However, public employers (especially local entities) should remember that GASB-type calculations are valuable in the “off-season” too. This post discusses one of the biggest missed opportunities for cost-saving: Measuring the cost impact of changes to retiree OPEB before contracts are signed.

In the corporate world, it is almost unheard of for employers to adjust their retiree benefit promises without first measuring the cost impact. This is especially true of collectively-bargained pension and retiree health plans. Both sides hire an actuary to estimate the cost of these benefits and bring their numbers to the table.

However, many local public entities may not be used to this process yet. During the biennial GASB 45 valuation process, we still encounter contractual changes to retiree benefits that occurred after the prior actuarial study but were not reported to us in the interim. There are two main problems with this approach:

1. It’s not prudent to make or change benefit promises without estimating the cost impact. Suppose an employer is renegotiating a contract and there is a proposal to change the retiree health benefit from “fully-paid single premiums until age 65” to “fully-paid family premiums for up to 5 years”. Is this a cost increase or decrease? There’s no way to know unless you measure the cost beforehand.

2. GASB 45 requires a full actuarial valuation if there is a significant change in benefit promises.  As we discussed in a previous post, public employers shouldn’t wait until the next scheduled actuarial study (2 or 3 years, depending on plan size) to reflect significant plan changes in their financial statements.

As public employers get acquainted with valuing the actuarial cost of their OPEB benefits for GASB 45 financials, they should embrace the philosophy of “measure it before you promise it” for any changes to these benefits. Public sector OPEB are becoming front page news and administrators must proceed cautiously when adjusting benefits or making new promises.

In addition to the standard 2 or 3-year cycle, GASB 45 rules also state that:

“A new valuation should be performed if, since the previous valuation, significant changes have occurred that affect the results of the valuation, including significant changes in benefit provisions, the size or composition of the population, … or other factors that impact long-term assumptions.”

Below are some factors which can compel a new valuation sooner than the standard 2 or 3- year cycle:

• Establishing an OPEB trust.
  • If a revocable trust is established, then this won’t change the unfunded liability for accounting purposes, but it can affect the liability discount rate. See our previous post on the effect of OPEB trusts on GASB 45 discount rates.
  • If an irrevocable trust is established, the discount rate may be impacted and the assets will decrease the plan’s unfunded liability. This will likely reduce the GASB 45 annual accounting expense (Annual OPEB Cost).

• Large change in retiree health benefits. This includes changes to plan coverage levels (e.g., deductibles and co-pays), premiums, or eligibility for benefits.

If employment contracts are amended to scale back (or increase) the amount of retiree health benefits paid by the employer, then this can have a big impact on plan liabilities as costs are shifted to retirees. See our previous post on the leveraging effect of OPEB liabilities.

Plan changes will affect the per-member costs and will likely affect future assumptions about retiree participation in the plan. A new valuation should be performed to capture this liability increase (or decrease) as soon as possible for the year of change.

• Large change in number of employees or retirees. If there are significant employee layoffs/retirements or if many retirees drop coverage due to increasing costs, then a new valuation may be needed to accurately capture the effect on the plan’s GASB 45 liabilities.

There are likely many other scenarios which would require a new GASB 45 study. This is especially true in the case of a plan on the 3-year cycle where there is an increased likelihood of a significant change in the “off-cycle” periods.

Important considerations for OPEB plans:

- Determining the implicit rate subsidy (health cost in excess of the average premium). This may include expected health care costs for disabled officers that are significantly higher than for non-disabled individuals.  Another factor to consider is whether or not disabled officers are Medicare-eligible. If so, how does that reduce the expected health care costs?

- Determining the direct subsidy (portion of the premium paid by the employer).  This is the premium cost not only for disabled officers, but also for dependents.

- Length of benefit coverage. Unlike regular retiree health care which can begin around age 50 to 55 for officers, disability health care begins much earlier.  Often officers disabled in the line of duty are in their 30’s and 40’s.

The earlier start creates significant additional costs.  For example, the direct subsidy for a disabled officer age 40 could exceed $150,000 ($6,000 in premium per year for 25 years) – and this does not include any costs for dependent coverage or the implicit subsidy.

