Solving the OPEB
puzzle:
Strategy & Implementation
Girard Miller
Senior Strategist
PFM Group
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 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
The first rule of getting out of holes is to stop digging
Today’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
Your OPEB Game Plan:
An Affordable, Sustainable, Sufficient
Benefit Structure

Start with the numbers




Build a multi-disciplinary expert team




Actuarial data – artificial vs realistic ?
“True Cost” projections for status quo
Model the potential scenarios
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 Solutions

OPEB sustainability audit


Product: strategic map
Comprehensive OPEB strategic plan
Funding strategy & plan
Benefits design strategy
DB plan modifications
Hybrid plan for future
Governance & trust structure
Investment infrastructure: DB & DC
OPEB bond strategy
Sustainability 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?
Sustainability 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
OPEB 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
OPEB 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
Comprehensive OPEB Plan



Sustainability analysis
Strategic map
Funding analysis and plan


Benefits plan




Restructuring analysis
Retirees vs incumbents (older/younger) vs new
Governance and trust structure design
Investment infrastructure & strategies


PAYGO vs DB vs DC vs Hybrid vs partial-pay vs
OPEB bonds and multi-year timetable for action
DB and DC components
Benefits administration 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?
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-brainer
 ERISA, cost uncertainty, competitive pressures

Can taxpayers really afford a second DB plan?
 And is this actually a defined benefit?
The Ultimate Blank Check
Why use a defined benefit plan design for an UNDEFINED benefit?
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
Cost 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
Cost 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 costs

Optimize: DB for EE pickup, DC for ER
A Hybrid (Tiered) Plan Design:
Hypothetical Illustration


Full career benefits to retirees
Same deal for 20-year incumbents upon
attaining 30 years


Incumbents < 20 years earn ½ of previous
defined benefit and make the up rest with a
DC plan


Pro-rated if they serve less
Leverages tax laws in their favor for EE pickup
DC plan only for new employees
Funding:
Structural Alternatives

Pay-as-you-go

Alfred E Newman approach
 “What,
me worry?”
 Problem:

Partial actuarial funding


cash management discount rate hikes liability
Ramp up to full funding in 5 years
Non-qualified trust or agency fund

Or designated fund balance
 Does
not qualify for beneficial discount rate
Structural Alternatives

Pay-as-you-go and related variations

Fully fund the ARC using a DB structure

Defined Contribution plans
 Section 115 Integral Governmental Function trust
 VEBA
 Rabbi Trust
 401(h) plan
 Collective DC plan
 Issue: tax status of employee contributions
Structural 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 funds
Pre-funded with ARC funding
 and/or OPEB bonds


Statewide plan
The OPEB Trust Issue

OPEB Trust must meet minimal GASB
45 requirements to secure beneficiaries’
interests
 ER
contributions irrevocable
 Exclusive benefit per plan
 Protected from creditors

Source: GASB, Po 50.101
 However,
nothing prevents an “escape clause”
The OPEB Trust Issue

Investment authority is really the primary driver of
the ARC calculation’s discount rate
 Need an OPEB investment policy with broad
authority
 Preferably prudent person or broad multiasset-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

Internal management


CalPERS


Issues: Flexibility and asset/liability suitability
Private OPEB pools


Issue: Capacity and professional risk;
documentation and structure, fiduciary risk
Issues: Asset-liability match, fees, selection
process, oversight
Customized external management

Issues: Fees, selection & oversight,
documentation
OPEB Bonds


Similar to Pension Obligation Bonds
(Risk premium) “arbitrage” opportunity



Issue taxable debt
Seek investment returns > TIC of bonds
Can solve budgetary problems
Use 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

High success rates over long periods

Kansas City Fed publication
 99

percent success over rolling 20-year periods
100 percent success over 30 year periods
 And

after bear markets > 25% down
Independent financial planner study
 100
percent success over rolling 240-month
periods
 Lower success rates when withdrawals = 5%

Implication: separate benefits cashflows from longterm investment fund
The Business Cycle and the
Benefit Bonds Window
Benefits Bond
Window
27
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
See Girard’s New Benefits Bonds Paradigm at
http://www.governing.com/articles/0901gmillerc.htm
OPEB Bonds:
Further Observations

Highest success rates occur when issuance follows
outset of recessionary bear market



But -- why sell bonds to buy bonds?



Entry after stock indexes decline 20%
Current market lows offer extreme opportunity and
challenges
Fundamental flaw in the old POB model
OPEB strategy: sell only the equity share, amortize rest
Should issuance (or equity entry point) be multiphasic?


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 Strategies

OPEB-DB plan structures:

Start-up OPEB funds will lack the scale of
your jurisdiction’s pension fund
 Walk
before you run
 Equities-only strategy is worth considering for
start-up plans even without OPEB bonds

One size does NOT fit all
 Asset-liability
modeling required over long term
 Custom portfolio management for local plans

Who’s overseeing & doing the investing?
OPEB Investment Strategies:
Defined-Contribution features

DC 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 convenient
 Arguably


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
Already an example in California
 Employer makes fixed contirbution


Employees can make fixed contribution
also
All benefit payments are tax-free
 Actuarial analysis, like a pension plan
 Trustees then determine the affordable
level of benefits


For example: $XXX per year or Y% of
medical premium for an unmarried retiree
Benefits 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 backoffice capacity
Financial and HR staff must work together
Summary



Start with OPEB sustainability audit/assessment
Establish an initial strategic map
Work on cost containment


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


May require a labor relations strategy
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
Summary



Start with OPEB sustainability audit/assessment
Establish an initial strategic map
Work on cost containment


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


May require a labor relations strategy
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 Info

310.795.1354
MILLERG@pfm.com
or
 girardinmalibu@charter.net


Governing columns:

www.governing.com/articles/gmiller.htm
Questions?

Cost control and management?

OPEB bonds?

OPEB investments

GASB issues?

Other?