Investment Policy for OPEB Massachusetts Collectors & Treasurers Association 42 nd Annual School August 14, 2012 Presented by: Dan Sullivan of Sullivan, Rogers & Company and Joshua Paul of Bartholomew & Company
GASB 43/45 The Governmental Accounting Standards Board released GASB 43 and GASB 45, new standards requiring state and local government agencies to report OPEB obligations on financial statements. 2
GASB 43 GASB 43 established uniform financial reporting standards for other post employment benefit plans, creating a framework for OPEB Trust reporting. It is important that your OPEB Trust falls under these reporting requirements. 3
GASB 45 GASB Statement 45 was designed to shed light on costs and financial obligations related to post employment benefits other than pensions. Rather than incurring costs after employees retire, GASB 45 requires public sector agencies to report obligations as they are incurred. This additional information can better position governmental bodies to prepare for and address future costs being incurred now. 4
The Primary Benefit of the OPEB Trust: Reducing the OPEB Cost & Liability One of the primary benefit of establishing an OPEB trust is to invest assets long-term to earn a rate of return higher than the return on general operating funds. A higher discount rate translates into lower accounting costs and liability for retiree benefits. 5
The Primary Benefit of the OPEB Trust: Reducing the OPEB Cost & Liability GASB 43 and 45 require government employers to recognize benefits during an employee s period of employment. The difference between the accrual cost of the retiree benefits within the given year and amount paid out during the year (in the form of benefit payments, insurance premiums, or payments to a trust) is known as the net OPEB obligation, or balance sheet liability. 6
The Primary Benefit of the OPEB Trust: Reducing the OPEB Cost & Liability One of the principal assumptions used for determining the accrual cost, called the annual required contribution (ARC), is the discount rate. This rate is calculated based on the estimated long-term yield on investments used to finance the employer s retiree benefits. 7
But Simply Establishing an OPEB Trust is not Enough Contributions to the trust must be significant enough to accumulate assets. GASB 43 and 45 allow for a higher discount rate only if the retiree benefits are paid by assets that have been invested in such a way as to achieve a higher long-term rate of return. Otherwise, the existence of the fund will have little effect on the OPEB cost and liability. 8
Possible Advantage of Trust with No Assets There is much discussion whether it is beneficial to create a trust when there are no substantial assets. Preparedness for the future Establishing the trust and putting procedures in place for managing the trust might allow you to act more quickly once funds do become available. 9
Potential Risk of a Trust with No Assets Low Commitment from Trustees It may be difficult to find responsible trustees for a trust with few or no assets. Their duties and actions would have more form than substance. 10
Potential Risk of a Trust with No Assets Reaction of credit-rating agencies Credit-rating agencies are most concerned with an employer s ability to manage OPEB costs and liabilities. On the one hand, the creation of an OPEB trust could be a positive sign to the rating agencies that you are actively seeking ways to manage costs associated with your OPEB obligation. On the other hand, an unfunded trust might signal to the rating agency an inability to follow through on funding and do little to demonstrate effective cost-management of retiree benefits. 11
Basic Steps for Establishing an OPEB Trust Fund Complete actuarial valuations of OPEB obligations. Adopt MGL 32B, Section 20 Draft legal documents to establish your local government s trust fund. Set your investment policy. Contribute to the fund. Provide oversight. 12
Qualifying as a formal trust You can look to your pension plan as a model for understanding the workings of an OPEB trust. Much like the pension plans, to qualify as a formal trust: Contributions to trust must be irrevocable. Assets must be dedicated to providing plan benefits to retirees and their beneficiaries. Assets must be protected from creditors. 13
Qualifying as a formal trust You want your OPEB trust to qualify for tax exemption under the Internal Revenue Code. This allows for earning to accumulate tax free. Contributions made to the trust and benefits paid out of the trust would also be tax exempt. Special-purpose government trust: IRC Section 115 Voluntary employee beneficiary association (VEBA): IRC Section 501C(9) Sub-account of a pension trust: IRC Section 401(h) 14
Qualifying as a formal trust Section 115 Trust Integral part of the government entity that performs an essential government function. The plan sponsor s governing body (Board of Selectmen, City Council, School Board) is responsible for the jurisdiction s singleemployer 115 trust. Independent governance is not required but is sometimes provided for. If an independent governing body is not designated, an oversight committee should be formed. Voluntary Employees Beneficiary Association (VEBA) Established under IRC Section 501(c)(9). Typically operate independently of the sponsoring employer and involve participants in their governance. 401(h) Trust A separate account, established within an existing qualified pension trust. 15
Qualifying as a formal trust You are not required to apply for an IRS private ruling when creating a section 115 Trust. You must obtain an Internal Revenue Service determination letter before creating a VEBA or 401(h) Trust. 16
Types of Plans Single-Employer Trusts Employers need to decide on the scope of the trust, subject to applicable federal and state law. Many OPEB trusts simply provide for prudent investment of plan assets and perform no other administrative functions except disbursements, which can be handled by the trust or employer s staff or third party administrator. Single-Employer Trusts are typically IRC Section 115 Trust.
