Author: Financial Management Resource Bureau
The DLS Financial Management Resource Bureau (formerly the Technical Assistance Bureau) has offered financial management advice to municipalities across the state for over 30 years. To share this guidance more broadly, we thought it would be helpful to highlight some of our more useful, timely, or interesting recommendations for the benefit of City & Town readers.
Actuarial liabilities are calculated based on benefits that members are projected to receive in the future. An Unfunded Accrued Liability (UAL) is the difference between the estimated cost of those future benefits and the assets that have already been set aside to pay for the benefits. In Massachusetts communities, there are two primary UALs: Pension benefits in the contributory retirement system and Other Post-Employment Benefits (OPEB) covering eligible retired employees.
Communities must participate in a contributory retirement system, either through a regional multi-unit system or a local city or town system, in order to administer public employee pensions in accordance with Massachusetts General Laws and regulations promulgated by the Public Employee Retirement Administration Commission (PERAC). Systems are required to perform a biennial actuarial valuation to determine each participating unit’s contribution requirements. The valuation, based on the system’s financial condition, calculates the UAL as the total actuarial liability less the actuarial value of the assets.
The UAL is amortized to establish a funding schedule that each system adopts as the basis for the annual assessments needed to achieve full funding. Each retirement system determines the year of full funding by employing a number of factors, but in all cases full funding must be assumed by the year 2040. Communities can find their retirement system’s unfunded liability in PERAC’s annual report by clicking here. Complete detailed information regarding funding activity and schedule, actuarial assumptions and methods, and system provisions are in individual retirement system’s actuarial valuation report found in Massachusetts Public Retirement Systems on the PERAC website.
Retirement systems annually provide their participating units with the appropriation amounts needed to meet the next fiscal year’s funding requirement as calculated and reported in their system’s actuarial valuation (Copies of appropriation letters for the last five years can be found in the systems link above). As part of the forecast and budget processes, communities should be aware of and understand the funding schedule and the factors that affect each valuation and subsequent scheduled contribution. As a required recurring expense, funding for the pension appropriation is generally provided in each annual budget within the fiscal year tax levy limitation.
OPEB is the community’s obligation to provide benefits (such as health insurance) to current and future retired employees. Communities that accept M.G.L. c. 32B, § 20 are required to establish an OPEB Trust Fund to accumulate assets to pay for these obligations and perform biennial actuarial valuations to estimate the value of its OPEB liability. Although there is no current requirement to fully fund this liability, a majority of communities routinely address their OPEB liability using a variety of funding strategies implemented with the goal of narrowing the gap between the community’s annual pay-as-you go amount and its Annual Required Contribution (ARC) as identified in the valuation. Cities and towns appropriate funds to provide annual funding to their OPEB Trust Fund using the tax levy or one-time revenue sources such as free cash and overlay surplus.
A sample of strategies for policymakers to consider when funding the OPEB liability include:
- Annually appropriating an amount from raise and appropriate equal to 10% of the prior fiscal year’s excess capacity or new growth amount or $50,000, whichever is greater.
- Annually appropriating an amount that is equivalent to 10% of meals and room occupancy excise revenues or $100,000, whichever is greater.
- Appropriating an incrementally increasing percentage of ongoing revenues each year.
- Designating a specific percentage of free cash to appropriate annually.
- Transferring unexpended funds from insurance line items to the OPEB Trust Fund.
- Identifying and including OPEB and Pension costs as indirect cost components to be recovered from enterprise funds.
- Once the pension system is fully funded, on a subsequent annual basis, appropriating to the OPEB Trust Fund the amount equivalent to the former unfunded liability expense (i.e., separate from the ongoing, or normal cost).
Cities and towns should adopt an UAL policy to fund both the pension system and OPEB. This policy should include options for using the tax levy, reserves, and excess or unexpected revenue. A prudent funding plan for OPEB will ensure fiscal sustainability while achieving generational equity among those called upon to fund this liability and thereby avoid transferring costs into the future. Further, the Pension Reserve Fund, as provided for in M.G.L. c. 40, § 5D, is available to offset anticipated funding costs for the contributory retirement system. Appropriations to this reserve, which can be used only to fund the retirement system, can mitigate spikes in annual appropriations due to a downturn in investment return or a change in actuarial assumptions.
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Editor: Dan Bertrand
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| Date published: | March 16, 2023 |
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