingorotheropinion
contained herein in making any investment decision. Ratings are based on information received by Ratings Services, Other divisions of Standard & Poor's may have
information that is not available to Ratings Services. Standard & Poor's has established policies and procedures to maintain the confidentiality of non-public information
received during the ratings process.
Ratings Services receives compensation for its ratings. Such compensation is normally paid either by the issuers of such securities or third parties participating in marketing
the securities. While Standard & Poor's reserves the right to diss eminatetherating,itreceivesnopaymentfordoingso,exceptfor subscriptions to its publications.
Additional information about our ratings fees is available at www.standardandpoors.com/usratingsfees
Any Passwords/user IDs issued by S&P to users are single user-dedicated and may ONLY be used by the individual to whom they have been assigned. No sharing of
passwords/user IDs and no simultaneous access via the same password/user 10 is permitted. To reprint, translate, or use the data or information other than as provided
herein, contact Client Services, 55 Water Street, New York, NY 10041; (1)212.438.9823 Of bye-mail to:research_request@standardandpoors.com.
Copyright C9 1994-2008 Standard & Poors, a division of The McGraw-Hill Companies, All Rights Reserved.
_fI1'l71~'1it!i'i~'Jil:n!l,fJlw'PiiN;'"
....
'''''1'1'';< "'\A"; ""
2-20