Retiree health: funding, design and the GASB 75 discount rate

For most governments, the retiree health liability under GASB 75 is larger than it feels. The benefit is often modest, sometimes only access to the active plan at the retiree's own cost, and yet the liability runs to tens or hundreds of millions of dollars because it is measured as a long-term promise, discounted at a low rate, with health care trend applied for decades. Understanding why the number is what it is leads directly to the decisions that can change it.

Where the discount rate comes from

GASB 75 does not let a government choose its discount rate. For an unfunded plan, the rate is the yield on a 20-year tax-exempt general obligation municipal bond index rated AA/Aa or higher, as of the measurement date. That rate has been low by historical standards for most of the past fifteen years, and a low rate means a high liability.

For a plan with assets in a qualifying trust, the rate is a blend. Projected benefit payments are compared with the trust's projected fiduciary net position, year by year. Payments the trust is projected to cover are discounted at the long-term expected return on trust assets. Payments it is not projected to cover are discounted at the municipal bond rate. The single rate that reproduces the same present value is the discount rate.

The practical effect is that putting assets in a trust can lower the liability twice, to the extent the trust is projected to cover benefit payments. The assets reduce the net liability directly, and the higher blended discount rate reduces the total liability as well. For a government paying benefits from the operating budget, funding even a portion of the actuarially determined contribution through a trust can reduce the reported net OPEB liability by far more than the dollars contributed.

To qualify, the trust must be irrevocable, dedicated to providing OPEB to plan members and legally protected from the creditors of the employer and the plan administrator. Section 115 trusts are the common vehicle for governments; the trust document and investment policy determine the expected return assumption the actuary can support.

The implicit subsidy

Governments that charge retirees the full premium often assume they have no liability. They usually do. When retirees under 65 are covered in the same risk pool as active employees and pay the same blended premium, the premium understates their expected claims and the active employees' premiums are higher as a result. GASB 75 requires that implicit subsidy to be measured as a benefit, using age-adjusted claims costs rather than premiums. For a plan with a large pre-65 retiree population, the implicit subsidy can be most of the liability.

The design levers and what each one moves

Post-65 coverage. Moving Medicare-eligible retirees from a supplemental plan to a Medicare Advantage arrangement, or providing a defined contribution toward an individual Medicare plan through an exchange, typically reduces cost substantially while preserving coverage. Group Medicare Advantage pricing has been favorable for several years; whether it remains so is a trend assumption, and the plan design should be able to adjust.

Pre-65 coverage. Options include a health reimbursement arrangement with a fixed employer contribution, an employer contribution capped in dollars or as a percentage of a reference plan, or access-only coverage with the implicit subsidy measured and funded. Each shifts trend risk from the employer to the retiree in a different proportion.

Eligibility. Age and service requirements, the treatment of spouses and survivors, and whether future hires are eligible at all. Closing the benefit to new hires reduces the liability slowly, over a generation, but it caps the exposure.

Cost sharing and caps. A fixed-dollar employer contribution, or a cap that grows at a stated rate below health care trend, converts an open-ended promise into a defined one and removes most of the trend risk from the liability.

Each lever has a different effect on the liability, on the annual budget and on retirees, and the three do not move together. A change that reduces the GASB 75 liability sharply may do little for this year's cash cost, and a change that saves cash this year may barely touch the liability. The decision needs all three columns.

Funding policy

A funding policy answers three questions: how much to contribute each year, how to amortize the unfunded liability and what to do when results differ from assumptions. The actuarially determined contribution is the usual anchor, with a closed amortization period of 20 to 30 years and a level-percentage-of-payroll or level-dollar pattern. Rating agencies and bond buyers read the OPEB disclosures, and a credible funding policy, even one that phases in over several years, is viewed differently from a liability that is simply reported.

Our approach

We measure the liability, including the implicit subsidy, from the plan's own claims and enrollment data. We then model the design options and funding policies together, showing for each the effect on the GASB 75 liability, the annual budget and retirees, over a 20-year horizon. Finance teams receive the valuation report, the disclosure tables and a decision summary the governing body can act on.

This article is general information about the topics discussed and is not actuarial, legal or tax advice for any specific plan or employer.