Other Postemployment Benefits (OPEB) Bonds
State and local governments should not issue OPEB bonds for a variety of reasons.
GFOA Advisories identify specific policies and procedures necessary to minimize a government's exposure to potential loss in connection with its financial management activities. It is not to be interpreted as GFOA sanctioning the underlying activity that gives rise to the exposure.
GASB Statement No. 75, Accounting and Financial Reporting for Employers for Postemployment Benefits Other than Pensions, requires public-sector employers to display, in the government-wide statement of net assets, the full amount of their net OPEB liability (NOL) for other postemployment benefits earned by employees for services rendered to date.1 In addition, employers that subsequently fail to fully fund their actuarially determined contribution (ADC) each year will also be required to report the cumulative effect of underfunding the ADC as required supplementary information. Nothing in GASB Statement No. 75 requires employers to advance fund their OPEB obligations. The decision to advance fund OPEB should reflect a given jurisdiction’s careful analysis of its own unique financial situation.
Some employers have considered issuing debt to fund their NOL for OPEB, as has sometimes been done in connection with pension obligations. In either case, the objective is to invest the proceeds in appropriate qualified investments at a return substantially higher than the interest rate of the debt. GFOA has adopted an advisory that addresses the issuance of debt in connection with pension obligations.2 While the underlying concept is the same, several crucial additional factors must also be considered for OPEB bonds.
GFOA recommends that state and local governments do not issue OPEB bonds, for the following reasons:
- The actuarial liability for OPEB is inherently and significantly more volatile than the actuarial liability for pension benefits, for several important reasons. First, health-care costs and utilization are less predictable than life expectancy. Second, unlike pension benefits, health-care benefits are not guaranteed by state law in many jurisdictions, and employers may choose to reduce, cap, or eliminate these benefits.3 Third, state or federal health-care initiatives might also significantly change the way health-care benefits are provided in the future. Furthermore, health-care cost trends are generally more volatile and difficult to project than inflation rates for pension costs because the former must take into account ongoing changes in medical technology and societal expectations.
- OPEB bonds may be complex instruments that carry considerable risk. OPEB bond structures must be intensively scrutinized, as debt structures may incorporate the use of guaranteed investment contracts, swaps, or derivatives, which can introduce counterpary risk, credit risk, and interest rate risk.
- Issuing taxable debt to fund the OPEB liability increases the jurisdiction’s bonded debt burden and potentially uses up debt capacity that could be used for other purposes. In addition, taxable debt is typically issued without call options or with “make-whole” calls, which can make it more difficult and costly to refund or restructure than traditional tax-exempt debt.
- Rating agencies and similar authorities have not provided definitive guidance as to what constitutes a safe and reasonable funded ratio for OPEB.
- Ratings agencies may not view the proposed issuance of OPEB bonds as credit positive, particularly if the issuance is not part of a more comprehensive plan to address OPEB funding shortfalls.
- The potential volatility in actuarial estimates could lead to over-funding, especially in cases where the jurisdiction fully funds the NOL. Such overfunding could raise potentially troublesome budgetary or policy issues.4
- The invested OPEB bond proceeds might fail to earn more than the interest rate owed over the term of the bonds, leading to increased overall liabilities for the government.
- Only employers participating in defined benefit plans will display a net pension liability.
- See GFOA’s Best Practice, Pension Obligation Bonds
- See GFOA’s Best Practice, Sustainable Funding Practices for Defined Benefit Pensions and Other Postemployment Benefits (OPEB)
- See GFOA’s Best Practice, Ensuring Other Postemployment Benefits (OPEB) Sustainability