Frequently asked questions about GASB 45 and the League’s JPA
Question: What is GASB 45 and why was it issued? Answer: The Governmental Accounting Standards Board (GASB) issued its new accounting standards for U.S. local public agencies in 2004, as a result of a growing concern that public agencies, like corporate entities in the 1990s, were not recognizing in their annual financial statements the total cost of promised post-employment health benefits for retired employees and thus not assessing the potential impact of these growing liabilities on future cash flow. In a recent article published in a national business journal, a team of retirement administrators and accountants wrote, “GASB has determined that pension benefits and health benefits are similar in that they accrue over time and are both a type of deferred compensation. The reason for this determination is that health benefits are becoming a very large part of retiree benefits. Twenty or 30 years ago, people at the negotiation table just threw in health benefits, because for every dollar paid for pension benefits, health care was going to cost a nickel. Well, that has changed. For every dollar now being paid in pension benefits, that nickel has become a quarter, a half-dollar, or maybe even more. We have to start looking at the long-term consequences of these retiree health insurance benefits, at the actuarial numbers, the accrued liabilities, and so forth.” GASB 45 requires pubic agencies to conduct regular actuarial studies to determine the actuarial accrued liability for retiree health benefits, to determine the annual cost to the district to fund this liability and to report the progress made in funding the liability. Question: Our accountant said that GASB has not made "funding" of this liability a requirement. Do you agree with this statement? Answer: Yes, GASB does not have the authority to force a public entity to fund their liability. However, GASB does have the authority to require your auditor to note this liability in your annual financial statement if you choose not to fund the liability as indicated by your actuarial report. Question: I understand. But are there really any consequences to not funding the liability? Answer: There are both real and possible implications of not funding the liability. The real implications are as follows: First, GASB 45 specifies that the investment return assumption in your district’s actuarial study should reflect the "estimated long-term investment yield on ...(1) plan assets for plans for which the employer's funding policy is to contribute consistently an amount at least equal to the Annual Required Contribution (ARC).” Not establishing a GASB plan means there are no plan assets. If an employer is setting aside cash in Fund 39 or maintaining cash reserves in the General Fund,
investment income is constrained by Gov Code Sections 53601 et seq. Over the long-run, LAIF has averaged about a 5% return. This is probably the maximum that could be expected for a revocable account. On the other hand, a funded GASB plan in an irrevocable account could take advantage of Gov Code Sections 53620-53622 and invest in assets more suitable for long-term liabilities. (Which is the intent of the League JPA.) This could easily result in an expected return of 7% plus or minus. The added investment income possible under a funded plan would dramatically reduce the present value of future retiree health benefits and, therefore, the Annual Required Contribution (ARC). Second, if a plan is not funded, the ARC must include as a component the difference between the assumed investment income and actual investment income. For example, in the current environment, it is difficult to achieve a 2% return on "surplus funds." Using 2% as the actual return to make the math simple, and assuming that a 5% rate was used in the valuation, an unfunded plan would have to include a 3% (i.e. 5%-2%) adjustment. In the early years, this amount would be unlikely to be substantial. However, as liabilities for an unfunded plan grow, this interest adjustment could be substantial. By contrast, under a funded plan, year-to-year differences between actual and assumed interest are only reflected when a valuation is done (i.e. every two or three years) and - even then - the difference will be an actuarial loss (or gain) which can be spread over 30 years. Third, by not funding the liability, benefits for current and future retirees will eventually either be reduced or eliminated through collective bargaining or the district will need to take dramatic steps sometime in the future to fully fund the liability. And finally, in a December, 2004 report, Standard & Poor’s, the nation’s largest rating agency, issued a report stating, “The new reporting (GASB 45) may reveal cases in which the actuarial funding of post-employment health benefits would seriously strain operations, or, further, may uncover conditions under which employers are unable or unwilling to fulfill these obligations. In such cases, these liabilities may adversely affect the employers’ creditworthiness.” Question: Yes, I understand. But we are funding the liability and putting the money in our own account, so we can control it. Answer: The new accounting standards require that those funds be irrevocably invested in the plan or trust. As a result, even if you have $50 million set aside for a $50 million liability but have that money in a revocable account, your district will be required to report a $50 million unfunded liability. Question: What exactly is the Annual Required Contribution or ARC? Answer: Without going into great detail, the ARC is the total amount a district should contribute – or set aside - each year to meet its actuarial accrued liability. The ARC is the amortized sum of the Normal Cost (the annual expense of both retired and current employees) and the Unfunded Actuarial Accrued Liability (UAAL), the cost of those same employees for past (and unfunded) years of service. The ARC, in effect, recognizes that retiree health benefits are “earned” and are financial obligations accrued during an employee’s entire period of service.
