Selecting the Best Funding Strategy for Your OPEB Trust

Bottom Line Up Front

• When determining the best OPEB funding strategies, you must consider all of your liabilities, funding tangibly important things like a new fire truck, new elementary, etc. which means we can’t give you a one-size-fits-all solution. 
• There are many different funding strategies available such as flat funding, annual increasing funding, post-pension funding, funding the service cost, and funding the Actuarially Determined Contribution (“ADC”). 
• We recommend working with your actuary and consulting with your auditor to develop customized funding scenarios to determine which are both sustainable and meaningful, in order to achieve long-term financial stability for the trust.

Municipalities from across the U.S. are struggling to fund their Other Post-Employment Benefits (OPEB) obligations. Rising healthcare costs and aging populations are exacerbating the problem, leading to budget shortfalls and potential credit downgrades. 

To address this challenge, many municipalities have established an OPEB plan trust in order to start pre-funding their plans. This can be very favorable as pre-funding allows for long-term investment and compound interest growth. But now you’re facing a new challenge – how much should you contribute to your trust?

How Much Should You Contribute to Your OPEB Plan Trust?

All of your problems will be solved with this one weird trick… fund the Actuarially Determined Contribution (“ADC”) from your OPEB report every year. There you go, next question. 

Is It Really as Simple as Funding the Actuarially Determined Contribution?

I promise you I’d tell you to stop reading now if it was, but there’s a reason I didn’t stop with that first question and it isn’t because I love writing. Sadly, like most things in municipal finance, there are a lot of things to consider when determining how much money should be diverted to funding an OPEB trust. 

Things like other liabilities, funding tangibly important things like a new fire truck, etc… The list is endless and you probably are juggling that all day so I won’t go on, but the takeaway is that the endless moving parts keep us from giving any kind of one-size-fits-all solution. 

Okay… So What Should We Do?

One of the goals in funding is to utilize a higher discount rate to determine the liability. On that front, it would be very tempting to shoot for the moon and commit to an unrealistic policy to get the highest discount rate possible. This has its own issues though. For one, your auditors may recommend a lower discount rate to be used and the rating agencies will take note of your failure to commit to the funding policy. On the flip side, if you fund whatever is leftover every year on an ad-hoc basis with no formal commitment or strategy, you will not reap the full benefits of a higher discount rate. 

The best bet is to commit to something that is realistically sustainable over time and meaningfully impacts the liability. Does that mean one year of undershooting the commitment will tank the discount rate and have you put on the rating agencies’ so-called, ‘naughty list’? No, life happens. A missed year here and there is unlikely to impact things, but a trend of bad years should lead to a conversation about revisiting the policy. 

Check out these 5 ways to reduce your OPEB liability

That’s a Whole Lot of Words for a Vague Non-Answer… Can You Give Us a Few Funding Examples?

I thought you’d never ask! Over the years we’ve seen interest in and the implementation of many different OPEB funding strategies. Here are some of the more popular ones:

• Flat Funding – Basically a set dollar amount that gets funded every year, for example, $500K per year beyond the pay-as-you-go cost until fully funded.  Many municipalities that do this will also put in extra funds if any but the amount they are committing to, and the amount used to determine the discount rate is $500K.
  
• Increasing Funding – Same thing as Flat Funding but the amount is set to increase every year.  If we go back to the $500K example, we might say the contributions will increase by an additional $10kk each year or contributions will increase by 3% per year.
  
• Post Pension Funding – If you have an underfunded pension plan that is currently being funded, there is likely a funding schedule that shows it reaching “full funding” at some future date. In Massachusetts, municipalities have a set year they expect to achieve full funding for their pension.  The idea here is that after the pension is fully funded some of the payments being made to the pension can be redirected to an OPEB Trust.  It is generally recommended to do some funding leading up to this year to show a commitment to solving the problem.
  
  For example, if a town is contributing $5 million annually to fund the pension which is expected to be fully funded in 2038, they may commit to $500K until 2038, then $4 million (80% of the pension contributions) be redirected to OPEB funding in 2039 and going forward until the OPEB liability is fully funded.  The advantage here is that it may allow the use of a much higher discount rate without materially affecting outgoing money in the short term.
  
• Funding the Service Cost – This is also known as “stop the bleeding”.  The idea here is to fund all new liabilities as they accrue while paying off past liabilities through benefit payments.  So every year you would contribute the Service Cost which is the future benefits accrued by all eligible active employees over the course of a year.
  
• Funding the ADC – This is a more aggressive version of funding the Service Cost.  On top of stopping the liability from growing by paying the Service Cost, you would pay an amortized amount of the prior or past service liability.

You’re probably wondering why funding the ADC wasn’t the first example listed, after all, it’s the “Actuarially Determined Contribution” right? It does seem like it was GASB’s goal to make this the gold standard in funding but as said before a one-size fits all solution doesn’t always work and we rarely see this OPEB funding strategy in practice.

Interested in learning more about pre-funding your OPEB plan: Here are the top 6 reasons to pre-fund your OPEB

How Do I Pick the Right OPEB Trust Funding Strategy?

Again, the goal here is to pick something that is both sustainable and meaningful.  $100 a year for a $50 million liability is certainly sustainable but definitely not meaningful.  $5 million a year is definitely meaningful but may not be sustainable.

At Odyssey Advisors, we understand the importance of finding the right funding solution to ensure the long-term financial stability of your trust. We recommend that you work with your actuary to come up with a few different scenarios to see what kind of change in liability you would get in each scenario.  Then look at the budget and perhaps ask your auditor for advice on which one (if any) fits best.

If you have any questions or need help developing customized funding scenarios, please don’t hesitate to contact us. Our team of experienced actuaries can work with you to identify the best strategies for your unique needs and circumstances. Let us help you navigate the complexities of OPEB funding and achieve your financial goals. Contact us today to get started today.