Copyright © 2011 GRS – All rights reserved.

What employers are doing to control OPEB liabilities.

GFOASCOctober 10, 2011

Jack Beam ASA, EA, MAAA

Change is coming

Change is the law of life. And those who look only to the past or present are certain to miss the future. ► John Kennedy (1917-1963) 35th US President

Not everything that is faced can be changed, but nothing can be changed until it is faced.► James Baldwin (1924-1987) African-American writer

Progress is impossible without change, and those who cannot change their minds cannot change anything.► George Bernard Shaw (1856-1950) Irish writer

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Introduction

Roughly 80% of private sector employees have no retiree medical benefits

This presentation is based on our composite OPEB experience for more than 160 employers

This presentation will illustrate the impact of the most common designs adopted by our clients

To include a change – it must be adopted by the governing body and communicated to affected employees

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Retiree Health Care – Sample Employer

Census data from an actual SC employer 60% of retirees will cover their spouses Using SCRS retirement assumptions and

eligibilities►Average retirement age is approximately 61

Valuation Date June 30, 2010 A combination of SC plan design features

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Baseline plan is very generous

Employer pays 100% of the cost for retiree and spouse to maintain the same plan coverage up to Medicare eligibility.

Employer also pays 100% of the cost for a $300/month third-party Medicare supplement that covers retiree and spouse

Most Common Changes

Eliminate Benefit for New Hires Examine post 65 Benefits Examine Service & Age Eligibility Examine pre 65 Benefits Limit benefit payment period Examine Spousal Benefit

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Starting Point - A very generous plan

UAAL Amortization – Level % of Payroll, form of compensation. Participation rate assumed to be 100%. ARC per member ranks in top 1% of SC employers.

Employer Pays 100% for pre and post-65

Normal Cost $12,626,000

UAAL Amortization 6,940,000

ARC $19,566,000

ARC per member $8,400

Retiree Liability $48,048,000

Active Liability $113,556,000

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Option 1 – Eliminate benefit for new hires or introducing DC option for new hires

Eliminate benefit for employees hired after January 1, 2009.Because covered group is now closed to new entrants,

amortization changed to a level dollar approach.Normal Cost and AAL decrease slightly, but ARC increases.

Will see savings over time. Valuation date June 30, 2010.

Baseline Option 1

Normal Cost $12,626,000 $10,505,000

UAAL Amortization 6,940,000 9,584,000

ARC $19,566,000 $20,089,000

ARC per member $8,400 $8,600

% change 2%

Retiree Accrued Liability

$48,048,000 $48,048,000

Active Accrued Liability

$113,556,000 $111,546,000

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Option 2 – Hard Cap on Post-65 Benefit

“Hard cap” – Employer contribution is fixed at some amount. The cap can be at the current contribution level, an amount that is less, or an amount that is higher than the current level. In example above, the employer contribution is capped at the current amount.

Participation rate assumed to be 100%, but will likely decrease.

Baseline Option 2

Normal Cost $12,626,000 $6,682,000

UAAL Amortization 6,940,000 3,976,000

ARC $19,566,000 $10,658,000

ARC per member $8,400 $4,600

% change -45%

Retiree Accrued Liability

$48,048,000 $30,506,000

Active Accrued Liability

$113,556,000 $62,078,000

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Option 3 – Soft Cap on Post-65 Benefit

“Soft cap” – Maximum employer contribution will grow at a rate which is less than assumed medical inflation, 3.0% in this exampleEmployer contribution towards post-65 benefit will grow at 3.0% per year, medical inflation over 3.0% passed onto retirees. Change applies to current retirees as well. Sometimes hard cap evolves into soft cap.

Baseline Option 3

Normal Cost $12,626,000 $8,952,000

UAAL Amortization 6,940,000 5,117,000

ARC $19,566,000 $14,069,000

ARC per member $8,400 $6,000

% change -29%

Retiree Accrued Liability

$48,048,000 $37,269,000

Active Accrued Liability

$113,556,000 $81,900,000

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Option 4 – Eliminate Post-65 Spouse Benefit

Member’s benefit still paid for at 100% and assumed to increase with expected medical inflation.

Change applies to current retirees.

Baseline Option 4

Normal Cost $12,626,000 $10,130,000

UAAL Amortization 6,940,000 5,601,000

ARC $19,566,000 $15,731,000

ARC per member $8,400 $6,700

% change -20%

Retiree Accrued Liability

$48,048,000 $38,927,000

Active Accrued Liability

$113,556,000 $91,501,000

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Option 5 – Eliminate Post-65 Benefit

Impact of eliminating post-65 benefits is particularly large for employers in SCRS since the average retirement age is approximately 61.

For the remainder of the presentation, the “new baseline” will be a plan with no post-65 benefit which pays 100% of the costs for retiree & spouse up to age 65.

