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Solving the OPEB puzzle:Strategy & ImplementationSolving the OPEB puzzle:Strategy & ImplementationGirard MillerGirard Miller Senior Strategist
PFM Group
GASB 45 Implementation:Status Report
GASB 45 Implementation:Status Report
GASB 45 Phase 1 & 2 ARC and UAAL now calculated in most places
But here’s what has NOT been done:
GASB 45 Phase 1 & 2 ARC and UAAL now calculated in most places
But here’s what has NOT been done:
GASB 45 Implementation:Status Report
GASB 45 Implementation:Status Report
But here’s what has NOT been done: Comprehensive strategic plans Assessment of sustainability
Full cost using average lives for actuarial amortization
Realistic medical cost inflation estimates Long-term funding strategy that taxpayers and tax
base can support Plan design and redesign for long-term
efficiency and affordability Tiered multi-generational benefits Hybrid plan designs with both DB and DC features
But here’s what has NOT been done: Comprehensive strategic plans Assessment of sustainability
Full cost using average lives for actuarial amortization
Realistic medical cost inflation estimates Long-term funding strategy that taxpayers and tax
base can support Plan design and redesign for long-term
efficiency and affordability Tiered multi-generational benefits Hybrid plan designs with both DB and DC features
The first rule of getting out of holes is to stop digging
Today’s Session TopicsToday’s Session Topics
Sustainability audit and strategy map
Comprehensive OPEB strategic plan
Benefits Cost Containment
Structural Alternatives (Benefits Plan Design)
Alternative Funding and Financial Strategies The OPEB and Benefits Bonds Window of 2009
Governance structure
Sustainability audit and strategy map
Comprehensive OPEB strategic plan
Benefits Cost Containment
Structural Alternatives (Benefits Plan Design)
Alternative Funding and Financial Strategies The OPEB and Benefits Bonds Window of 2009
Governance structure
Your OPEB Game Plan:An Affordable, Sustainable, Sufficient Benefit Structure
Your OPEB Game Plan:An Affordable, Sustainable, Sufficient Benefit Structure
Start with the numbers Actuarial data – artificial vs realistic ? “True Cost” projections for status quo Model the potential scenarios
Build a multi-disciplinary expert team Avoid professional biases and myopia Figure out who will herd the cats and play
referee Your Goal: Total-Cost Plan Efficiency in Long
Run Strategies
Consider various alternatives Think outside the box Look beyond “getting by until next year”
Start with the numbers Actuarial data – artificial vs realistic ? “True Cost” projections for status quo Model the potential scenarios
Build a multi-disciplinary expert team Avoid professional biases and myopia Figure out who will herd the cats and play
referee Your Goal: Total-Cost Plan Efficiency in Long
Run Strategies
Consider various alternatives Think outside the box Look beyond “getting by until next year”
The Path to Sustainable Long-term OPEB SolutionsThe Path to Sustainable
Long-term OPEB Solutions OPEB sustainability audit
Product: strategic map Comprehensive OPEB strategic plan
Funding strategy & planBenefits design strategy
DB plan modificationsHybrid plan for future
Governance & trust structureInvestment infrastructure: DB & DCOPEB bond strategy
OPEB sustainability audit Product: strategic map
Comprehensive OPEB strategic planFunding strategy & planBenefits design strategy
DB plan modificationsHybrid plan for future
Governance & trust structureInvestment infrastructure: DB & DCOPEB bond strategy
Sustainability AuditSustainability Audit
Have you determined whether your taxpayers can ever afford to maintain the status quo, indefinitely?
Are your first-round GASB 45 data truly representative of probable future costs?
Have you determined whether your taxpayers can ever afford to maintain the status quo, indefinitely?
Are your first-round GASB 45 data truly representative of probable future costs?
Sustainability AuditSustainability Audit
Have you determined whether your taxpayers can afford to maintain the status quo, indefinitely?
Are your first-round GASB 45 data truly representative of probable future costs?Amortization periods
30 years vs incumbents’ average service lives and retirees’ expected lives
Medical cost inflation assumptions
Have you determined whether your taxpayers can afford to maintain the status quo, indefinitely?
Are your first-round GASB 45 data truly representative of probable future costs?Amortization periods
30 years vs incumbents’ average service lives and retirees’ expected lives
Medical cost inflation assumptions
OPEB sustainability auditOPEB sustainability audit
Model future cost streams Assess costs vs. fiscal capacity
Comparable to analysis that rating agencies would employ
Overlay expected OPEB cost streams on other competing demands for resources
Will services suffer in order to perpetuate current benefits?
