OPEB Trust Investment Return

Many municipalities, school districts, and other governmental entities have established OPEB trusts as a way of starting to prefund their postretirement benefit promises to employees. In addition to the perceived fiscal responsibility of prefunding OPEB benefits, setting aside assets can also help the plan sponsor’s GASB 45 accounting.

This post deals with certain situations where the anticipated accounting relief from establishing an OPEB trust isn’t as great as expected. This generally occurs when trust assets are invested in very conservative investments and/or a revocable trust is established instead of an irrevocable trust.

Recall the following two important items that affect GASB 45 accounting:

– The Unfunded Actuarial Accrued Liability (UAAL). This is the portion of accrued liability for which dedicated assets have not yet been set aside. The UAAL is a significant determinant of the annual GASB 45 accounting expense.

– The discount rate is the basis for determining the present value in today’s dollars of expected future OPEB payments. It is based on the long-term expected return on assets that will be used to pay OPEB benefits. The higher the discount rate, the lower the present value of liabilities.

So, setting aside asset in an irrevocable trust will lower a plan sponsor’s UAAL and their GASB 45 accounting expense. However, a sponsor must carefully consider how those dedicated assets will be invested once they are in the trust fund since that decision will determine the liability discount rate.

Consider the case where a plan sponsor establishes an irrevocable trust and funds the entire AAL (i.e., their UAAL becomes $0). However, as with many investors nowadays, they are hesitant to put trust assets into the stock market and instead invest in very short-term bonds (with low yields) and money market securities.

This conservative investment portfolio is expected to have a long-term return of about 2.5%. The plan sponsor’s previous discount rate for an unfunded plan was 4.0% (based on a long-term expectation for their general funds). The net result is that the lower discount rate (and resulting higher liabilities) significantly counteracts the impact of trust prefunding on their GASB 45 accounting results.

A similar, but less desirable, situation can occur if a revocable trust is established and trust assets are invested very conservatively. In this case not only does the AAL increase (because of the lower discount rate), but the revocable trust assets are not allowed to reduce the UAAL under GASB 45 accounting rules. The only benefit of this situation for the plan sponsor is that they have set money aside with the intent of prefunding their OPEB benefits.

There’s nothing inherently wrong with the situations described above, they just don’t have the accounting benefits that the plan sponsor may have been hoping for. The main takeaway is that plan sponsors need to consider all of the possible accounting repercussions of prefunding OPEB benefits and investing the trust assets.