CalPERS effort would aid public sector employers by ROBERTO CENICEROS Published on July 17, 2006 : AM CST The California Public Employees Retirement System is attempting to create an investment fund that would help government agencies in the state cover the cost of retiree health benefits.

The effort comes as public-sector employers nationwide scramble to address the impact of an accounting standard change that will require them to disclose their post-employment health benefit liabilities in their financial statements.

As the standard kicks in over the next two and a half years, government agencies will either have to make significant changes to their retiree health benefits funding or cut back those benefits, observers say. In some cases, the recognition of the cost of the benefits may lead public employers to do both, they say.

The accounting rule*Governmental Accounting Standards Board Statement 45*will drive public agencies to abandon unfunded, pay-as-you-go systems for retiree health benefits.

The accounting rule does not require public entities to prefund their retiree benefit offerings, said Stephen J. Gauthier, director of the Government Finance Officers Assn.'s Technical Service Center in Chicago. But it is making them realize the cost of promising benefits for retiring workers.

Many public agencies that had never tabulated their liabilities for retiree health benefits are contracting with actuaries in preparation for complying with the rule.

Under the pay-as-you-go mechanism that public employers have traditionally used, employers have promised retiring employees health benefits without immediately funding the cost of the benefits, Mr. Gauthier said.

But now, because they will soon have to report their retiree health expenses for the first time, public entities are immediately faced with the cost implications of those benefits, Mr. Gauthier said.

Others agree.

"This is going to make them face the impact of what they are doing today," said Catherine E. Walker, deputy general manager for the Alameda County Employees' Retirement Assn. in Oakland, Calif. Ms. Walker is also a member of the GFOA's Committee on Retirement and Benefits Administration.

The impact on financial statements will be large because in addition to accounting for their current retiree health expenses, employers also must state the projected retirement health plan costs for currently active employees, Ms. Walker said.

As public employers make their liabilities known, it will impact their bond and credit ratings, observers say. Because of such concerns, employers now are weighing how they will address the costs of their retiree health benefits.

There are two basic avenues for addressing those costs, Mr. Gauthier said.

Employers can give greater consideration to the amount of benefits they offer, which will impact plan design, he said, or they can "advance fund" their benefit plans.

The investment fund that CalPERS is looking to create would help California public employers with such advance funding.

CalPERS is sponsoring legislation that would allow public agencies to contribute to a fund with CalPERS serving as the trustee responsible for investing employer contributions. Senate Bill 1729, introduced by Sen. Nell Soto, D-Ontario, has already passed the Senate and is not facing opposition in the House, a CalPERS spokeswoman said.

To help it prepare for the undertaking, the giant pension fund recently approved a one-time administrative fee increase it charges the approximately 1,100 agencies that contract with it for health benefits. The administrative fee increased from 0.27% to 0.44%.

Additionally, California's recently approved budget contains funding for CalPERS to calculate the state's obligation under the GASB rule.

About 2,500 agencies contract with CalPERS for pension fund services.

CalPERS said employers that currently rely on it for employee health care and pension services have pressed it to set up the fund for covering and administering retiree health benefits.

Employers would benefit by drawing on the same investment expertise that CalPERS applies in managing pension funds, the CalPERS spokeswoman said. She pointed out that $3 out of every $4 CalPERS provides in retiree pension benefits comes from investment returns on money collected from employer and employee participants in the pension system.

Some other public entities already prefund their retiree health benefit liabilities.

For example, the Ohio Public Employees Retirement System in Columbus has prefunded retiree health coverage since 1974 and currently provides those benefits and pensions for 3,700 employers.

It has $12 billion in investments just for retiree health benefits and another $58 billion for pensions, an OPERS spokesman said.

In other cases, individual employers have begun putting money aside or have inquired about how they may form a trust, according to GASB.

But many public entities nationwide are still in a "calculationand recognition" phase, andhave not yet developed a funding mechanism, said Keith Brainard, research director for the National Assn. of State Retirement Administrations.

While protections for retiree health benefits vary across states, in most cases it is legal to reduce them or eliminate them altogether, Mr. Brainard said. When some public policymakers see the size of their liabilities, their first reaction may be to consider slashing the offerings rather than funding them, he added.

For now, many employers are seeking help to answer the "what ifs," said Richard Feller, president of Lynchval Systems Worldwide Inc., an actuary and benefit plan software company in Chantilly, VA.

They are asking questions such as what would happen if they delay funding, or what they should do if they are able to earn a certain return on their investments, Mr. Feller said.

Like many other employers operating under a pay-as-you-go system, Denver Water recently hired an actuarial firm to assess the potential impact on its retiree health liabilities of Statement 45, saidJames Crockett, manager of risk and benefits for the Denver-based entity.

While Denver Water may eventually modify retiree contributions required for participating in its health plans, he doesn't expect it will cease to offer the coverage, Mr. Crockett said.

But Denver Water will not face as great an impact as public agency employers that have promised to provide health benefits for many years from retirement age on, Mr. Crockett said. Denver Water only provides health benefits for early retirees and only until they become Medicare eligible, usually at 65.