A new accounting standard is forcing public-sector finance chiefs to calculate the future value of total retiree health benefit assets or liabilities and include those figures on their companies’ balance sheets. For some, the downside numbers will be staggeringly high. Thus, if the government agencies that must comply with the standard don’t figure out how to address their unfunded liabilities soon, they could lose their investors’ confidence.
Indeed, the dilemma facing the finance departments of state and local governments parallels the one that corporations encountered more than 16 years ago when the Financial Accounting Standards Board implemented FAS 106. Government agency finance chiefs are now dealing with a fresh OPEB (other post-employment benefits) headache as they begin complying with the Government Accounting Standards Board’s similar standard for accounting for non-pension liabilities.
Not long ago, when corporations started using FAS 106, observers noted that companies — airlines and automakers in particular — had realized they had offered retirement benefits they couldn’t afford. For example, just a few years ago GM reported a $52 billion OPEB liability.
A similar story is occurring in the government sector. In 2004, the governmental equivalent of FASB adopted GASB 45, Accounting and Financial Reporting by Employers for Post-employment Benefits Other Than Pensions, which requires state and local governments to estimate their OPEBs and count them as a future liability.
Rather than use the current “pay as you go” system and account for retiree-benefit payout as they’re due, GASB 45 requires the agencies to account for the expenses as the benefits accrue for their current employees. Similar to the current government accounting system for pension plans, governments will now include an actuarially determined annual cost for OPEB obligations for current and future retirees on their financial statements each year.
The accounting standard doesn’t require governments to fund those future obligations. But the billions of dollars in liabilities estimated by actuaries cannot be ignored.
To be sure, governments had underfunding problems all along, observers say. “GASB 45 really doesn’t change anything,” says Warren Ruppel, director of government services for accounting firm Marks Paneth & Shron LLP. “Governments have had this liability, and their financial condition doesn’t change at all, although credit agencies were probably surprised at the size of the numbers to come out.”
The estimated numbers vary depending on a government’s size and financial standing. Examples of total unfunded OPEB liabilities include $53 billion for New York City; $22.9 billion for Maryland; $749 million for Utah; and $577 million for Charlotte, N.C.
So far, credit-rating agencies have been mum on specifically how such figures could affect their estimates of a state’s or municipality’s worth. In the meantime, they will closely watch how governments decide to bring their OPEB liabilities down—an area in which finance chiefs play a key role. In a report issued earlier this year, Fitch Ratings said managements that are “forward-thinking, anticipate potential problem issues, and take an active approach to minimizing or eliminating them” will be viewed positively.
Some of the solutions announced by governments include eliminating health-care subsidies for current employees, switching the health-care agreements to a defined-contribution plan, and creating a special trust fund. Others are mulling more creative ways to address GASB 45. Governments, for example, could issue OPEB bonds or introduce a state law to exempt itself from the standard.
Bring on the Actuaries
GASB 45 is being rolled out in phases over three years, with the largest governments — those with annual revenue of $100 million or more — required to start using the standard after December 15, 2006. The rule requires most states to have already hired actuaries to predict their liabilities based on Census data, health-care trends, mortality rates, and other factors.
So far, many government agencies have disclosed their actuaries’ estimates and the breadth of solutions they’re considering, observers say. For example, last week, California state controller John Chiang announced that the state has a $47.9 billion liability for its future health benefits of retirees. The 60-page actuarial report presents two scenarios California is contemplating: include an estimated $3.59 billion annual required contribution liability on its financial statement every year or create a trust fund to fully fund the state’s obligation. “As long as we come up with a methodical, responsible plan to pay for these future obligations, we will satisfy the bond and credit rating agencies, and we will fulfill our promise to state workers and to the citizens who depend on the state for vital public services,” Chiang said at a Sacramento press club meeting last week.
On the other side of the country, New York City has set up a trust fund for its OPEB liabilities and contributed $1 billion to it last year from its general fund. To be sure, that’s just a “small down payment” for its total $53 billion in unfunded liability for OPEBs, Ruppel told CFO.com.
Consider Texas, which has an estimated OPEB liability of $26.8 billion, according to Credit Suisse. State officials have taken a completely different approach there. Supported by state comptroller Susan Combs, the Texas House unanimously passed a bill last Friday that would exempt the state from GASB 45. The measure awaits Senate consideration. Rating agencies are likely to frown on the measure if it’s approved, however. Fitch Ratings has already said that it would consider noncompliance with GASB 45 a “weak management practice.”
Still, just as FAS 106 spurred many employers to think about the real costs of their long-term benefit plans, GASB 45 has compelled governments to revisit the promises previous administrations made to employees. Prior government leaders have been “moving the cost to future generations and keeping promises,” says analyst David Zion of Credit Suisse. “When you see the size of that promise measured in today’s dollars, you think, Wow, this is a pretty big promise, maybe we’re promising too much.”
The good news is that since government agencies are now taking the time to measure how much they truly owe, they can start managing it, he adds.