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Louise401: I have a copy of the 11 actions city could take.

Some are good, others bad.

Here they are:

JEFFERSON SOLUTIONS, INC.

14 Brittany Oaks Clifton Park, New York 10265 518-461-7805 www.gasb45.com

May 26, 2015

Mr. Ernest Zmyslinski, Director of Finance City of Warwick Rhode Island ernest.m.zmyslinski@warwickri.com 3275 Post Road

Warwick, Rhode Island 02886

RE: Funding OPEB Liability Dear Ernie:

I wanted to respond to your email dated May 19, 2015 regarding the use of an OPEB Trust and partial funding of the City’s OPEB liability.

In summary, your email contained the following questions:

1. What position does Jefferson Solutions, Inc. take with respect to OPEB Trusts?

2. What position does Jefferson Solutions, Inc. take with respect the city contributing $200,000

to a state-wide OPEB trust?

These are excellent questions to be asking with respect to careful management of the City’s OPEB liability. Our response follows:

POSITION ON AN OPEB TRUST: Jefferson Solutions, Inc. would support the City’s decision to make contributions into an OPEB trust if it is able to afford the cost. Pre-funding the OPEB liability can have a significant impact on the overall liability and costs associated with OPEB due to the fact that it may allow an entity to increase its assumed discount rate with respect to the funds that have been set aside in the trust.

Pre-funding OPEB could allow the City to adjust the discount rate to the level of the expected return on the assets placed into the trust. Typically, a well-managed OPEB trust would earn rates of return similar to those earned on the State Employee Pension Fund. Presently, the City uses a discount rate of 4.00% in determining its OPEB liability and Costs. The State Employee Pension fund used a 7.50% assumed rate of return in its actuarial report dated June 30, 2015.

Since there is an inverse relationship between the assumed rate of return and the OPEB liability and costs, pre-funding and taking advantage of higher assumed rates of return could have a significant impact on the City’s OPEB provided that the contributions are material.

POSITION ON MAKING A $200,000 CONTRIBUTION: Jefferson Solutions, Inc. does not want to discourage the City from making contributions to an OPEB trust in any amount.

However, it making a decision on the funding level for the City, it is important to focus on the results in the June 30, 2014 report to evaluate if the amount funded would make a material difference.

A brief recap from June 30, 2014 report is as follows:

The Annual OPEB Costs .............................................................. $23,100,000 The amount Paid for Retiree Benefits ............................................. 7,300,000 Leaving:

An Unfunded OPEB Cost of .................................................. $15,800,000

This unfunded portion of the OPEB costs is attributable to the active employees.

Proposed Funding ........................................................................... $200,000

Increase in OPEB Funding ....................................................................... 1.2%

If the City placed $200,000 into an OPEB Trust this would equate to funding 1.2% of the unfunded portion of the OPEB costs. In our opinion, this would be relatively immaterial, but it is also a step in the right direction. We also believe that this level of funding would not provide an increase in the discount rate due to the limited amount.

Jefferson Solutions, Inc. has prepared an attachment to this letter with suggestions on how to manage the OPEB liability. We would suggest that the City consider some of the alternative strategies mentioned in the attached.

I am looking forward to meeting with the City Council at the June 8, 2015 meeting. I will be happy to address their concerns with respect to the most recent report. I also encourage discussion on the attached strategy.

Very truly yours,

Raymond R. Cerrone, CPA, EMT-1 Principal

Jefferson Solutions, Inc.

Suggestions for Managing the Liability

Mitigating strategies for Reducing the Impact of OPEB:

We encourage the City of Warwick to consider the following suggestions for reducing the OPEB liability and related costs. These suggestions should be taken into consideration with the assistance of the City’s legal counsel and in cooperation with the various bargaining units.

1. Make Greater use of Medicare:

According to the GFOA, jurisdictions like the City of Warwick can leverage Medicare to lower OPEB costs:

Many municipal governments can use Medicare to lower their OPEB costs, according to Moody’s Investors Service. For retirees over age 65, this liability consists primarily of Medicare premium subsidies and supplemental health insurance benefits.” Leveraging Medicare for these employees is worth considering because “even small reductions in the cost of health benefits for Medicare-eligible retirees can have a considerable impact on future costs because savings compound over retirees’ increasingly long lifetimes.”

2. Consider funding the Annual Required Contribution:

One of the most important factors in determining OPEB liabilities and costs is the interest rate used to discount future benefit payments to the present. As a general guideline, a 1% decrease in the discount rate may cause a 15% - 20% increase in liability and the ARC. GASB rules state that the discount rate to value OPEB liabilities must reflect expected returns on assets used to pay benefits. If OPEB liabilities are not funded in advance, this means the discount rate would be the expected return on the assets of the sponsoring employer. Statutory restrictions on fund investments (and the fact that few entities have extra funds that can be invested) likely means a low rate of return on assets. This results in the mandated use of a low discount rate for OPEB liabilities (and correspondingly high liabilities and costs). On the other hand, if the OPEB liabilities are funded in advance in a separate trust dedicated to provide OPEB benefits, the assets may be invested in longer- term investments with higher expected returns.

The City of Warwick should consider funding of the annual required contribution in an amount that is greater then what is required under the current pay-as-you-go practice. Funding a larger portion of the ARC will results in increasing demands on the budget while accomplishing two other important goals:

(a) Increasing the discount rate and lowering the cost for OPEB in the long run; and

(b) Providing future retirees with some level of assurance that the resources to pay the benefits will be available at a future date.

