OPEB Options

 

Pay-As-You-Go

The simplest and cheapest option in the short run is to continue pay-as-you-go. However, at some point in the future pay-as-you-go will become much more expensive than the ARC or fixed bond payments. Pay-as-you-go will result in annually increasing NOO for GASB 75 purposes. This in turn will cause higher OPEB UAAL and ARC amounts, due to the inability to apply a higher investment return assumption to the calculation of these amounts, which might become a ratings factor.


OPEB Trusts


Funding may consist of just the ARC or a larger portion of the UAAL, for which purposes the municipality may choose to use OPEB Bonds. GASB 75 does not require OPEB liabilities to be funded, or if funded, to use an irrevocable trust. However, the existence of GASB 75 creates strong incentives to establish such a trust. OPEB trusts generally must satisfy at least the following three requirements: exemption from federal income tax (not only income on investment of trust assets but contributions to the trust must not be treated as income to the employee or retiree); a qualified trust for GASB 75 purposes (irrevocable, protected from creditors and dedicated solely to providing benefits in accordance with the OPEB plan); and have diverse investment options including equities. Funding a trust offers the ability to apply a higher investment return assumption in the actuarial assumption, creating a lower OPEB UAAL and ARC than pay-as-you-go. The trust must be able to invest in a broad range of investments. This includes investing in equities in order to use a higher investment rate of return in calculating the UAAL and ARC.

There are three different options for an OPEB trust: 115 trust, 501(c)(9) trust and 401(h) account. All of these OPEB trusts are named for the section of the Internal Revenue Code where their exemption from federal income tax is derived. An OPEB trust may be a single-employer trust established by and for a single municipality or a multiple-employer trust established by an association or other collection of municipalities for membership by any interested municipality or by specific categories (such as cities, counties, school districts, etc.) A 115 trust is considered exempt from federal income tax either because it is an integral part of a single governmental entity or because it serves an essential governmental function of one or more governmental entities. This is the type of trust most municipalities are likely to use, whether alone or in combination with other municipalities.

A 501(c)(9) trust is also known as a “Voluntary Employees’ Beneficiary Association” or VEBA trust. This type of trust is frequently used by the private sector for funding health benefits. Requirements of a VEBA trust include voluntary membership (which is deemed satisfied if membership imposes no detriment and is required of all employees or if mandated by collective bargaining agreement) and that the trust be controlled by its membership (either directly or through representatives or designated trustees, or if a collective bargaining agreement specifically designates the trustees). A 401(h) account is a separate account in a tax-qualified pension fund for health benefits of retirees, their spouses and dependents. A major limitation of a 401(h) account is that the aggregate actual contributions to this account cannot exceed one-quarter of the total actual contributions to the pension fund after the date on which the account is established. Another factor to consider is that funds in a 401(h) account may not be diverted or used for any other purpose, including pension income benefits.


OPEB Bonds


The benefits of OPEB bonds include interest rate savings (comparing bond interest costs against the investment return assumption/discount rate used in calculating the UAAL and ARC), arbitrage opportunities and budget relief (when ARC is greater than debt service). Another benefit is reduced UAAL and ARC by fully funding a qualified trust versus pay-as-you-go or funded internal reserve plans. Although debt service on OPEB bonds (like the ARC) will generally be higher than pay-as-you-go costs for the first few years, pay-as-you-go costs (and resulting ARC costs and NOO) are likely to increase sharply, and after a few years exceed the cost of debt service and continue to grow thereafter. Finally, rating agencies will be evaluating a municipality’s strategy for managing its OPEB liability. Several rating agencies have indicated that OPEB bonds could be considered a positive favor in a municipality’s general credit evaluation.

The possible disadvantages of OPEB bonds include replacing negotiable or even discretionary OPEB obligations with immutable bond obligations, the concentration of investment risk through lump-sum deposit compared to spreading market timing risks by making ARC deposits annually, and possibly negative arbitrage.



For more information, contact Jeremy Langley at 850.552.5224 or Nicolle Bournival at 850.701.3630.