For what purpose?
Labor market competitive analysis and “reasonable total compensation” analysis
Model future cost streams Assess costs vs. fiscal capacity
Comparable to analysis that rating agencies would employ
Overlay expected OPEB cost streams on other competing demands for resources
Will services suffer in order to perpetuate current benefits?
For what purpose?
Labor market competitive analysis and “reasonable total compensation” analysis
OPEB Strategic MapOPEB Strategic Map
Byproduct of OPEB sustainability audit
Forms basis of a more complete comprehensive OPEB mgmt plan
Directional and strategic, w/ some tactics
Avoids “muddling into a mess”
Lays out the next steps and path to long-term solvent solutions
Identifies key players, timelines, critical path and end-game objectives
Byproduct of OPEB sustainability audit
Forms basis of a more complete comprehensive OPEB mgmt plan
Directional and strategic, w/ some tactics
Avoids “muddling into a mess”
Lays out the next steps and path to long-term solvent solutions
Identifies key players, timelines, critical path and end-game objectives
Comprehensive OPEB Plan
Comprehensive OPEB Plan
Sustainability analysis Strategic map Funding analysis and plan
PAYGO vs DB vs DC vs Hybrid vs partial-pay vs OPEB bonds and multi-year timetable for action
Benefits plan Restructuring analysis Retirees vs incumbents (older/younger) vs new
Governance and trust structure design Investment infrastructure & strategies
DB and DC components Benefits administration strategies
Sustainability analysis Strategic map Funding analysis and plan
PAYGO vs DB vs DC vs Hybrid vs partial-pay vs OPEB bonds and multi-year timetable for action
Benefits plan Restructuring analysis Retirees vs incumbents (older/younger) vs new
Governance and trust structure design Investment infrastructure & strategies
DB and DC components Benefits administration strategies
Cost Containment Strategies
Cost Containment Strategies
This is a key part of the strategic map
What is the actual legal obligation today? Is there a property right?
Should you freeze the existing plan?Tier the benefits to ramp costs down?
This is a key part of the strategic map
What is the actual legal obligation today? Is there a property right?
Should you freeze the existing plan?Tier the benefits to ramp costs down?
Cost Containment Strategies
Cost Containment Strategies
Defined Benefit vs. Defined Contribution (DC)/Hybrid
This is eventually the most fundamental issue
In corporate America, the decision is a no-brainerERISA, cost uncertainty, competitive pressures
Can taxpayers really afford a second DB plan?And is this actually a defined benefit?
Defined Benefit vs. Defined Contribution (DC)/Hybrid
This is eventually the most fundamental issue
In corporate America, the decision is a no-brainerERISA, cost uncertainty, competitive pressures
Can taxpayers really afford a second DB plan?And is this actually a defined benefit?
The Ultimate Blank CheckThe Ultimate Blank Check
Why use a defined benefit plan design for an UNDEFINED benefit?
Cost Containment in a DB structure
Cost Containment in a DB structure
Properly define a full career E.g., 30 years of service and Social Security
eligible
Raise the benefits age to a “Get Real” number Social Security is already age 66-67 Require Medicare eligibility Very difficult with public safety, of course
But does the paradigm need to change?
Pro-rate benefits or actuarially adjust for earlier retirements E.g. 20 years of service at age 65 gets 2/3 benefit
Properly define a full career E.g., 30 years of service and Social Security
eligible
Raise the benefits age to a “Get Real” number Social Security is already age 66-67 Require Medicare eligibility Very difficult with public safety, of course
But does the paradigm need to change?