Question: Will GASB someday mandate funding of the liability? Answer: We don’t think so. GASB’s mission is to establish accounting standards. It is not empowered with fiscal control over the nation’s local government agencies. Question: Can a district join the League’s JPA for purposes of having the actuarial studies performed and not be required to participate in the "funding"? Answer: Yes. But we would hope that eventually the district would begin to at least make partial irrevocable contributions to their retiree health benefit plan. Question: Okay, but can the JPA force my district to pay the Annual Required Contribution (ARC) determined by our actuarial study? Answer: Absolutely not. The JPA by-laws do not require such action by any member to the JPA nor does any law give the JPA such power. In this regard, the JPA document states that it is the responsibility of the JPA Board to establish a yearly contribution amount for each college district through which the college district could fund its portion of any retiree health benefit program. The ultimate decision to participate in any investment program offered by the JPA is exclusively held by the respective college district’s governing board, not the JPA. Question: Speaking of the JPA and its authority, could my district be held liable for the financial responsibilities of another in terms of retiree health benefits? Answer: Under the JPA Agreement, each district is only responsible for its pro rata share of the debts or liabilities of the parties to the Agreement. A “party’s pro rata share” consists of such party’s cumulative contributions and assessments relative to the cumulative contributions and assessments of all parties to the JPA Agreement. No debt, liability or obligation incurred in the administration of the Agreement is to be considered a debt, liability or obligation of any individual college district member to the JPA. Question: Our funds will be separated from the funds of other districts? Answer: According to the League’s JPA attorney, “Your district’s investments will be entered into pursuant to investment agreements signed by the various college district members to the JPA that choose to participate in any particular investment. These same investment agreements will delineate the responsibilities and indemnifications to be provided to the college district members participating in each investment program. The indemnification provision of the JPA Agreement is intended to address indemnification on a broad basis, in the context of the Agreement. More specific indemnification terms and conditions will be crafted and set forth in each investment agreement, tailored to the characteristics of each investment arrangement.” Question: What would happen if a college district were to deposit funds into an investment in excess of their liability?
Answer: According to the League’s JPA counsel, “One function of the actuarial service the JPA will provide districts will be to evaluate and make recommendations to each district on the nature and amount of revenue necessary to pledge for GASB compliance. Presumably, the actual investment amount for each college district will be determined and agreed upon by each college district before any such investment is made. Nevertheless, each participating district will have in its investment agreement with the trust a provision that describes what procedures would be followed in the event any college district over funds its liability, including provisions that would provide for the release back to the respective college district of the over funded amount.” Question: In keeping with "an investment policy that precludes undue risk of loss," as stated in the JPA’s preliminary investment policy, how much "investment advantage" can we realistically expect from the JPA? Couldn’t the investment advantage be reduced by working with one's County Treasurer on an alternative investment approach, outside the county pool, and could the remaining advantage perhaps not be worth the costs and time associated with JPA membership? Answer: This is a good and important question. One of the major reasons for the organization of the JPA is to help the districts meet the requirements of the proposed GASB standards (including contributing annually to the district's post-employment benefit liability and providing access to actuarial services to help calculate that liability.) Another important reason is the expectation that the investment pool will outperform what districts can do locally. Sate law allows pooled groups such as the League JPA to access more investment options than do county treasurers. Over 30 years, we believe a more diverse portfolio (include stocks and long-term bonds) can outperform a portfolio limited to short-term treasury notes. By law, your County Treasurer must keep her/his investments short term. Question: You know, retiree health benefits are part of our culture. Trying to sell the concept to employee groups of meeting the GASB standards and contributing significantly more toward meeting this liability is difficult. Trying to sell the concept of what that means in terms of a monthly charge to active employees for future medical benefits has not been easy. Can the League assist districts in applying the results of an actuarial study to operational tasks? Answer: The League’s Retiree Health Benefit Program JPA will develop a “White Paper” on how districts are attempting to fund and/or reduce their retiree health benefit liability. It is scheduled to be published in Fall, 2005. Question: What restrictions, if any, will exist going forward relative to joining or exiting the JPA? For example, could we join in 2006-07? Could we join and then later exit if we concluded the JPA wasn't all we believed it to be ... and would the ability to exit be constrained if the district previously had made deposits? Answer: Districts may join at any time. All districts will pay a one-time participation fee. Districts that join will be committed to the program for three years to allow for prudent investing and management of funds. Districts will be allowed to exit but only after giving appropriate and orderly notice.
Question: What kinds of costs would be shared and what costs would be incurred on a districtspecific basis? Answer: All districts, regardless of when they join, will pay the one-time participation fee. The JPA board of directors will establish an annual budget and determine how the on-going costs of the program will be paid by participating districts.
Prepared by: Ray Giles, Director, Special Services Community College League of California