By Kathryn Kretschmer-Weyland
June 18, 2007

How can cities keep up with the spiraling cost of retiree health care benefits, when it’s hard enough controlling health care expenses for active employees? That was one question at hand during a recent meeting of the Hampton Roads Planning District Commission in Portsmouth (VA). At the suggestion of Portsmouth Mayor James Holley, along with the support of Jim Oliver, Portsmouth City Manager, representatives from Nationwide Retirement Solutions were invited to deliver a 30-minute workshop on Conference of Mayors Post Employment Health Plan (PEHP). This workshop provided education and specific recommendations to 17 city and county managers on an approach to offering Other Post Employment Benefits (OPEBs) without running afoul of recent IRS guidelines and, worse yet, running up an uncontrolled expense. The workshop was well received. In fact, upon the recommendation from their respective city/county managers, several HR and Finance Directors attended a live webcast detailing the specifics of the Conference of Mayors plan.

The Government Standards Accounting Board issued Statement 45 in 2006. This statement requires Public Sector jurisdictions to calculate and disclose Annual Required Contribution (ARC) for defined benefit OPEB plans. The ARC itself is made up of two financially significant items beginning in 2007. First is the normal cost of the benefits in the year that services are received by the employer. The second component is the amortization of the total unfunded actuarial accrued liabilities (UAAL) of the plan (not to exceed 30 years). As many who have recently completed their actuarial assessments know, each of these components can be significant and for some the UAAL can be a true horror story. With several large city plan’s holding unfunded liabilities in the billions of dollars and with health care expenses rising much faster than the rate of inflation, how can they ever get these expenses under control?

Many cities are responding to this question in a variety of ways. Approaches to the problem range from setting up a trust to pre-fund future liabilities, to generating additional revenue to pay off the majority of unfunded liability. Some are even going so far as to reduce or eliminate OPEBs altogether for either new hires/employees/retirees or all of the above. Throughout all this activity one simple approach is attracting a lot of attention. Many cities are stemming the tide of future GASB 45 reporting requirements by implementing retiree health reimbursement accounts for their employees now.

A Retiree Health Reimbursement Account as defined by the IRS is… More specifically a Defined Contribution form of Retiree HRA is catching on as a simple alternative/addition to current pay-go plans. This alternative is important since DC type OPEB plans are not required to recognize the costly accounting for the Annual Required Contribution.

Additionally, these arrangements do not create an Unfunded Actuarial Accrued Liability for the employer.

It is also worthwhile to note that in a recent Private Letter Ruling (PLR-1146686-06), the IRS emphasized:

• that a tax favored HRA is an arrangement paid for solely by the employer (Notice 2002-45, 2002-2 C.B 93),

• that contributions to the HRA must not be attributable to salary reduction (Part IV of Notice 2002-45)

• that amounts paid pursuant to Rev. Rul. 2006-36 as reimbursement of the substantiated medical care expenses of a beneficiary designated by the employee (other than the spouse and dependants of the employee) are not excludable from gross income effective December 31, 2008

When designed correctly a Retiree HRA allows retirees access to tax favored dollars to reimburse for qualified medical expenses and allows employers to meet their obligation of providing retiree medical insurance benefits, while limiting the ongoing accruals of the ARC.

Beginning in the mid ‘90s, the Conference of Mayors endorsed defined contribution plan partner, Nationwide Retirement Solutions, began offering a Retiree HRA aptly named the Post Employment Health Plan. Developed by a Chicago firefighter, the plan was conceived as a vehicle to lessen the burden of medical expenses prior to qualifying for Medicare. At that time, Statement 45 was merely a glimmer in the eye of GASB. Today the plan has been implemented in over 400 jurisdictions and has the added benefit of being a GASB compliant OPEB Trust and Plan.

In simple terms, The Post Employment Health Plan (PEHP) is utilizes a 501c(9) Trust that has been issued an IRS determination letter confirming the compliance of the trust. This trust is used in conjunction with the plan to allow employers to contribute funds tax free (important in cases where FICA taxes apply). Employees then accumulate earnings tax free and ultimately receive reimbursements for qualified medical expenses and health insurance premiums – also tax free.

For employers, there are many ways to fund the plan including unused sick, vacation or personal leave, as well as early retirement incentives. Once funded, employees self-direct their assets in their personal account to meet their investment objectives. As you can expect, Nationwide takes care of all the administration and education, and the administrative cost is deducted annually from the participant’s account. There is more to it of course, but if this much makes sense for your city then it is just a matter of making some final design choices before recommending implementation.

To summarize, GASB 45 has created a sense of urgency around developing a long term solution for retiree health care costs. Now that IRS Guidance has clarified requirements for tax-favored status, retiree HRAs can be part of the solution. The Conference of Mayors PEHP program is a turnkey retiree HRA that is a GASB compliant OPEB Trust and Plan and can be an integral part of your strategy to avoid increasing unfunded liabilities while still providing a needed benefit.

For additional information on how PEHP can be part of your OPEB Solution, or to schedule a PEHP workshop/webcast, contact Kathryn Kretschmer-Weyland at kweyland@usmayors.org or call 301-460-5251.