Strasburger Governmental Newsletter - New Governmental Accounting

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					    GOVERNMENTAL NEWSLETTER         • August 13, 2007 • STRASBURGER & PRICE, LLP
                              New Governmental Accounting Rules for
                              Retiree Medical and Other Welfare Benefits
                              - Part I

                              At the end of its most recent session, the Texas Legislature
                              enacted House Bill (HB) 2365, which was signed by Governor
                              Perry and became law on June 15, 2007. The purpose of HB
                              2365 is to provide relief, for those local governments and
                              agencies that want it, from the impending accounting
      Luke D. Bailey          requirements of Governmental Accounting Standard Board
                              (“GASB”) Statement Nos. 43 and 45. In this and a following
901 Main Street, Suite 4400   Governmental Newsletter, we explain the requirements of
 Dallas, Texas 75202.3794     GASB Statement Nos. 43 and 45. A third newsletter will
   214.651.4572 Direct        explain the implications of HB 2365 for Texas municipalities
        luke.bailey@          and other Texas governmental entities.
                              BACKGROUND TO GASB STATEMENTS 43 AND 45

     GOVERNMENTAL             Several factors (chiefly, an aging workforce and a medical
           GROUP              care cost inflation rate that continues to outpace general
       Katie Anderson         price level inflation) have caused a substantial increase in the
      Thomas K. Anson         likely future cost to governmental employers of providing
                              promised retiree welfare benefits. GASB Statement Nos. 43
     Melinda K. Bradley
                              and 45 would essentially require governmental employers to
     Merritt M. Clements      come to terms with those increased costs through some
  William Duane Darling       combination of increased revenues, changed allocation of
William C. (Trey) Dowdy III   existing revenues, effective use of available financial and tax
       J. William Earle       strategies, or benefit reductions. Because this is occurring in
     Katherine T. Garber      an environment in which private sector employees (a/k/a,
        Angela Green          “voters”) are suffering (or, in many cases, have suffered)
       Tiffany Hildreth       substantial reductions in, or eliminations of, their own retiree
                              welfare benefits, the new disclosures that would be required
        Arcie I. Jordan
                              by Statement Nos. 43 and 45 are, among other things,
       P. Michael Jung        politically sensitive.
       David J. LaBrec
       Patrick J. Larkin
                              EFFECTIVE DATES
      Kimberly S. Moore
  Christine D. Roseveare      Statement No. 45, Accounting and Financial Reporting by
   Rider Scott          Employers for Postemployment Benefits Other than Pensions,
Kenneth E. Siegel       prescribes the required financial reporting by governmental
Ashley M. Stewart       employers for postemployment benefits other than pensions
                        (i.e., retiree medical, prescription drug, dental, and vision
                        benefits; life insurance and long-term care insurance, if not
Printer friendly page   provided through a pension plan).1 These benefits are
                        referred to in Statement No. 45 as “other postemployment
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                        benefits,” or “OPEB’s.” A companion GASB Statement,
Subscribe: RSS Feed     Statement No. 43, prescribes the financial reporting for OPEB
                        funds as entities separate from their sponsoring employers.

                        The required implementation date for Statement No. 45
                        depends on a governmental employer’s total annual
                        revenues in its first fiscal year ending after June 15, 1999.
                        The required implementation date for Statement No. 43
                        depends on the total annual revenues of the plan’s
                        sponsoring employer (or, in the case of a multiple employer
                        plan, the total annual largest participating employer) in the
                        employer’s first fiscal year ending after June 15, 1999, and in
                        all cases is one year earlier than the corresponding
                        Statement No. 45 implementation date. The following table
                        summarizes the required Statement Nos. 43 and 45
                        implementation dates:

                        Revenue in first fiscal   Reporting required for fiscal years
                        year ending after         beginning after
                        June 15, 1999
                                                  Funds         Employers (GASB 45)
                                                  (GASB 43)

                        $100 million or more      December      December 15, 2006
                                                  15, 2005

                        Between $10 million       December      December 15, 2007
                        and $100 million          15, 2006

                        Less than $10 million     December      December 15, 2008
                                                  15, 2007

                        Thus, for example, a large municipality (i.e., one with total
                        annual revenue for its first fiscal year ending after June 15,
                        1999 of $100 million or more) with a July 1-June 30 fiscal
                        year is required to report its OPEB obligations in accordance
                        with Statement No. 45 in its financial statements for its fiscal
                        year ending June 30, 2008. If the municipality sponsors or
                        participates in an OPEB fund and the fund also has a July 1 –
                        June 30 fiscal year, the fund would first need to prepare its
                        financial statements in accordance with Statement No. 43 for
its fiscal year ended June 30, 2007.


