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January 30, 2007


Testimony From First Deputy Comptroller Thomas Sanzillo Regarding GASB 45 Accounting Change

First Deputy Comptroller Thomas Sanzillo today gave testimony to the New York State Assembly regarding the impact of GASB 45 on New York state and local governments. The testimony follows:


GASB 45 is intended to increase transparency in governmental financial statements so that government leaders, policy makers and taxpayers see the real costs of providing retiree benefits. Governmental entities that follow Generally Accepted Accounting Principles will now have to actuarially determine their retiree health liabilities and disclose those liabilities. We estimate that in New York this will affect about 430 or one-quarter of our local governments and all 700 school districts. It should be kept in mind that the majority of local governments in the State do not issue GAAP financial statements and don’t issue debt, and therefore will not be impacted by GASB 45 reporting requirements. But any government that offers this type of benefit will eventually have to face this challenge.

Let me emphasize that many governments, including New York State, have for decades promised medical and other benefits to employees when they retire. The initial impact of GASB 45 will be to increase transparency and reveal the true long-term cost of providing these post employment benefits. This is not a new liability. What is new is the requirement that governments accurately and fully disclose these commitments. These costs are not covered by the pension system; they are budgeted separately and are currently funded out of annual budget appropriations on a pay-as-you-go basis.

Let me briefly review the significance of these new accounting guidelines and their potential impact on State and local governments.

GASB, the Government Accounting Standards Board, is a national body that sets the standards for governmental accounting and reporting. By and large, these are accounting standards that governmental entities use when preparing financial statements. The Comptroller’s Office interprets these standards and issues advice and opinions on how the State and local governments should implement them.

GASB Statement 45 establishes accounting and reporting standards for Other Post-Employment Benefits (OPEB), which are primarily retiree health care benefits. Before GASB 45, governmental financial statements did not recognize the actuarially calculated accrued liability (the total amount that is currently owed for employees and retirees) or the annual required contribution (the amount necessary to fully fund that year’s actuarially calculated OPEB costs). GASB believes retiree health costs are a part of the compensation for services rendered by employees. Benefits are earned and obligations accrue during employment. Therefore, the current pay-as-you-go method failed to recognize the real cost of funding this liability when it was incurred. GASB 45 requires disclosure of this cost. The annual required contribution that is calculated under GASB 45 will include two components: the cost of the OPEB benefits that are being accrued currently by a government; and paying off the unfunded liability of the OPEB benefits that have been incurred in prior years. GASB 45 allows up to 30 years to pay off these past unfunded liabilities. As a result, the annual required contribution to fully fund the accrued OPEB liability is substantially larger than what is currently budgeted by most governmental entities.

Let me give you an example. The city of Rye in Westchester County has a population of 15,000 and a budget of approximately $33 million. The city currently pays $1.1 million for retiree health costs annually. The initial actuarial estimate for its total unfunded OPEB liability approaches $40 million, which would result in an annual required contribution of $4.4 million in the first year - $3.3 million more than what is budgeted by the city - to fully fund this liability over a 30 year period. Depending on the method adopted by the city to fund the liability the amount actually paid could be considerably less, but it will present a significant challenge as the city makes decisions on how to balance future budgets.

While GASB 45 disclosure is important, it also presents governments with significant long-term financial reporting and budgeting issues. Nationally, public sector retiree health liabilities have been estimated between $600 billion and $1.3 trillion. By comparison, the total outstanding value of all state and local government municipal bonds in the nation is between $2.1 and $2.6 trillion.

It is important to note that GASB 45 does not require governments to fund their liability. It does, however, lay out the rules if an entity decides to do so, and there are real benefits to doing so. Basically, a government that commits to funding its accrued liability is allowed to assume higher rates of return on its contributions as they accumulate, helping to lower the annual contribution from state and local budgets. 

While it is fiscally prudent to begin to fund these costs, many governments may not be able to meet their required annual contribution amount. But all governments need to develop plans to address these costs, and they can do it in several ways. First, they can set aside some amount of resources above their pay-as-you-go costs for future liabilities. For example, New York City is using budget surpluses as a funding source. Last year the City established an irrevocable health benefits trust fund and contributed $1 billion toward an estimated unfunded OPEB liability of $50 billion. The City intends to contribute another $1 billion to the trust this year and Mayor Bloomberg recently proposed adding an additional $500 million next year. New York City has reported record budget surpluses recently, and I commend the Mayor and the City Council for putting a portion of these resources aside to help reduce its unfunded OPEB liability.

Other governments have been addressing their retiree health liabilities by reducing benefits or sharing costs. In 2004, faced with an actuarial accrued liability of over $18 billion, the state of Ohio increased the expected contribution toward health insurance premiums that current employees and retirees with less than 30 years must pay. Similarly, the state of Alabama increased payments for health insurance premiums for certain employees, including smokers and those that retire with only a limited term of service. 

Still others have utilized financing techniques to fund their retiree health liabilities. For example, the city of Gainesville, Florida issued bonds to cover its unfunded actuarial accrued liability of $35 million. These bond proceeds will be deposited into a trust for future use. Another potential funding method is the sale of assets and the use of these proceeds to finance a portion of the liability.