Pro-rate benefits or actuarially adjust for earlier retirements E.g. 20 years of service at age 65 gets 2/3 benefit
Cost Containment, cont’dCost Containment, cont’d
Cap Costs: hard cap or CPI cap
Cost-sharing with retirees
Deductibles
Co-pays
Employee % of premium
Assigning retirees to separate risk pool E.g. Orange Co example
Cap Costs: hard cap or CPI cap
Cost-sharing with retirees
Deductibles
Co-pays
Employee % of premium
Assigning retirees to separate risk pool E.g. Orange Co example
Cost Containment, cont’dCost Containment, cont’d
Require an active employee contribution if none exists now
Increase the existing employee contribution rate
Install a “half-and-half” hybrid DB-DC plan to cut and cap employer costsOptimize: DB for EE pickup, DC for ER
Require an active employee contribution if none exists now
Increase the existing employee contribution rate
Install a “half-and-half” hybrid DB-DC plan to cut and cap employer costsOptimize: DB for EE pickup, DC for ER
A Hybrid (Tiered) Plan Design:
Hypothetical Illustration
A Hybrid (Tiered) Plan Design:
Hypothetical Illustration Full career benefits to retirees Same deal for 20-year incumbents upon
attaining 30 years Pro-rated if they serve less
Incumbents < 20 years earn ½ of previous defined benefit and make the up rest with a DC plan Leverages tax laws in their favor for EE
pickup DC plan only for new employees
Full career benefits to retirees Same deal for 20-year incumbents upon
attaining 30 years Pro-rated if they serve less
Incumbents < 20 years earn ½ of previous defined benefit and make the up rest with a DC plan Leverages tax laws in their favor for EE
pickup DC plan only for new employees
Funding:Structural Alternatives
Funding:Structural Alternatives
Pay-as-you-go Alfred E Newman approach
“What, me worry?”Problem: cash management discount rate hikes
liabilityPartial actuarial funding
Ramp up to full funding in 5 years
Non-qualified trust or agency fundOr designated fund balance
Does not qualify for beneficial discount rate
Pay-as-you-go Alfred E Newman approach
“What, me worry?”Problem: cash management discount rate hikes
liabilityPartial actuarial funding
Ramp up to full funding in 5 years
Non-qualified trust or agency fundOr designated fund balance
Does not qualify for beneficial discount rate
Structural AlternativesStructural Alternatives
Pay-as-you-go and related variations
Fully fund the ARC using a DB structure
Defined Contribution plansSection 115 Integral Governmental
Function trustVEBARabbi Trust401(h) plan Collective DC plan
Issue: tax status of employee contributions
Pay-as-you-go and related variations
Fully fund the ARC using a DB structure
Defined Contribution plansSection 115 Integral Governmental
Function trustVEBARabbi Trust401(h) plan Collective DC plan
Issue: tax status of employee contributions
Structural AlternativesStructural Alternatives
Pay as you go Alfred E Newman approach “What, me worry?”
Defined Contribution plans VEBA vs. 115 vs CDC vs other trust forms Issue: tax status of contributions
Governmental trust fundsPre-funded with ARC funding and/or OPEB bonds
Statewide plan
Pay as you go Alfred E Newman approach “What, me worry?”
Defined Contribution plans VEBA vs. 115 vs CDC vs other trust forms Issue: tax status of contributions
Governmental trust fundsPre-funded with ARC funding and/or OPEB bonds
Statewide plan
The OPEB Trust IssueThe OPEB Trust Issue
OPEB Trust must meet minimal GASB 45 requirements to secure beneficiaries’ interests
ER contributions irrevocable Exclusive benefit per planProtected from creditors
Source: GASB, Po 50.101However, nothing prevents an “escape
clause”
OPEB Trust must meet minimal GASB 45 requirements to secure beneficiaries’ interests
ER contributions irrevocable Exclusive benefit per planProtected from creditors
Source: GASB, Po 50.101However, nothing prevents an “escape
clause”
The OPEB Trust IssueThe OPEB Trust Issue
Investment authority is really the primary driver of the ARC calculation’s discount rate Need an OPEB investment policy with broad
authorityPreferably prudent person or broad multi-
asset-class Most municipal plans are using 7-ish % rates But, if the plan adopts all-equity strategy for
initial years, discount rate could be higher until portfolio is fully diversified
Especially important with OPEB bond strategy
Investment authority is really the primary driver of the ARC calculation’s discount rate Need an OPEB investment policy with broad
authorityPreferably prudent person or broad multi-
asset-class Most municipal plans are using 7-ish % rates But, if the plan adopts all-equity strategy for
initial years, discount rate could be higher until portfolio is fully diversified
Especially important with OPEB bond strategy
Basic OPEB Investment Options
Basic OPEB Investment Options
Internal management Issue: Capacity and professional risk;
documentation and structure, fiduciary risk CalPERS
Issues: Flexibility and asset/liability suitability
Private OPEB pools Issues: Asset-liability match, fees, selection
process, oversight Customized external management
