Many states and local governments are taking steps to pre-fund health benefits for their retirees a move that could mean billions of dollars in new business for money managers.
The move is being spurred by the Governmental Accounting Standards Boards Statement 45 a new requirement that state and local governments begin including in annual financial statements the actuarial valuations of their overall post-employment benefits for fiscal years beginning after Dec. 15, 2006. In the past, agencies only had to list what they actually paid out in benefits on a pay-as-you-go basis.
To prevent bond ratings from plummeting under the weight of the huge new liabilities, some states and local governments including California, Maryland, South Carolina, Georgia, Nevada, Alabama and New York City have launched or have proposed new investment trusts to pre-fund the obligations.
Many other governments are considering following suit.
Were looking at all options and seeing whats in the best interests of the state, said Edward Woods III, spokesman for the Michigan Department of Management and Budget, Lansing.
Everybody is looking at this (pre-funding), said J. Richard Johnson, senior vice president and public sector health practice leader in the Washington office of The Segal Co., an actuarial and consulting firm.
The new accounting requirement is forcing state and local governments to disclose the present value of the total promised retiree health and other post-employment benefits, or OPEBs. A March 22 Credit Suisse Group report estimates that promised OPEBs will create a combined nationwide liability among state and local agencies exceeding $1.5 trillion. If the 26 states that currently fund their OPEBs on a pay-as-you-go basis begin pre-funding their plans, at least $35.6 billion in new investments could be generated annually, according to the Credit Suisse report.
Of course, the number would be much higher if we extended our scope to include the remaining states and local governments, the Credit Suisse report said.
Exactly how big the new pot of investment gold will be at the end of the GASB 45 rainbow is anyones guess, according to benefits industry analysts. Thats partially because some governments are balking at losing access to the money that pre-funding would require them to put into trusts. Once in a trust, legislators would not be able to use the money for other projects.
Some employers are concerned about the loss of that flexibility, said Paul Zorn, director of governmental research for Gabriel, Roeder, Smith & Co., a benefits consulting and actuarial services company based in Southfield, Mich.
Still, GASB 45 allows pre-funding jurisdictions to use a more favorable interest rate to calculate their OPEB liabilities a huge incentive to pre-fund. You can dramatically reduce the liability by pre-funding because you can use a higher discount rate when valuing the liability, said Michael Merlob, consulting actuary for Gallagher Benefits Services Inc., Boca Raton, Fla.
In Nevada alone, actuarial projections for its OPEB liability range from $1.6 billion with pre-funding to $4.1 billion without it, according to Leslie Johnstone, executive officer for Nevadas Public Employees Benefits Programs, Carson City.
Also, credit ratings agencies are going to look much more kindly on pre-funders, Mr. Merlob said.
Liability management plan
Most governments will start to pre-fund at least partially in some way, said Parry Young, director, public finance department, Standard & Poors, New York. We want to see a plan for how theyre going to manage the liability.
New York City created an OPEB trust last year, contributing $1 billion to the effort with plans to add $1.5 billion over the next two years, and charged the citys comptroller with investing trust assets, according to Raymond J. Orlando, director of media and investor relations for New York Citys office of management and budget.
• The $235.5 billion California Public Employees Retirement System, Sacramento, on March 1 announced a plan to allow all public employers in the state that contract for employee health benefits with CalPERS to contribute to a trust fund that will be invested for OPEBs. CalPERS spokesman Ed Fong said the system will manage the health trust virtually the same way it manages its pension assets, avoiding only investments not publicly traded such as private equity and private real estate partnerships. CalPERS spokeswoman Karen Perkins said the strategy allows us to leverage our in-house expertise and experience to help public employers pre-fund future OPEB costs.
• In Nevada, pending legislation would earmark $25 million to an OPEB trust, with investment responsibility given to the $19.5 billion Public Employees Retirement System of Nevada, Carson City. Theyre already set up with the infrastructure and personnel, Ms. Johnstone said, adding the state constitution limits investments to secured government instruments. Were funding as much as possible. Ms. Johnstone said.
• The Alabama Legislature in March approved a bill to create a pair of OPEB trusts to help pay health-care costs of retired teachers and state employees, according to Marcus H. Reynolds Jr., deputy director of the Retirement Systems of Alabama, Montgomery, which oversees $26 billion in state pension assets.
The state teachers trust has been funded with a $200 million surplus from the teachers existing Public Education Employees Health Insurance Plan. Funding for the state employees trust has yet to be determined, according to Mr. Reynolds.
The OPEB trusts will be overseen by the same board members that currently oversee the teachers and state employees pension and health insurance funds, respectively, Mr. Reynolds said. Everybody will just have a little bigger job, he said.
Mr. Reynolds said the assets in the trust fund would be generally invested the same way state pension plan assets are, but without an allocation for real estate and other alternative investments. It will be plain vanilla stocks and bonds, Mr. Reynolds said.
cMaryland has already set aside $200 million for an OPEB trust, according to Robin Sabatini, chief of staff of the Maryland Department of Budget and Management. The money, now in a dedicated state account, will be transferred to the trust July 1, 2008, with the investments managed by the same board that oversees the investments of the assets of the $35.4 billion State Retirement & Pension System of Maryland, Baltimore.
Ms. Sabatini said state law requires the $200 million to be invested conservatively while in the dedicated account. But once the assets are transferred to the trust, the assets will be invested by outside managers along the same lines that other state pension funds are invested.
A blue-ribbon panel, which has yet to be appointed, is also supposed to recommend by Dec. 31, 2008, what steps the state should take to address its estimated OPEB liability of $14.5 billion, Ms. Sabitini said.
cAs part of his proposed fiscal 2008 budget, South Carolina Gov. Mark Sanford proposed to set aside $439 million for an OPEB trust to help pre-fund the states $9 billion liability, but the states House of Representatives cut that to $200 million, according to Joel Sawyer, Mr. Sanfords press secretary. Its anybodys guess what the Senate will do, Mr. Sawyer said.
cGeorgia Gov. Sonny Perdue in his fiscal 2008 budget proposed setting aside $100 million for an OPEB trust, according to Bert Brantley, the governors press secretary. The governor has said that the earlier we can start, the easier its going to be to ensure that those commitments are met down the line, Mr. Brantley said, adding that its unclear how the governors proposal will look after state lawmakers finish their work on the budget.
One state already pre-funding its OPEB obligations is Ohio, which has been doing so since 1974, according to Scott Streator, director of health for the $77.6 billion Ohio Public Employees Retirement System, Columbus, which includes $12.8 billion in the states health care trust.
Under OPERS, public employers contribute 13.77% to 13.85% of their payroll into the state pension system each year; 5% of that contribution goes to the health care fund, Mr. Streator said.
OPERS spokesman Rich Baker said 73.1% of the assets of the health fund are managed internally, while the remainder is managed externally. The target asset allocation for the health care trust is 50% equity and 50% fixed income. The equity assets cover domestic equity, non-U.S. equity and real estate investment trusts, while the fixed-income component covers global bonds, Treasury inflation-protected securities short-duration bonds and less than 1% cash.