Types of Plans Agent multiple-employer plan (agent plan) - An aggregation of single employer plans, with pooled administrative and investment functions. Separate accounts are maintained for each employer so that the employer's contributions provide benefits only for the employees of that employer. A separate actuarial valuation is performed for each individual employer's plan to determine the employer's periodic contribution rate and other information for the individual plan, based on the benefit formula selected by the employer and the individual plan's proportionate share of the pooled assets. The results of the individual valuations are aggregated at the administrative level.
Types of Plans Cost-sharing multiple-employer plan - A single plan with pooling (cost-sharing) arrangements for the participating employers. All risks, rewards, and costs, including benefit costs, are shared and are not attributed individually to the employers. A single actuarial valuation covers all plan members, and the same contribution rate(s) applies for each employer.
Management of the Trust The terms of the trust would be formalized in a trust agreement. This trust agreement would establish a board of trustees and specify the number of trustees, the composition of the board, member terms, board powers and duties, uses of the funds, and procedures related to the administration and oversight of the trust. 20
Ongoing Administrative Considerations The board of trustees would oversee the trust and meet regularly to handle administrative policies and procedures. Your own retirement system provides a good example of the administrative responsibilities that would be involved in the management of an OPEB trust. Separate financial statements would be developed for the trust, and the local government s financial statement would refer to the trust s financial statements with relevant information extracted. The trust would also require an annual audit by an outside party with the findings reported in the financial statements. 21
Management of the Trust The board of trustees will establish investment policy. It may select an investment advisor. It may retain a separate custodian of the funds. It may determine the local government s contribution, which could be lower than or as high as the full accounting cost of the benefits based on an actuarial valuation using GASB 43 and 45 guidelines. 22
Trustees Fiduciary Responsibility Duty of Loyalty As fiduciary, you must invest and manage Trust assets. Duty of Diversification A fiduciary trustee shall prudently diversify investments unless the trustee reasonably determines that the beneficiaries are better served without diversifying. Duty to Control Costs A fiduciary may incur only costs that are appropriate and reasonable in relation to the assets, the purposes of the trust and the skill of the fiduciary. Delegation of Investment and Management Functions Trustees may delegate certain investment and management functions. The trustee shall exercise reasonable care, skill and caution in selecting an agency, establishing the scope of the delegation and monitoring the agent s performance and compliance with stated terms of the delegation. 23
Trustees Fiduciary Responsibility Adherence to the Trust You are expected to carry out all duties and terms outlined in the Trust document. Duty of Care You are expected to show the same degree of skill and attention as any prudent investor would in a similar situation. Management decisions are judged not by the actual results, but rather the soundness of the decision-making process that led to those results. This is known as the Prudent Investor Standard. Duty to Make the Trust Productive As fiduciary, you are expected to obtain returns commensurate with the terms of the trust, the needs of the beneficiaries and prevailing economic and financial conditions. 24
General Funds MGL Chapter 44, Section 55. Public funds on deposit; limitations; investments Maturities of one year or less, very restrictive investment guidelines, no equities 25
Trust Funds MGL Chapter 44, Section 54. Investment of trust funds No limit on maturities for fixed income Fewer than 30 equities on Massachusetts Legal List of Investments 26
OPEB Funds MGL Chapter 203C, Section 3. Prudent person rule Broad investment universe Governed primarily by Investment Policy Statement 27
OPEB Investment Policy Goal is to provide a clear understanding of the objectives, goals, risk tolerance, and investment guidelines established for the OPEB trust. Extremely important document for the municipality, oversight board, and investment advisor 28
OPEB Investment Policy Introduction: Section details rationale for creating an investment policy statement Purpose and execution of policy Attempt to avoid trustee risk 29
OPEB Investment Policy Objective: Section explains risk/return characteristics of longterm vs. short-term investments Reinforces point of using both stocks and bonds to achieve account objective 30
OPEB Investment Policy Strategy: Section details asset allocation targets for portfolio Includes general asset classes: Fixed Income Equities Alternatives Investments Cash 31
OPEB Investment Policy Investment Instruments: Section states that funds will be invested utilizing Chapter 203C, Section 3 (prudent person rule) for security selection May also include list of specifically approved investment vehicles 32
OPEB Investment Policy Specific Risks: Section details specific risks that should be considered when implementing and reviewing OPEB investments, namely: Credit Risk Custodial Risk Concentration of Credit Risk Interest Rate Risk Foreign Currency Risk 33
Thank You! Questions? 34