Issues: Fees, selection & oversight, documentation
Internal management Issue: Capacity and professional risk;
documentation and structure, fiduciary risk CalPERS
Issues: Flexibility and asset/liability suitability
Private OPEB pools Issues: Asset-liability match, fees, selection
process, oversight Customized external management
Issues: Fees, selection & oversight, documentation
OPEB BondsOPEB Bonds Similar to Pension Obligation Bonds (Risk premium) “arbitrage” opportunity
Issue taxable debt Seek investment returns > TIC of bonds
Can solve budgetary problemsUse interest-only amortization during recession
Cost caps are suggested GFOA policy statement
Risks and due diligence Timing: business cycle risk
Lessons from POBs in the late 1990s
Similar to Pension Obligation Bonds (Risk premium) “arbitrage” opportunity
Issue taxable debt Seek investment returns > TIC of bonds
Can solve budgetary problemsUse interest-only amortization during recession
Cost caps are suggested GFOA policy statement
Risks and due diligence Timing: business cycle risk
Lessons from POBs in the late 1990s
OPEB Bonds:Historical Analysis
OPEB Bonds:Historical Analysis
High success rates over long periodsKansas City Fed publication
99 percent success over rolling 20-year periods100 percent success over 30 year periods
And after bear markets > 25% downIndependent financial planner study
100 percent success over rolling 240-month periods
Lower success rates when withdrawals = 5% Implication: separate benefits cashflows from long-
term investment fund
High success rates over long periodsKansas City Fed publication
99 percent success over rolling 20-year periods100 percent success over 30 year periods
And after bear markets > 25% downIndependent financial planner study
100 percent success over rolling 240-month periods
Lower success rates when withdrawals = 5% Implication: separate benefits cashflows from long-
term investment fund
The Business Cycle and the Benefit Bonds
Window
The Business Cycle and the Benefit Bonds
Window
Benefits Bond Window
27
The New Benefits Bonds Paradigm: POBs and OPEB-
OBs
The New Benefits Bonds Paradigm: POBs and OPEB-
OBs Issue only during recessionary window, not any
time Invest only in equities initially
Why sell bonds to buy bonds?Eventually migrate to balanced asset allocation
Requires a separate POB trust OPEB plans can set up new integrated OPEB trust
But not if a pooled investment is used Enables surplus equity returns to pay off debt Properly rewards taxpayers for the added risk they absorb
Prevents future earnings from funding another benefits increase that inevitably causes yet another deficit
Issue only during recessionary window, not any time
Invest only in equities initiallyWhy sell bonds to buy bonds?Eventually migrate to balanced asset allocation
Requires a separate POB trust OPEB plans can set up new integrated OPEB trust
But not if a pooled investment is used Enables surplus equity returns to pay off debt Properly rewards taxpayers for the added risk they absorb
Prevents future earnings from funding another benefits increase that inevitably causes yet another deficit
See Girard’s New Benefits Bonds Paradigm athttp://www.governing.com/articles/0901gmillerc.htm
OPEB Bonds:Further Observations
OPEB Bonds:Further Observations
Highest success rates occur when issuance follows outset of recessionary bear market Entry after stock indexes decline 20% Current market lows offer extreme opportunity and
challenges But -- why sell bonds to buy bonds?
Fundamental flaw in the old POB model OPEB strategy: sell only the equity share, amortize
rest Should issuance (or equity entry point) be
multi-phasic? Should be 60-65% into equities; suggest first sale @
33% Avoid single-point-of-entry market risk
Highest success rates occur when issuance follows outset of recessionary bear market Entry after stock indexes decline 20% Current market lows offer extreme opportunity and
challenges But -- why sell bonds to buy bonds?
Fundamental flaw in the old POB model OPEB strategy: sell only the equity share, amortize
rest Should issuance (or equity entry point) be
multi-phasic? Should be 60-65% into equities; suggest first sale @
33% Avoid single-point-of-entry market risk
http://www.governing.com/articles/0807gmmw.htm
Investment StrategiesInvestment Strategies
OPEB-DB plan structures:Start-up OPEB funds will lack the scale of
your jurisdiction’s pension fundWalk before you runEquities-only strategy is worth considering
for start-up plans even without OPEB bondsOne size does NOT fit all
Asset-liability modeling required over long term
Custom portfolio management for local plansWho’s overseeing & doing the investing?
OPEB-DB plan structures:Start-up OPEB funds will lack the scale of
your jurisdiction’s pension fundWalk before you runEquities-only strategy is worth considering
for start-up plans even without OPEB bondsOne size does NOT fit all
Asset-liability modeling required over long term
Custom portfolio management for local plansWho’s overseeing & doing the investing?
