TEXPERS Summer Forum. Retiree Healthcare Funding. April 15, Charles Dean, FSA. Dean Actuaries, LLC 74/75. The Big Picture

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1 TEXPERS Summer Forum Retiree Healthcare Funding April 15, 2016 Charles Dean, FSA Dean Actuaries, LLC 74/75 The Big Picture Is it a Big Deal? What are the Changes How to Manage GASB 74/75 1

2 Other Postemployment Benefits (OPEB) GASB 74 Applies to financial statements of funded plans Effective 6/30/2017 GASB 75 Applies to financial statements of employers Effective 6/30/2018 Replaces GASB 45 What are the Key Changes? Unfunded Liability is on the Balance Sheet OPEB expense will be more volatile Change the Actuarial Cost Method Discount rate: A reason to fund 2

3 Balance Sheet liability Terms Funding GASB 45 GASB 74/75 Unfunded Actuarial Liability Net OPEB Liability (not on balance sheet) Net OPEB Liability (but different) May be significantly larger On the balance sheet Total OPEB Liability Actuarial present value Project future benefits Discount to present value Attribute present value to specific periods 3

4 Balance Sheet liability GASB 45 GASB 74/75 Theoretical assets for 30-year funding Entire OPEB Liability (Unfunded Actuarial Liability) Balance Sheet liability 4

5 Changes: Actuarial Cost Method GASB 45: Choice of methods Most plans use Projected Unit Credit (PUC) GASB 74/75 Entry Age Normal (EAN) Pay-related approach Blended Discount Rate General Rule (GASB 74/75) Project all trust cash flows related to current participants benefit payments to current participants employee contributions from current participants employer contributions on behalf of current participants employer contributions on behalf of future participants in excess of their projected service costs trust investment earnings administrative expenses Projection assumes no future economic or demographic gains or losses 5

6 General Rule Blended Discount Rate Project year-end trust balance until the earlier of: the year trust assets are depleted the year all benefit payments on behalf of current participants have been made Discount all benefit payments through the last year before trust assets have been depleted using the expected rate of return Discount all benefit payments from the first year trust assets have been depleted a municipal bond rate (20-year investment grade general obligation municipal bonds) General Rule Blended Discount Rate Sum the two discounted benefit payment streams to get a single present value Determine the single discount rate that all results in the same present value when applied to all future benefit payments 6

7 Discount Rate Unfunded Plans Muni-bond Index 20-year AA+ Funded Plans Blend expected return for asset mix with Muni bond index % Fed Reserve Range from 3.01% to 7.5% or higher GASB 74/75 Sensitivity Studies Sensitivity to Discount Rate 1% Decrease Discount Rate 1% Increase 2.80% 3.80% 4.80% Net OPEB Liability $ 7,535,000 $ 6,134,000 $ 5,053, % 82% 7

8 GASB 74/75 Sensitivity Studies Sensitivity to Healthcare Trend Healthcare Cost 1% Decrease Trend Rates 1% Increase 4.01% 5.01% 6.01% Grading to Grading to Grading to 3.87% 4.87% 5.87% Net OPEB Liability $ 5,086,000 $ 6,134,000 $ 7,455,000 83% 122% Managing GASB 74/75 True up the actuarial assumptions Retirement rates Healthcare curve Healthcare trend Test drive GASB 75 actuarial valuation now Study effects of funding the plan Asset/liability/expense projection With and without funding 8

9 Retirement Rates Especially important for OPEB plans Pension assumption may not be appropriate Retirement rates from age 55 to 70 Use blue rates (age-by-age based on experience) Not red (average age) Healthcare Curve Female Male 9

10 Study effects of funding the OPEB plan Funding allows a blended return discount rate Higher discount rate reduces the Total OPEB Liability Plan assets also reduce the Net OPEB Liability on the employer s balance sheet Plan assets reduce annual OPEB expense Investment volatility is smoothed over 5 years for OPEB expense 401(h): A dip in the Retiree Medical Plan pool Charles Dean, FSA Dean Actuaries, LLC 10

11 Section 401(h) Allows qualified pension and annuity plans to provide: Medical expense coverage To retired employees spouses and dependents Retired means eligible to receive a pension (including disability) Section 401(h) Must not discriminate in favor of highly compensated employees Pension plan document must specify how much is to be paid 11

12 401(h) Separate account Requires separate account in pension trust A bookkeeping account; does not require segregated assets 401h benefits must be paid from this account Contributions for retiree medical benefits must be designated for this account 401(h) Funding No minimum funding requirement under the Code Contributions may be from employer or employee or both Maximum contribution is subject to limit: 25% of the normal cost for the total plan (pension + retiree medical) Equivalent to 33% of pension only normal cost Maximum is cumulative from start of 401(h) provision. Unused amounts carry forward. 12

13 401(h) Funding Example Pension Funding $ 6 million for pension normal cost 3 million for amortizing the unfunded liability $ 9 million 401(h) contribution may be as large as: 33% of $ 6 million or $ 2 million plus unused limits from prior years. 401(h) Taxation Entering a tax free zone Contributions are not taxed Investment earnings in the separate account are not taxed Benefits are not taxed when paid out (as medical benefits) 13

14 Big Spring Retiree Medical Subsidy Plan Form of Plan 401(h) sub-account in the pension trust. Provisions included in the pension plan document. Only retiree medical benefits may be paid from the sub-account. Subaccount receives a proportionate share of pension trust earnings. Eligibility for Benefits Members retiring at age 50 or older with 20 or more years of service. Benefits Paid Reimbursement for up to $340 month in medical expense for retiree and/or spouse. Maximum amount can be adjusted in the future based on plan funding level. Big Spring Retiree Medical Subsidy Plan Funding assumptions Entry Age Normal Cost Method 10 year amortization of the unfunded actuarial liability 6% interest 4% assumed pay increases Other demographic assumptions are the same as the pension valuation Member contributions are a uniform monthly amount which is increases based on average pay increases of all participants. 14

15 Big Spring Retiree Medical Subsidy Plan Plan Funded Level Big Spring Retiree Medical Subsidy Plan 15

16 Big Spring Retiree Medical Subsidy Plan Big Spring Retiree Medical Subsidy Plan Very disciplined funding Conservative approach to benefit up-grades Benefits can only be increased if10 year funding standard is maintained Conservative measurement of plan funding level 16

17 401(h): How to Excellent addition to an existing pension plan Requires an amendment to the plan document and employee communication Requires adherence to IRS funding rules Can be administered in-house or by a third party Payments must always be limited to eligible medical expenses Good fit to new accounting requirements (GASB 75) GASB 75 and 401(h) For more information: Website addresses chuck@retsource.com sean@retsource.com 17