Section 115 Trust
Governments seeking to serve an essential governmental function, such as prefunding OPEB, can establish Section 115 ("governmental") trusts. Contributions to these trusts are unlimited; their investment earnings are not taxed; and benefits received by participants and beneficiaries are normally tax free. When established as an irrevocable trust for the sole benefit of participants and beneficiaries, these trusts meet Governmental Accounting Standard Board (GASB) 45 guidelines allowing government sponsors to reduce their reported OPEB liabilities. Medical Subaccount 401(h)
A second prefunding option, the 401(h) health benefits subaccount, serves as an OPEB trust established as a separate subaccount within an existing qualified pension plan. The subaccount is separate from the pension fund for accounting purposes, but the assets from both can be commingled for investing purposes.
Voluntary Employees' Beneficiary Association (VEBA) Section 501(c) (9) Trust VEBAs, the third OPEB prefunding mechanism considered here, typically function as independent, tax-exempt entities (trusts) existing for the benefit of a voluntary membership of active employees and retirees and their beneficiaries. Contributions are made on a pretax basis and distributions for qualified health care expenses are normally tax free. VEBAs allow for funding up to 100 percent of OPEB liability. To be tax-exempt, VEBAs need to obtain a private qualification letter from the U.S. Internal Revenue Service.
Prefunding Experience of Likely Adopters Establishing OPEB Trusts For jurisdictions that indicated they have established a prefunding vehicle, the logical follow-up question is whether they have started to prefund their liabilities by depositing funds into the trusts. Fully funding OPEB liabilities requires governments to contribute the actuarially determined Annual Required Contribution (ARC). The ARC reflects funding that is sufficient to cover the current year's OPEB costs (that is, the "normal cost") and the accrued liability amortized over an extended period of time (no more than 30 years). By including payment for the amortized unfunded liability, the ARC will likely be substantially higher in the near term-perhaps as much as five or even 10 times higher-than annual pay-asyou- go payments. Such short-term increases, however, should pay off in the long term because prefunding allows for the investment of trust assets. Investment earnings, in the long term, should reduce required contributions.
Over half the respondents that reported adopting an OPEB trust indicated that they have deposited at least some funds-over and beyond the current year costs-to prefund OPEB. This finding corroborates results reported for 2009 by the Government Accounting Office (GAO), in which some state and local governments responded that they fully funded the ARC, while others made partial ARC payments based upon the availability of additional resources. Though this represents some progress in local governments addressing their OPEB obligations, there is also room for improvement.
Since the release of the July 2009 comprehensive survey, the economy, insufficient revenues, and competing budget priorities have posed the greatest impediment to their plans.
The new brief finds that many jurisdictions are making sweeping changes in their retiree health care plans: o 36 percent have increased or plan to increase the years of service required to vest. o 11 percent have increased the retirement age. o 39 percent have eliminated or plan to eliminate retiree health benefits for new hires.
At the conclusion of the survey, respondents were asked an open-ended question seeking any additional comments regarding RHC and OPEB. A few respondents spoke directly to local governments' experiences with prefunding. No claim is made that such comments are representative of all local governments, but they do offer insights as to the challenges they face in both establishing OPEB trusts and meeting the associated ARC.
These results seem to support the view that, of the governments that establish trusts to prefund OPEB, many will gradually work their way up to fully funding the ARC, given that such full funding likely requires substantially larger annual payments-at least initially-than the pay-as-you-go (PAYGO) approach.
Read the full brief at www.tinyurl.com/howlocgovts.
Read the original 2009 survey at www.tinyurl.com/atacrossroads.
The Center also brings state and local leaders together with respected researchers and features the latest demographic data on the aging workforce, research studies, and news on health care, recruitment, and succession planning on its website, www.slge.org.