A risky business

Because the Governmental Accounting Standards Board (GASB) will soon require governments to disclose any unfunded actuarial accrued liability for other post-employment benefits (OPEB), such as post-retirement health care, a number of communities are exploring ways to finance those benefits. Some are even considering issuing bonds and then reinvesting the proceeds at a higher rate of return, following the model set by pension obligation bonds (POBs).

The Government Finance Officers Association (GFOA) is urging governments to exercise caution when considering the possibility of issuing OPEB bonds. Like POBs, OPEB bonds would increase a jurisdiction’s total debt, potentially lessen its financial flexibility, and could lead employees to demand increased benefits when they see the plan reporting a higher funded level — even though the government’s overall obligation would remain unchanged.

OPEB bonds pose several additional risks. For instance, it could be more difficult to determine the amount to borrow because future health care costs are harder to predict than the future amount of retirement income. Likewise, local governments might change their employee retirement benefits in the wake of GASB’s rules, once again making it difficult to determine how much to borrow. Moreover, there is no consensus on a reasonable funded ratio for OPEB, and legal and technical issues need to be resolved before trust funds can be established to pay future OPEB.

Because of those risks, GFOA suggests governments consider the following before issuing OPEB bonds:

• Allow sufficient time for a public policy discussion to occur to ensure that the concerns of all interested parties are adequately addressed;

• Consult with a financial advisor who is not expected to underwrite OPEB bonds;

• Compare the expected results of using OPEB bonds with the expected results of simply fully funding the amount to be contributed each year (i.e., the annual required contribution, or ARC); and also with the expected results of continuing to pay out benefits as they are needed;

• Wait until a trust fund is established and investment procedures and guidelines are in place before issuing the bonds; and

• Solicit the help of experts to establish an appropriate funded ratio.

The unfunded actuarial accrued liability for OPEB will be disclosed in the notes rather than reported on the face of financial statements. The financial statements themselves will be affected only as that amount is factored into annual employer contributions over a period of up to 30 years. Thus, the new GASB guidance on OPEB neither requires nor encourages the immediate financing of the unfunded actuarial accrued liability for OPEB. There is no more reason for a government to borrow today to finance the liability for future OPEB payments than there is for the parent of a small child to borrow today to finance the future costs of that child’s college education.

GFOA’s recommended practices can be found at www.gfoa.org under “Recommended Practices — Committee on Governmental Debt Management.”

The author is the director of the Technical Services Center for the Chicago-based Government Finance Officers Association.