- Participation assumptions. Most, if not all, officers elect the employer’s coverage upon disability due to the employer’s direct subsidy of the premium.  In contrast, many regular retirees will waive the employer’s coverage if they receive little or no direct subsidy.

- Accounting for reimbursements. A number of states reimburse the employer for the direct subsidy costs. We haven’t found any written guidance on proper accounting, so we checked with GASB.  They said they would probably view the reimbursement as a “voluntary nonexchange transaction” accounted for under GASB 33, which would not reduce an employer’s GASB 45 liability.   This would be similar to GASB’s view of the Federal Medicare Part D reimbursement known as the Retiree Drug Subsidy (RDS).

How to ensure that your plan is valued appropriately:

To determine if your OPEB liability appropriately addresses the impact of disabled officers, you should:

- Understand your state and local health care rules for officers disabled in the line of duty.

- Identify any disabled officers you have and the amount they contribute to continue coverage.

- Consult with your actuary to determine if the OPEB liability is your responsibility or if it is the responsibility of another higher level of government.

The participation assumption has a direct and leveraged effect on OPEB liabilities.  For example, if the assumption is that 60% of employees are assumed to elect coverage at retirement, but the actual “crystal ball” rate is 40%, then the plan’s liability is 1½ times what it should be.  As a result of healthcare reform, similar examples may become a reality that employers and actuaries should address proactively. 

How will healthcare reform affect participation rates?  That’s kind of a grey area.  How grey?  “Charcoal” as Fletch would say.

Participation rates will be different in the future due to anticipated cost-saving changes to retiree plans by employers.  Recently, 61% of the companies included in an Aon Hewitt survey were either already evaluating or expected to evaluate their long-term retiree medical strategy by the end of 2011.

Another factor affecting participation rates is that retirees will be able to comparatively shop the benefits, features and costs of their employer’s plan with private and state-run exchange plans.  It is inevitable that some retirees will find a plan, and not their employer’s plan, that provides a better value and/or fit of benefits.

What’s the next step?  Be proactive and determine your organization’s long-term goals for retiree healthcare.  This involves learning what options are or will be available to retirees, strategizing as to which options best meet your goals and consulting with your actuary to determine the impact that changes will have on your OPEB costs.

 What it is:

 A non-deductible 40% excise tax paid by the coverage provider (employer and/or insurer) on the value of health plan cost in excess of certain thresholds. Currently, most plans are well below the thresholds, but are likely to exceed them in the next decade. This is because the thresholds will be indexed at CPI-U which is significantly lower than medical inflation rates affecting plans.

Purpose of the provision:

One of the goals of the Patient Protection Affordable Care Act (PPACA) was to lower long-term healthcare costs. By their nature, plans with generous benefits implicitly encourage participants to maximize their usage and thus cause higher medical costs. This provision seeks to discourage high-cost plans by leveling a tax on “excessive” benefits and possibly help fund healthcare reform.

Important considerations for retiree health plans:

Health plan costs for early retirees, which are often significantly higher than employee costs, may exceed their thresholds sooner, even though thresholds for early retirees are slightly higher than thresholds for employees.

Combining early retiree and Medicare eligible retiree costs is allowed and can keep plans under the retiree thresholds longer. Prescription drug costs for Medicare retirees on your plan may be another area to reduce cost by considering other options for these retirees.

If your plan is self-insured, then you are the coverage provider paying the tax. You will need to decide whether to reduce benefits to avoid the tax or how the additional cost will be allocated by you and/or the participants.

If your plan is fully-insured, then the insurer is on the hook for the tax. However, I suspect insurers will pass the tax to the employer through higher premiums. For many public sector employers with implicit rate subsidy OPEB liabilities, the effect should be minimal since the additional cost will be paid by the retiree who pays the premium. It’s possible this could slightly decrease OPEB costs if some retirees are swayed to search for other non-employer options.

Next steps:

To be proactive, employers have a couple of steps that they can take now to explore how they’ll be affected by the PPACA “Cadillac Tax”. These include:

Determine if and when your plan is expected to exceed the thresholds. Start with your current premium rates (plus FSA, HSA and HRA contributions) and project out what you think they will be in 2018.

