Ronald W. Nossek is a partner at BlumShaprio in Rhode Island. Nossek specializes in audits of government entities. He talks with Providence Business News about an ongoing issue related to retirement benefits known formally as other post-employment benefits.
The benefits, mostly related to health insurance for municipal workers, are a looming issue for cities and towns throughout the country. Nossek talks about the challenges, what municipal leaders should be thinking about and the risks of ignoring the issue into the future.
PBN: Can you explain briefly what makes up other post-employment benefits?
NOSSEK: Other post-employment benefits are payments to retirees, or on behalf of retirees, that typically include health care-related benefits such as medical, dental and vision. Some plans also include life insurance, disability and long-term care.
PBN: How are they causing headaches for the public sector?
NOSSEK: Prior to 2006, municipalities did not measure OPEB liability. For many years, rather than providing pay increases that would have immediate impacts on the budget, municipalities would promise greater benefits upon retirement, which would defer the budgetary impact of the benefit increase down the road. When the Governmental Accounting Standards Board issued GASB statements 43 and 45, the measurement and disclosure of the OPEB liability became a requirement.
At the time of adoption of 43 and 45, many municipalities were taken aback by the magnitude of the liability. After that, some municipalities created trust funds to put money aside with the ultimate goal of having a funded plan. Other municipalities – ones that were not in the financial condition to take this route – continued to pay for these benefits on a pay-as-you-go basis. With the cost of health care rising and the number of retirees increasing, the annual costs necessary to fund the benefits continue to increase.
While municipalities with established trust funds are in a better position than those managing on a pay-as-you-go basis, many cities and towns continue to struggle with managing the liability because investment earnings on the trust assets are being outpaced by the inflation on medical costs and increasing numbers on the retiree rolls.
PBN: For most municipalities, the unfunded levels for OPEB plans are daunting. How should elected leaders be thinking about tackling this issue?
NOSSEK: The unfunded levels for OPEB plans are daunting indeed. In governments where the unfunded liability is significant, the government should start thinking about several issues that are both short term and long term in nature:
- Evaluate your funding exposure: Obtain a full understanding of what the funding-contribution needs will look like over the next 15, 20 or 25 years. One of the benefits of such an analysis is that it will become very clear that continuing on a pay-as-you-go basis will likely become unsustainable.
- Address the long-term structural problems that exist in the plan: Consider new and reduced benefits for new hires moving forward; explore the ability to roll back benefits for incumbent employees (this could be difficult or even statutorily [unallowable]); and consider other cost-reduction options (tightening eligibility rules, employer group waiver plans, retiree drug subsidy programs).
- Consider ongoing strategies: Evaluate your current requirements for employee contributions and consider increasing the employee contribution percentage and consider the establishment of a defined-contribution OPEB benefit for new employees.
PBN: What are the options when it comes to opening trusts? Isn’t that expensive to set up?
NOSSEK: Generally, there are two primary options when considering an OPEB trust: Single-employer trusts or multiple-employer trusts. Generally, if the OPEB plan is not established within an existing qualified pension fund and a municipality wants to establish a trust, the municipality will open a Section 115 trust. An Internal Revenue Code section 115 trust is established by the government and becomes part of the governmental entity. Typically, a governance structure and/or governing body will be established as part of the establishment of the trust.
Other trusts less commonly used are voluntary employees’ beneficiary association trusts and IRC section 401(h) trusts. VEBA trusts are employee associations that operate separately from the sponsoring government. IRC section 401(h) trusts are separate accounts established within an existing qualified pension fund that is dedicated to paying OPEB benefits. VEBA and 401(h) trusts require the government to obtain an Internal Revenue Service determination letter prior to creating the trust. An IRC section 115 trust can be established by a government without an IRS private letter ruling.
There is a cost to establishing an OPEB trust, however it is important to ensure the trust is set up and administered properly. As such, if an OPEB trust is being considered, the government should consult qualified legal counsel to assist in the process.
PBN: What’s the risk of continuing to pay these benefits on a pay-as-you-go basis?
NOSSEK: The risk of continuing along on a pay-as-you-go basis is that the costs over time are most likely going to become unsustainable. Once that point is reached, government executives and elected officials will have to face the reality of a reduction in the short-term cost demands for public services to fund the unsustainable long-term benefit costs.