Governmental employers have traditionally funded OPEB’s on
a pay as you go (“PAYGO”) basis. That is, the payment of
each year’s premium or benefit expense was simply made
from current revenues without prefunding and the annual
PAYGO expenditure was reported in financial statements.
Under PAYGO accounting, OPEB liabilities are not accrued as
they are earned by active employees, and there is no
requirement to determine the employer’s total accrued
liability to retirees and to active employees for already
earned benefits. This is similar to the reporting of OPEB
expense in the private sector before the imposition of
Financial Accounting Standards Board (“FASB”) Statement
No. 106 in 1992.

GASB Statement No. 45, like FASB Statement No. 106,
requires that governmental employers determine and
disclose in their financial statements: (a) their unfunded
actuarial accrued liability (“UAAL”),2 and (b) the actuarial
value of new benefit rights earned each year by active
employees after the implementation date. The employer
need not, however, accrue the entire UAAL as a liability on
its balance sheet on the implementation date.3 Instead,
employers are required to record in their financial statements
annually an amount called the “annual required
contribution” (“ARC”). The ARC consists of (a) the present
value of the future benefits actually earned during the year
by active employees (called in actuarial parlance, the year’s
“normal cost”), plus an amount necessary to amortize the
UAAL over a period of no more than 30 years.

If the employer funds all of the ARC for the year, then there
is no increase in the employer’s balance sheet liability for
OPEB. On the other hand, any portion of the ARC that is not
funded must be recorded as a balance sheet liability and will
increase annually thereafter with interest.

The employer’s annual normal cost for OPEB’s, as the
present value of future benefit rights currently earned by
active employees, is likely in and of itself to exceed the
employer’s PAYGO amount. When the cost of amortizing the
UAAL over 30 years is added to the normal cost, an
employer’s ARC is likely to be a multiple of the PAYGO
amount that it has traditionally expensed, resulting in OPEB
“sticker shock.”
Actuaries have used an “iceberg” analogy, like the one below
to summarize the relationship between an employer’s PAYGO
amount, normal cost, and UAAL. The PAYGO amount, which
municipalities and other governmental employers have
traditionally shown in their financial statements, is the “tip”
of the OPEB iceberg, with the present value of future normal
costs for the current workforce, and the UAAL, together
being the vastly larger portion of the OPEB iceberg
submerged beneath the surface of municipal financial


GASB Statement No. 45 requires that valuation of both the
employer’s normal cost and its UAAL be based on what
Statement No. 45 refers to as the “substantive plan,” which
is the plan as its terms are understood by the employer and
the plan’s members at the time of the actuarial valuation.
The “substantive plan” is evidenced by written documents (e.
g., municipal ordinances, board resolutions), employee and
retiree communications (e.g., a plan summary prepared by
the employer or insurer), and by patterns and practices (e.
g., an established pattern of cost sharing between the
employer and retirees, even if not prescribed by statute).
Under Statement No. 45, legal or contractual limits (“caps”)
on an employer’s share of costs are taken into account in
determining the “substantive plan” only if the limits may be
assumed to be effective based on a past pattern of
enforcement. In other words, the “substantive plan” is more
of a business concept than a strictly legal one. It is the
pattern of future expenditures for OPEB that the employer is
considered to be committed to, not the unavoidable cost of
its strict legal obligations.
                              In Part 2 of this series, we will discuss the key actuarial
                              drivers of OPEB liability, ways that municipal and other
                              governmental employers are addressing OPEB liability, and
                              the likely effects of GASB 45 on bond ratings.

                              1Because   retiree medical benefits are typically by far the most expensive
                              component of an employer’s OPEB, this Governmental Newsletter refers
                              to retiree medical and OPEB interchangeably in places.

                              2The UAAL is the present actuarial value at the Statement No. 45
                              implementation date of all plan obligations to retirees and active
                              employees for previously earned benefits, reduced, if the plan is funded,
                              by the present actuarial value of the plan’s existing assets.

                              3That is, unlike FASB Statement No. 106, GASB Statement No. 45 does
                              not contain a requirement to book a “transition liability. ”

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