Our office would suggest that the best way for the State and its local governments to address this issue is to move quickly toward quantifying retiree health liabilities using the most cost-effective means possible, and move thoughtfully but deliberately toward developing options to fund these costs.

The Office of the State Comptroller (OSC) can play a critical role in this discussion. We have moved expeditiously to help the State value its own OPEB liability. In consultation with the Department of Civil Service and the Division of the Budget, OSC has now chosen an actuarial methodology for measuring the unfunded accrued liability, and the method by which we will calculate the State’s annual required contribution. In doing so, we emphasized the need to choose an approach that produced relatively low costs and stable funding patterns over time, and we believe the recommended actuarial methods achieve those goals. 

As a result, the preliminary estimate of the State’s accrued OPEB liability (including SUNY) is nearly $47 billion. This produces an annual required contribution of $3.7 billion assuming that the liability is not fully funded. If the State were to commit to fully fund this obligation over 30 years, the annual required contribution is reduced to $2.4 billion. You can see the fiscal advantage to fully funding these costs and being able to assume a higher investment rate - in this case, 8 percent.  Even partial funding would help reduce that liability. The State’s current annual pay-as-you-go amount for retiree health benefits is $1.1 billion. In order to get a full picture of the State’s annual retiree health liability you subtract the current payment of $1.1 billion from the annual required contribution of $2.4 billion. The remaining outstanding annual unfunded liability for New York State is $1.3 billion.

The accounting work now being done keeps the State on schedule. No appropriations are required for the FY 07-08 budget.  It is now up to the Executive and the Legislature to decide how to address these costs. While I recognize that fully funding retiree health costs in the State budget may not be immediately feasible, it is essential that the State consider developing a funding plan. OSC stands ready to assist you in analyzing options and creating such a plan.

There are two very important reasons for doing so. First, as I just discussed, once a plan is in place and begins to be funded, either fully or partially, the higher rate of return on investment can substantially reduce the State’s unfunded liability and therefore the annual required contribution in subsequent years. Second, failure to develop a plan and make progress in paying down this unfunded liability could affect the State’s credit rating in the future, as the rating agencies have made clear.

OSC has also identified implementation issues associated with these new guidelines. For example, there are specific legal issues for both the State and local governments regarding the creation of irrevocable trusts in which potential OPEB funding would be placed. We have concerns as to whether any local government has the necessary authority to establish trusts by local enactment. Furthermore, there is some risk in funding OPEB by establishing an irrevocable trust that needs legal review. If circumstances change (for instance, if a national health insurance program were to be created) local governments may be unable to access resources placed in a trust fund for other municipal purposes.

The Legislature can play an important role by providing express authority for local governments to establish OPEB trusts. This would avoid any question as to the underlying authority to create these irrevocable trusts.  The legislation could also spell out the procedures for creating the trust and the terms and conditions of the trust, including circumstances when funds may be accessed.

We are also concerned about the costs associated with obtaining actuarial valuations, particularly for smaller local governments. Not only will the initial assessments be expensive, but these assessments must be updated every two to three years depending on the number of beneficiaries. The same care and attention that the State must give to this issue needs to be afforded to each unit of local government so they can accurately gauge their liability, and so State decision makers can have a clear understanding of the aggregate liability (based on uniform accounting methodology) facing all local governments. The prospect of managing trust funds is also complex and potentially expensive for local governments. The New York State Association of Counties has proposed the idea of pooling actuarial services and managing trust funds in which individual counties may choose to invest. We are supportive of that approach, and OSC could potentially assist with a broad range of services that would benefit local governments - by working with the Office of General Services to procure a State contract for actuarial services, by providing technical advice, and - should the Legislature decide - potentially managing pooled investments at local option. 

As people are living longer and the baby boom generation retires, we will start to see some instances where the number of retirees exceeds the number of active public sector employees. As health care costs continue to increase at several times the rate of inflation, the cost of health care benefits for employees as well as retirees will become increasingly burdensome to local governments. In many cases, the cost of providing health benefits already surpasses pension costs.

For example, the city of Rochester is projecting that the cost of providing health benefits in 2007-08 will be $25.8 million for employees and an additional $19.6 million for retirees, for combined health benefit costs of $45.4 million. In contrast, Rochester’s pension contributions in 2007-08 are estimated at $25.2 million. By 2011-12, the city is projecting that combined health benefit costs will total nearly $80 million while pension costs will be about $32 million.

Similarly, New York State’s current pay-as-you-go annual payment for health benefits already exceeds the State's pension contributions.

As the true actuarial accrued liabilities become known, they are likely to change the dynamics of future budget negotiations. Pressures to fund these liabilities could add more public debt to an already overburdened tax base. Longer term, there are both credit rating and budgetary implications from failing to address these liabilities in some fashion.

How New York State and its localities deal with this issue will have important implications for public policy at a time when many of our local governments are already facing mounting fiscal stress. We want to continue to work with the Executive and the Legislature as well as representatives of local governments to discuss these issues further. The creation of a task force to study these issues could be very beneficial, and we will be discussing this idea with the new Comptroller.

OPEB is an issue, like many that we face, that requires thoughtful and careful analysis. We have time, but no time to waste. Those individuals who are currently receiving these benefits, as well as those who will retire in the future, are depending on us to make decisions in ways that assure their continued health as well as the continued fiscal health of the governments for whom they have worked.



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