OPEB, LX Edition. What s under the hood of a benefits valuation

Transcription

1 OPEB, LX Edition What s under the hood of a benefits valuation

2 What s under the hood of a benefits valuation Many Canadian municipalities offer various types of Other Post- Employment Benefits ( OPEB ): retiree health, retiree life insurance, LTD benefits, sick leave bank payouts on termination or retirement, WSIB and others. Municipalities are required to include the liabilities in their financial disclosure under public sector accounting rules. This means that they must engage an actuary to perform a valuation of these plans. Given that municipal budgets are tight, you naturally want to find the actuary with the best price in your province who is qualified to perform the task. Typically you issue a request for proposals (RFP) for the contract, establishing a set of selection criteria that weighs fees and experience. The actuary is chosen, the valuation gets done and out of the way, and you move on to something else. If there were no accrual accounting required for OPEB and benefit payments were expensed as they are paid, would you ever engage an actuary to do a valuation? Probably not, but there are reasons to do a valuation that go beyond regulatory requirements. Attaching a liability figure to future benefits that are promised to employees can be vital to your economic forecasting. Employee benefits are expensive, and they are typically on the agenda of employee groups during collective bargaining. If you only look at the cost of benefits over the next year or two, then you might be unaware that financial disaster may be coming in years three and on. A valuation wouldn t miss that. This is why accounting rules are there to begin with. There is the need and desire of all involved to have a reasonable estimate of future benefit obligations. Most actuaries will get you from point A to point B, but not all of them will give you a comfortable and safe ride along the way. A valuation report provides all of the necessary figures to measure the financial disclosure of the benefit plans, discloses the assumptions and methodology used, summarizes the underlying membership data, and provides certifications of compliance. Think of a valuation report like a car (but please don t think of me as a car salesman). Once you figure out that you need a car, your decisions have just begun. What kind of car do you want? SUV, sedan, minivan, hatchback? How much do you want to spend? How much are you willing to spend? Ever go to buy a car with a limit on price in mind and then end up driving off with something more expensive? You did that because of the perceived value. It was worth it to spend the extra money to get that extra safety feature. Hiring an actuary is similar. Most actuaries will get you from point A to point B, but not all of them will give you a comfortable and safe ride along the way. Unfortunately for those in my profession, cars are a lot cooler than actuaries, and it s easier to figure out which car gives you more value for your money. When we respond to an OPEB RFP, it can be a challenge to deliver the message of value. To keep with the car analogy, we want to tell you that we have a better engine, we are more fuel efficient, we have improved safety features, and that you get more car for your money. But if the work is treated as just a compliance checklist item, the choice of actuary ends up based on price, not value. 2

3 Municipalities can often end up engaging an actuarial firm based primarily on its fees to do the work. The firm with the lowest quote may be giving you a basic, templated OPEB valuation that leverages the work they did for another municipality. On the surface that seems to make sense: Many municipalities have similar benefit provisions and there are efficiencies for one firm to do multiple entities with the same approach. But is your city, town, or region really the same as every other municipality? Do all your employees retire at the same age and have the same health claim patterns as everyone else? Unlikely. There are differences with every municipality that require a more thorough approach to managing the financial risks involved. But is your city, town, or region really the same as every other municipality? Do all your employees retire at the same age and have the same health claim patterns as everyone else? Here are some common pitfalls that can lead to significant fiscal dangers: Using the same retirement age assumption for different groups that experience shows have very different retirement patterns. People are just not predictable enough to fit into a cookie-cutter template. Using premium rates that are a composite of active employees and retirees. It s really the retiree claims experience that matters to a post-retirement benefits valuation; the active-member experience needs to be removed from the equation. Providing a report without providing the rationale for the assumptions. In order to keep the price low, the basic valuation uses the same economic and demographic assumptions for everyone. It s like assuming that all cars will be driven the same way and maintenance costs will be the same in every locale. What you really need is a rationale for the development of the assumptions in order to manage risks properly. Improper attribution of accrued liabilities to future liabilities. There are accounting rules for how to do this. Some actuarial firms with more basic valuation systems simplify this methodology without you knowing or understanding the significant difference that it can make. Not understanding the plan provisions. A basic valuation isn t priced to include much, if any, investigative time. Time has to be budgeted by the actuary to investigate detailed plan provisions which can be extensive where there are multiple collective bargaining units and benefits to value. If the deeper details of the plan terms are not understood by the actuary, then the liabilities can t be right. Double counting! If an actuary is valuing a particular provision within the benefit obligation, service cost, and resulting annual expense, then the benefit payments made for this provision should not be expensed. If they are then you are effectively expensing the provision twice. If your municipality s benefit obligation isn t properly represented, you risk mismanaging taxpayers dollars. Saving a few thousand dollars in actuarial fees could cost much more down the road, causing embarrassment to you, who will be held accountable to explain what happened. An experienced actuary will go into a high level of detail in reviewing your plans, making sure you don t fall into these danger zones. Again, time isn t budgeted into the basic valuation price for this level of commitment. Avoiding this all starts with putting a proper OPEB RFP together. 3