Strategize as to your options for managing your plan’s costs to stay under thresholds or at least to delay the day when you will exceed them.

A recent Governing article provides a good summary of the relevant issues for public employers. Many of these ideas are equally applicable to private sector retiree health and OPEB plans. I thought it would be useful to summarize some of these points and add a couple of other considerations.

- If a retiree medical plan offers post-65 coverage to retirees, it is often through a Medicare supplement plan which just pays costs that aren’t covered by Medicare. If Medicare payments for benefits decrease, then this will increase the costs paid by the employer plan.

- Suppose that changes to the Medicare program are extreme and it starts paying a premium subsidy instead of paying for benefits. In this situation, Medicare would pay a fixed monthly cost while private insurers (or employers with self-insured plans) would end up paying for the variable benefits. How might this affect employers’ willingness to offer post-65 coverage?

- Lower benefit levels or higher out-of-pocket costs for post-65 coverage could force older employees to stay on the job longer to maintain their active health coverage. How would this affect your workforce demographics and active health plan costs?

It’s really too soon to speculate on what Medicare reform might ultimately look like. However, it’s not too early to consider a range of possibilities and what risks they pose to your plan. At some point Medicare reform will become a reality and plan sponsors should be thinking now about how this could affect their plans.

The last time we blogged about this, the ERRP money was going fast.  Now the urgency is clear.

So if you’ve been thinking about applying, it’s now or never.   Elvis says so.

So, if you’re thinking about applying, it’s time to make your move.  The application process isn’t as bad as it initially appeared.  Our last ERRP post outlines how to go about it.

The retiree healthcare promises measured under GASB 45 generally consist of two pieces: a gross health claims component (i.e., the expected cost of retiree health coverage) and a premium offset component (i.e., the amount that retirees pay for their coverage). The net OPEB liability is just the difference between these two elements. The following example illustrates how a small change in either of the input components can have a much larger effect on the net liability result. We call it the “leveraging” effect.

In Scenario 1, we see that if claims increase by 5% more than expected then the net liability increases by 25%. Similarly, Scenario 2 shows a net liability decrease of 20% if premiums increase by 5% more than expected. Although the variance in gross liability and premium is relatively mild, in both cases the net liability change is leveraged specifically because it is a “net” amount.

The point is that a leveraged change can occur whenever we are dealing with a net difference between two larger pieces. OPEB liabilities often fit this description. Moreover, the leveraging is compounded as the gross claims and premium offset components get closer in value. This is why the GASB 45 Implicit Subsidy liability has the potential to be quite volatile.

Public plan sponsors who are used to dealing with pension liabilities under GASB 27 may be accustomed to relatively stable liabilities from year to year. However, the retiree healthcare promises measured under GASB 45 will likely be more volatile. This is especially true as plan sponsors fine-tune details like health claims and premiums during the first few GASB 45 actuarial studies.

We’ve been watching the ERRP since its inception (posts 1, 2, 3, 4), and didn’t think the $5 billion allocation would last long. A July 2010 EBRI article estimated that it would last two years – and it might go even faster than that.   The EBRI article estimates the average reimbursement at about $2,000 per early retiree (Figure 4 on page 5: $2,544m / 1.3m = $1,957) – but there can be huge variations for  your own retiree group.

Many of our clients have applied for the ERRP and have been accepted. For employers that haven’t yet, there’s still time.  And the application process isn’t as onerous as it initially appeared.

Here’s what you need to do:

1. Check with your health insurer to see if you’re likely to have any individual early retiree claims above $15,000.  For midsize and large public-sector employers in Minnesota, Iowa, Indiana and Florida it’s almost a given – because subsidized early retiree coverage (the GASB 45 implicit rate subsidy) is mandated in those states.

2. Fill out and submit the ERRP application. Your health insurer can help with the trickiest parts of the application, i.e. cost control provisions and estimated reimbursements.

3.  Once your application is approved, follow the process on the ERRP website to obtain reimbursements. Your health insurer will have an important role in the reimbursement process, since you won’t usually know when you have an eligible claim.