Baseline Option 5

Normal Cost $12,626,000 $4,201,000

UAAL Amortization 6,940,000 2,268,000

ARC $19,566,000 $6,469,000

ARC per member $8,400 $2,800

% change -67%

Retiree Accrued Liability

$48,048,000 $14,412,000

Active Accrued Liability

$113,556,000 $38,409,000

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Option 6 – 20 year service requirement with access to plan if service is less than 20 years

20 year service requirement is based on service with current employer, not total SCRS service. Retirees who do not meet the requirement for the full subsidy are allowed to keep their coverage by paying a blended active/retiree premium.

30% of retirees who are not eligible for the subsidy are assumed to maintain their coverage.

Baseline Option 6

Normal Cost $4,201,000 $2,563,000

UAAL Amortization 2,268,000 1,890,000

ARC $6,469,000 $4,453,000

ARC per member $2,800 $1,900

% change -32%

Retiree Accrued Liability

$14,412,000 $14,412,000

Active Accrued Liability

$38,409,000 $29,600,000

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Option 7 – 20 year requirement without access to plan if service is less than 20 years

In Option 7, retirees who are not eligible for the subsidy are not allowed to maintain their coverage (or are charged separate, stand-alone retiree premiums).

Baseline Option 6

Option 7

Normal Cost $4,201,000

$2,563,000

$2,362,000

UAAL Amortization 2,268,000 1,890,000 1,843,000

ARC $6,469,000

$4,453,000

$4,205,000

ARC per member $2,800 $1,900 $1,800

% change -32% -36%

Retiree Accrued Liability $14,412,000

$14,412,000

$14,412,000

Active Accrued Liability $38,409,000

$29,600,000

$28,511,000

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Option 8 – Employer’s share of premium is based on service – a common change

Employer’s share of premium is 5% for each year of service with current employer. After 20 years, employer pays 100% of premium.

Participation rate will vary based on the amount of subsidy. To simplify the example, the assumed participation rate is equal to the percentage of the premium the employer pays. For example, if employer pays 80% of the premium, 80% are assumed to take the benefit.

State of South Carolina has introduced a tiered approach for new hires.

Baseline Option 8

Normal Cost $4,201,000 $3,200,000

UAAL Amortization 2,268,000 2,074,000

ARC $6,469,000 $5,274,000

ARC per member $2,800 $2,300

% change -18%

Retiree Accrued Liability

$14,412,000 $14,412,000

Active Accrued Liability

$38,409,000 $33,891,000

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Option 9 – Hard cap on pre-65 benefit

No growth in employer’s share of pre-65 premiums.Insulates employer from inflation and passes all future cost increases in to the retirees.

Much more common in private sector.Impact will be felt down the road. Ten years from now, retiree premiums will be much

higher than current level.Participation rates will gradually decrease.

Baseline Option 9

Normal Cost $4,201,000 $2,707,000

UAAL Amortization 2,268,000 1,610,000

ARC $6,469,000 $4,317,000

ARC per member $2,800 $1,800

% change -36%

Retiree Accrued Liability

$14,412,000 $11,570,000

Active Accrued Liability

$38,409,000 $25,922,000

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Option 10 – Soft cap on pre-65 benefit

Growth in employer’s share of pre-65 premiums is limited to 3.0% per year.Insulates employer from medical trend and passes cost increases in excess of 3.0% to

the retirees. Hard cap may evolve into soft cap.Impact will be felt down the road. Ten years from now, retiree premiums will be much

higher than current level.Participation rates will gradually decrease.

Baseline Option 10

Normal Cost $4,201,000 $3,289,000

UAAL Amortization 2,268,000 1,862,000

ARC $6,469,000 $5,151,000

ARC per member $2,800 $2,200

% change -21%

Retiree Accrued Liability

$14,412,000 $12,601,000

Active Accrued Liability

$38,409,000 $30,752,000

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Option 11 – Limit Subsidy to 5 years

This change would have a greater impact on employees in PORS since they are more likely to retire before the age of 60. Should consider whether the 5 year limit should apply to disability retirement.

In this example, 30% of the retirees are assumed to maintain their coverage after the 5 year subsidy expires. The 5 year limit also applies to disability retirements.

A similar approach would be to base premiums on age.

Baseline Option 11

Normal Cost $4,201,000 $2,540,000

UAAL Amortization 2,268,000 1,621,000

ARC $6,469,000 $4,161,000

ARC per member $2,800 $1,800

% change -36%

Retiree Accrued Liability

$14,412,000 $14,412,000

Active Accrued Liability

$38,409,000 $23,345,000

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Option 12 – Only employees who retire after the age of 60 are eligible

This change would have a greater impact on employees in PORS. Delaying retirement for police officers may not be desirable.

In this example, the assumed rates of retirement have been decreased by 50% for ages less than 60. The age 60 requirement does not apply to disability retirements.

