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Public employers face up to funding issue

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As a deadline approaches for public employers to disclose their outstanding liabilities for nonpension retiree benefits including health care, some are taking steps to begin funding or reducing those liabilities.

Until recently, many governmental entities didn't even tabulate their accrued obligation for the nonpension benefits they have promised their workforces over the years. They funded post-employment health care benefits through a pay-as-you-go accounting approach and did not report the expense on their books until after employees retire.

But to comply with Governmental Accounting Standards Board Statement No. 45, public entities as soon as Dec. 15 must account for their current retiree health plan expenses along with the actuarially accrued cost of unfunded retiree benefits promised to current employees.

Substantial impact

The impact on state and local government financial statements will be substantial, experts say.

To comply with GASB 45, public employers need only reveal the extent of their obligations to retirees. However, failure to establish a funding mechanism and reduce their obligations could damage public entities' bond and credit ratings.

That has driven many state and local governments to hire actuaries to evaluate their previously unknown liabilities. That process will guarantee their compliance and is a first step in developing strategies for paying down their liabilities, observers say.

Potential strategies include reducing benefit offerings or increasing employee contributions, issuing bonds, setting up trust funds and educating employees about Medicare options rather than relying on their employer's post-retirement plan.

Many public entities, however, do not yet have a plan in place to address their outstanding liabilities, say consultants, public entity benefit managers and government finance experts.

"There are some who are very much aware and, like us, have begun to do something about the liability in terms of contributions or strategies to mitigate the liability over the long haul," said Paul Hackleman, benefits manager for San Mateo County, Calif. "And then there are some that it's not even on their radar screen."

Deadline set by revenue

After Dec. 15, the United States' largest public employers-those with annual revenue of $100 million or more-must begin complying with GASB 45, with the deadline depending on the start of their fiscal year. For entities such as San Mateo County, that means a compliance deadline of July 1, 2007.

For governments with $10 million to $100 million in annual revenue, GASB 45 is effective after Dec. 15, 2007. For governments with less than $10 million in annual revenue, the effective date is after Dec. 15, 2008.

Michael Merlob, a Boca Raton, Fla.-based health care consulting actuary specializing in public entities for Apex Management Group, a unit of Gallagher Benefit Services, agrees that some entities have been slow to valuate their liabilities.

"The deadline is rapidly approaching and we haven't seen as many valuations get done as I would have expected," Mr. Merlob said.

Easier for some

Some public entities that have completed the valuation, however, have found that funding post-employment benefits is not an issue, Mr. Merlob said. Municipalities with a young workforce far from retirement might fit that category. Or they could be entities that recently experienced a rapid growth in tax collections that allowed them to accumulate assets in anticipation GASB 45.

Still others may already require substantial worker contributions to their benefit plans. Doing so reduces a government entity's liability in two ways. First, it reduces the amount a public body must put away for each employee. Second, requiring contributions reduces the number of employees that participate in a plan, so a public entity can actuarially assume it will need to fund such benefits for fewer retired workers, Mr. Merlob said.

Older cities with older workforces that historically have contributed the full cost of retiree health benefits, however, could be looking at a potential cost of $100,000 per currently active employee, Mr. Merlob said.

Norwalk, Conn., completed its valuation in July 2005, said Thomas S. Hamilton, the city's director of finance. It also has held workshops so elected officials, budget planners and employee groups understand how moving from a pay-as-you-go to a funded system will impact them and the city.

Mr. Hamilton has recommended that Norwalk establish a trust fund and gradually phase into fully funding the city's nonpension liabilities. It could do so by increasing the amount of money that currently flows from its operating budget to retiree benefits.

That way, the current benefits under the pay-as-you-go system would continue to receive funding while the additional money from the operating budget could build up in the trust fund for future liabilities.

"The magnitude of the numbers we are looking at, I don't think it's feasible in one fell swoop to go from pay-as-you-go financing to advance funding the liability without some transition period," Mr. Hamilton said.

How Norwalk will oversee the fund and invest its assets are among issues that must still be determined, Mr. Hamilton said. Norwalk currently has a defined benefit pension plan with $450 million in assets. The pension fund's board of trustees could oversee a nonpension benefit trust, Mr. Hamilton said.

Potential benefits cuts

Several public entity benefit managers said they are looking at options to reduce retiree benefits. However, the benefit managers, citing fear of backlash, declined to discuss such ideas publicly until they address the issue with unions in which workers participate.

Mr. Hackleman said he opted for an early calculation of San Mateo County's retiree benefits obligations to be ready to address future union negotiation requests for increased retiree benefits.

The county is in "comparatively good shape" because it already incorporates a defined contribution approach to retiree health, Mr. Hackleman said. Any unused sick time that accumulates during an employee's career can be used to offset the worker's health plan contribution upon retirement.

Mr. Hackleman also has recommended that the county set up a retiree health savings account that would not become a GASB liability. Such accounts would have time to grow to fund benefits for employees with retirement dates that are still a long way off.

Meanwhile, contributions the county has already made to retiree health would pay for those closer to retirement. The structure of such arrangements has yet to be worked out, Mr. Hackleman said.

Still another approach some public entities are weighing would rely on educating employees about Medicare Advantage plans, Mr. Merlob said.

Under Medicare Advantage arrangements the federal government pays health insurers to manage an enrollee's health care rather than paying claims directly. If an employer requires a contribution from a retiree, it could be more advantageous for a retiree to enroll instead in a Medicare Advantage plan, Mr. Merlob said.

"Some Medicare Advantage plans provide excellent coverage including prescription drugs and there is no (additional) premium," Mr. Merlob said. "So it actually can be advantageous for retirees."

Out of concern about how a substantial liability would look on their balance sheets, some entities also are exploring issuing bonds to raise funding, said Robert Friedman, a partner whose specialty includes employee benefits, at Holland & Knight L.L.P. in Miami.

"The bond issue is going to end up being a strategy that a lot of governmental entities take advantage of," Mr. Friedman said. "Some will keep going with pay-as-you-go."