3. Change the plan for new hires:

The easiest long-term reform for retirement benefits is to reduce them for new employees. Unfortunately that won’t save much money for years to come, but it’s a start. With private-sector employers rapidly abandoning retiree medical benefits, there is little competitive pressure to maintain traditional OPEB plans. A modest defined contribution plan for retirement health savings is usually all the market requires. Some employers are providing employee-only coverage for new hires.

4. Cap the benefits:

With medical costs outstripping general inflation by two or three times each year, the biggest move employers can make is to put a dollar ceiling on the benefit and index it to the CPI. This single action has huge actuarial cost-reducing benefits.

5. Require employee contributions:

Most public employees, especially the older ones, know the value of their OPEB benefits. It’s only fair that they pay part of the costs. If you are freezing salaries, you can’t ask for much, but a symbolic sliver of cost-sharing can be expanded later when the economy gets better.

Presently, the City covers 100% of the cost for both the retired employee and any covered dependent.

Continued

Suggestions for Managing the Liability (Continued)

6. Fund the plan actuarially:

Most public employers with massive OPEB liabilities have not even set up a trust fund to pre-fund the benefits. This ostrich-like behavior guarantees that the problem will worsen. Even if budgets are tight, it makes sense to make partial payments toward the actuarially required contributions and then “ramp up” a little each year. Employees can’t be asked to contribute if there’s no trust fund in place.

7. Install a “narrow network” HMO:

Along with higher deductibles and co-pays, many employers have also installed a narrow-network HMO as the primary health-care benefit for their employees. Narrow networks exclude high-cost medical providers and thus cut premium costs. This can then become the basis for the retirees’ OPEB benefit as well, which can cut costs by 25 percent in some locations.

8. Sell bonds to fund one-third of OPEB liabilities:

Nobody can tell for sure whether the stock market’s latest swoon was a bottom, but interest rates are now near their lowest levels in a century. That enables some public employers to sell taxable municipal bonds for as much as a third of the total OPEB plan liability, and invest the money in the stock market at depressed levels. For more on this strategy and pitfalls to avoid, see my article, Benefits Bonds Revisited, in the Public Money section on Governing.com.

9. Buy out the benefits:

Beverly Hills, Calif., won national attention and a professional association award for its innovative solution to skyrocketing OPEB costs. The big idea: Get out of the business of guaranteeing retiree medical benefits the city can’t afford. First, the city set up a defined-contribution OPEB plan for new employees. Then it sold a bond issue at 4.5 percent and used the money to fund a voluntary exchange program in which current employees could cash out the actuarial value of their previously earned OPEB benefits and receive an employee health savings account plus a package of cash and deferred compensation. More than half of the eligible employees made this election, which will save the city millions of dollars. It’s been so popular that employees who didn’t take the original deal now want in.

10. Reform Benefits for Incumbent Employees:

Legal issues are likely to arise here, as each state has its own laws (with limited case law) regarding the vested rights of employees to receive retiree medical benefits. In some states, the OPEB benefit is a gratuity and can be cancelled or modified by the plan sponsor. In others, however, the courts might find that employees have vested rights similar to those regarding pension benefits.

Beyond legal concerns, there are also moral and morale issues to consider when modifying benefits of incumbent employees. For example, a fully vested employee who has satisfied all the age and service requirements for a full OPEB benefit has a strong claim that the benefit cannot be reduced.

At most, public employers in such cases might attempt to raise the distribution age by a few years, increase the employee contribution, and cap the annual benefit with a CPI escalation limit. Such measures can mitigate costs while still recognizing the employees’ legitimate claims to the core benefits they have already earned through prior service.

For younger workers, the employer has a stronger case and an easier path to modifying the benefit structure, if state law allows. In addition to raising the age and service eligibility requirements and establishing a cap (based on a dollar amount or CPI/ inflation) on the annual benefit, OPEB plan reformers can explore the feasibility of restructuring the benefit to a tax-free monthly retirement medical stipend of $10 to $20 monthly for each year of service. Vesting for such employees should be revised upward, in many cases, to strengthen employee retention.

Continued

Suggestions for Managing the Liability (Continued)

11. Consider Labor Relations:

Experienced financial managers know that benefits plan changes can be disruptive in the workforce and cannot be imposed in a vacuum without major repercussions. In states that have strong collective bargaining laws and traditions, these changes must be negotiated.

Even in right to work states that have greater employer discretion, the morale impact of changing benefits must be taken into account. Employees and their labor representatives must first be informed of the long-term true-cost trajectory of their current benefits plans.

If the cumulative costs are unsustainable, employees should be made aware of this unavoidable fact of life and the consequences of inaction. The actuarial data and graphics discussed above should make that picture clear and undeniable.

When confronted with the prospect of a “lost decade” with virtually no salary increases and chronic workforce attrition, many public employees will eventually accept the need for change, especially if the reforms are phased in incrementally and designed thoughtfully. A cohesive labor relations strategy should be developed and must be supported by elected officials to be effective.

CONCLUSIONS:

Many governmental employers have avoided material unfunded OPEB liabilities, but most of those that provide especially generous early-retirement medical benefits and now face a dismal future unless they act soon to mitigate costs. Long-term solutions that affect future employees are helpful, but they typically fail to offset imminent cost increases. Increased employee contributions for OPEB benefits will become far more common in the near future.

Where permitted by state law, public employers are likely to begin restructuring benefits obligations to current employees as well as new hires, and the sooner this process begins, the greater the cost savings. Innovative financial strategies can be considered, but they are, ironically, best suited for those whose balance sheets and operating budgets need help the least, and infeasible for employers that need the most help.

Many public officials will eventually conclude that medical benefits for public employees who retire before attaining Medicare age can be sustained only through employee matching contributions to a defined contribution plan or a very modest defined stipend based on a full lifetime career of public service.