4 OPEB RFPs from municipalities are rarely structured in a way that lets the cream rise to the top. The scope of the project is often vague. As a result, the wide spectrum of responses that you get makes it hard to compare offers. Here are some keys to putting together your RFP: 1. Specify what role the actuary will need to play in recommending management best-estimate assumptions. Request complete documentation of the rationale for assumptions to be included in the report. A review of the actuarial assumptions used in the valuation can potentially add a significant additional cost to the project. As I pointed out earlier, if you are only getting the basic valuation, then the actuary is not spending a lot of time on assumptions and can easily provide a lower fee quote. Why does it matter? Because your auditors will very likely question this, which will ultimately lead you right back to paying your actuary to help justify assumptions at the tail end of the project. The justification needs to be done first. Do you want to cut corners on a fundamental part of the valuation process? If so, you just bought a lemon! 2. Will annual updates review key economic assumptions such as discount rates? Often the project scope asks for annual updates for three years. If there are no changes in assumptions each year then this is a straightforward task. If, however, the discount rate requires updating each year, then it requires more work and more reporting. The difference in cost can be significant. If you re deciding among a number of actuaries who interpret the scope differently from each other, then forget about lemons because you now have apples and oranges! 3. Provide a full description of plan provisions and summary of membership data. It s surprising how many RFPs we see that don t provide a full description of benefits beyond saying post-retirement health, dental, and life. Often there are multiple collective bargaining units with different benefits or various grandfathered provisions. Without knowing the plan provisions, how could anyone properly provide a fee estimate? This puts all proponents other than your current actuary at a disadvantage. 4. Time the release of your RFP so that there is time for a new actuary to do the work. Don t plan on selecting the winner in late December for a valuation due in January. Actuaries other than the incumbent will require some time to set up their programs with your plan provisions before beginning the actual project. Most actuaries won t charge for transition costs, especially if they can transition during off-peak times of year. The willingness to provide the best fee discount could change depending on the amount of time given to do the work. Some municipalities do a one-year lag on their membership data to disclosure. For example, the year-end 2013 disclosure can be based on January 1, 2013 membership data. This is smart: the data and setup work can be done throughout 2013 and avoid the mad rush at year-end. This is better for everyone, and potentially cheaper. 5. Public sector entities that include unfavourable contractual terms and conditions, with little or no room permitted for modification or negotiation by the proponent, can inadvertently be limiting their choice of actuary. Like any other sophisticated and reputable business, an actuarial firm may be more likely to respond to a bid and ultimately provide services where the services contract contains commercially reasonable terms and conditions. Contentious provisions may often include those dealing with intellectual property, insurance, liability, and indemnification. A public sector entity may at first glance be more eager to deal with a firm that is readily prepared to expose itself to unlimited liability. But before doing so, it should consider whether the firm can meet that obligation should the occasion arise. If your municipality s benefit obligation isn t properly represented, you risk mismanaging taxpayers dollars. Saving a few thousand dollars in actuarial fees could cost much more down the road, causing embarrassment to you, who will be held accountable to explain what happened. In the end, of course, you have to decide what s of value to you. Your own balancing act is choosing the best combination of quality, price, and risk. Knowing more about what s under the hood is the best way to make that choice. 4

5 About the author Darren Klorfine, MA, ACIA, is a Director and Actuarial Consultant for Buck Consultants. He has more than 17 years of experience in all aspects of pension and post-retirement benefits consulting. An MA majoring in statistics, he also has an Honours BA degree in Mathematics, specializing in actuarial sciences. To find out more, contact: or hrconsulting@xerox.com About Buck Consultants at Xerox Within Xerox, Buck is the consulting strength of the Human Resource Services (HRS) division. Buck offers advisory, technology, and administration solutions to help you effectively manage your programs while engaging your employees in their health, wealth, and career. By integrating our HR consulting know-how with HRS core services, we can offer additional innovative and customized solutions to help you overcome your HR challenges. Together, we can ensure you have the right people in the right positions at the right time to save money and achieve your business goals. Learn more at Since the invention of Xerography more than 75 years ago, the people of Xerox have helped businesses simplify the way work gets done. Today, we are the global leader in business process and document management, helping organizations of any size be more efficient so they can focus on their real business. Headquartered in Norwalk, Conn., [remove United States,] more than 140,000 Xerox employees serve clients in 180 countries, providing business services, printing equipment and software for commercial and government organizations. Learn more at Xerox Corporation and Buck Consultants, LLC. All rights reserved. Xerox and Xerox and Design are registered trademarks of Xerox Corporation in the United States and/or other countries. Buck Consultants is a registered trademark of Buck Consultants, LLC. in the United States and/or other countries. BRP2825