Baseline Option 12

Normal Cost $4,201,000 $2,368,000

UAAL Amortization 2,268,000 1,422,000

ARC $6,469,000 $3,790,000

ARC per member $2,800 $1,600

% change -43%

Retiree Accrued Liability

$14,412,000 $14,412,000

Active Accrued Liability

$38,409,000 $18,696,000

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Option 13 – No pre-65 benefit for spouses

No change to member’s benefit. Spouse would only be offered COBRA coverage.

Savings would be less if spouses are allowed to maintain their coverage at retiree’s expense.

Baseline Option 13

Normal Cost $4,201,000 $2,919,000

UAAL Amortization 2,268,000 1,634,000

ARC $6,469,000 $4,553,000

ARC per member $2,800 $1,900

% change -32%

Retiree Accrued Liability

$14,412,000 $11,128,000

Active Accrued Liability

$38,409,000 $26,919,000

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Option 14 – Members pay 100% of premium

In this example, the change would also impact current retirees. If change impacts current retirees, many retirees would drop coverage (not modeled). If current

retirees are grandfathered, new ARC would be 80% lower. Access to care is a benefit.In this example, retirees would be required to pay $350/month for retiree only coverage and

$750/month for retiree and spouse coverage. The only cost to the employer comes from the “implicit subsidy”.

Baseline Option 14

Normal Cost $4,201,000 $474,000

UAAL Amortization 2,268,000 416,000

ARC $6,469,000 $890,000

ARC per member $2,800 $400

% change -86%

Retiree Accrued Liability

$14,412,000 $5,308,000

Active Accrued Liability

$38,409,000 $4,387,000

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Option 15 – Employer contribution not tied to premiums

Insurance carrier has developed stand-alone retiree premiums. Eliminates the implicit subsidy. Retiree’s must pay higher retiree premiums to maintain coverage. Employer will provide a $300/month subsidy or $600/month subsidy if spouse is also covered. Access to care is a benefit.

Employer sets the amount of the contribution and future increases. Future increases assumed to be 3.0% per year in this example.

Employer can base the subsidy on years of service.

Baseline Option 15

Normal Cost $4,201,000 $1,402,000

UAAL Amortization 2,268,000 829,000

ARC $6,469,000 $2,231,000

ARC per member $2,800 $1,000

% change -64%

Retiree Accrued Liability

$14,412,000 $6,052,000

Active Accrued Liability

$38,409,000 $13,253,000

GRS’s SC Clients

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State’s Design

$300/mo Hard Cap

No Post-65

25 years service req.

No Post-65Plan Closed to New

Entrants

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Strategies for underlying health plan

Controlling costs►Disease and large case management►Centers of excellence►Wellness programs►Utilization reviews►Generic Rx►Mail-order RX plan►Medicare Advantage Plans►Increase deductibles/co-pays

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Establishing a Trust

Pros► Higher interest rate leads to lower liabilities► Can eliminate balance sheet liability or keep the balance sheet

liability from growing► Provides added benefit security and institutionalizes the benefit► Annual expense will decrease as unfunded liability decreases

Cons► Ties up capital, contributions no longer belong to employer► Investments may be restricted. Expected return may only be

between 5.0 – 5.5%. (clients without restrictions 7.0 to 7.5%)► Benefit may go away with future federal programs► Easier to change benefits if plan is unfunded

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Defined Contribution Plans

Types of DC arrangements► Retirement Health Savings Plan ► Health Savings Accounts► Health Reimbursement Arrangement► Flexible Spending Account

Each type of DC plan has it’s own set of advantages and disadvantages.

Usually done for new hires or employees below age 35.

Only 2 of our 160 clients have established DC arrangements to phase out the DB program

Defined Contribution Plans

Employees covered by DC plan may be eliminated from OPEB liability

Employees have a pool of money from which they purchase coverage

No guarantees Employer may allow retirees to purchase

coverage through the employer’s plan Pricing structure for retirees will

determine implicit subsidy

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Accounting changes may be imminent

Many people believe the proposed changes in pension accounting and reporting will apply to OPEBs.

The unfunded actuarial accrued liability will be included on the employer’s financial statement.

With no trust, a low discount rate will be required.

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GFOASC

Special thanks to all of our SC clients who made this presentation possible.

Special thanks to Mehdi Riazi.► Phone 469-524-1343► Email mehdi.riazi@gabrielroeder.com

Special thanks to Kevin V. Yokim, CPA, CGFO, who invited us to participate.

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GFOASC

Circular 230 Notice: Pursuant to regulations issued by the IRS, to the extent this presentation concerns tax matters, it is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding tax-related penalties under the Internal Revenue Code or (ii) marketing or recommending to another party any tax-related matter addressed within. Each taxpayer should seek advice based on the individual’s circumstances from an independent tax advisor.

This presentation shall not be construed to provide tax advice, legal advice or investment advice.

Readers are cautioned to examine original source materials and to consult with subject matter experts before making decisions related to the subject matter of this presentation.

This presentation expresses the views of the author and does not necessarily express the views of Gabriel, Roeder, Smith & Company.