OPEB Investment Strategies:Defined-Contribution
features
OPEB Investment Strategies:Defined-Contribution
featuresDC plans:
Can parallel the 457 or 401(a) plan menu
Piggy-back on the 457 plan: most efficient Less confusing to employees
Target date funds are convenientArguably the best default in a startup plan
If free-standing, consider limited investment menu
AND, you should consider a . . . . .
DC plans:Can parallel the 457 or 401(a) plan
menuPiggy-back on the 457 plan: most efficient Less confusing to employees
Target date funds are convenientArguably the best default in a startup plan
If free-standing, consider limited investment menu
AND, you should consider a . . . . .
“Collective Defined Contribution” OPEB Trust
Fund & Plan
“Collective Defined Contribution” OPEB Trust
Fund & PlanAlready an example in CaliforniaEmployer makes fixed contirbution
Employees can make fixed contribution also
All benefit payments are tax-freeActuarial analysis, like a pension planTrustees then determine the
affordable level of benefits For example: $XXX per year or Y% of
medical premium for an unmarried retiree
Already an example in CaliforniaEmployer makes fixed contirbution
Employees can make fixed contribution also
All benefit payments are tax-freeActuarial analysis, like a pension planTrustees then determine the
affordable level of benefits For example: $XXX per year or Y% of
medical premium for an unmarried retiree
Benefits AdministrationBenefits Administration
Important to avoid letting the tail wag the dog
Lowest-cost administrators typically do not bundle other services Why buy costly insurance or a
“wrapped”product just to get a benefits administrator?
An OPEB DC plan administrator may have a partnering claims payment firm with back-office capacity
Financial and HR staff must work together
Important to avoid letting the tail wag the dog
Lowest-cost administrators typically do not bundle other services Why buy costly insurance or a
“wrapped”product just to get a benefits administrator?
An OPEB DC plan administrator may have a partnering claims payment firm with back-office capacity
Financial and HR staff must work together
SummarySummary
Start with OPEB sustainability audit/assessment Establish an initial strategic map Work on cost containment
May require a labor relations strategy Seriously and objectively study DB vs. DC-Hybrid
Consider freezing existing plan Possible to piggyback a DC plan on 457
Consider all your financing options Could include OPEB bonds once the window opens
Investments infrastructure for both DB and DC OPEB governance and trust: start out right Develop a comprehensive OPEB strategic plan
Assemble an unbiased, multi-disciplinary team
Start with OPEB sustainability audit/assessment Establish an initial strategic map Work on cost containment
May require a labor relations strategy Seriously and objectively study DB vs. DC-Hybrid
Consider freezing existing plan Possible to piggyback a DC plan on 457
Consider all your financing options Could include OPEB bonds once the window opens
Investments infrastructure for both DB and DC OPEB governance and trust: start out right Develop a comprehensive OPEB strategic plan
Assemble an unbiased, multi-disciplinary team
SummarySummary
Start with OPEB sustainability audit/assessment Establish an initial strategic map Work on cost containment
May require a labor relations strategy Seriously study DB vs. DC-Hybrid or a new ‘CDC’
Consider freezing existing plan Possible to piggyback a DC plan on 457
Consider all your financing options Could include OPEB bonds during recession
Investments infrastructure for DB and DC OPEB governance and trust: start out right Identify optimal benefits administrator Develop a comprehensive OPEB strategic plan
Assemble the right unbiased, multi-disciplinary team
Start with OPEB sustainability audit/assessment Establish an initial strategic map Work on cost containment
May require a labor relations strategy Seriously study DB vs. DC-Hybrid or a new ‘CDC’
Consider freezing existing plan Possible to piggyback a DC plan on 457
Consider all your financing options Could include OPEB bonds during recession
Investments infrastructure for DB and DC OPEB governance and trust: start out right Identify optimal benefits administrator Develop a comprehensive OPEB strategic plan
Assemble the right unbiased, multi-disciplinary team
Girard’s Contact InfoGirard’s Contact Info
310.795.1354
[email protected] [email protected]
Governing columns:www.governing.com/articles/
gmiller.htm
310.795.1354
[email protected] [email protected]
Governing columns:www.governing.com/articles/
gmiller.htm
Questions?Questions?
Cost control and management?
OPEB bonds?
OPEB investments
GASB issues?
Other?
Cost control and management?
OPEB bonds?
OPEB investments
GASB issues?
Other?
