Double Check Retirement Model Assumptions
Faced with growth of the retired population, the volatility of markets and interest rates, and ever-escalating health costs, many institutions of higher education have revisited-and redesigned-their pension and retiree health programs in recent years. The trend has been toward contraction of defined-benefit pension plans and other post-employment benefits.
GASB 45 is likely to accelerate action in these areas. Even institutions that have over-funded defined benefit pension plans and advance-funded retiree health may move toward defined contribution arrangements to attain greater predictability of costs-even if those costs are higher and the benefits less generous.
As governing boards and state legislatures assess the implications of GASB 45, many public institutions will likely need to take a hard look at the benefits they provide employees. Colleges and universities may also need to consider educating their employees on retirement planning. To better prepare its teachers and other employees for such changes, the California system, among others, has greatly expanded its financial and retirement planning educational offerings.
Education efforts are needed. In fact, Employee Benefit Research Institute's (EBRI) 2007 Retirement Confidence Survey finds growing concern among employees about their ability to afford healthcare in retirement. At the same time, despite ongoing political debates about funding Social Security and Medicare, the survey indicates that few people are taking action to increase their savings. The public continues to believe that Medicare covers more than it actually does. Most survey respondents mistakenly believe that Medicare covers the majority of retiree health expenses; in past surveys, more than two thirds incorrectly thought Medicare would pay for long-term care.
According to the Urban Institute, for a family with earnings of $40,000 at the age of 65 and average life expectancy (age 81 for the man and 85 for the woman), Social Security has a current value of just under $600,000 and Medicare just under $300,000. Medicare, on average, pays for about 51 percent of the average retiree's total retiree health expenses, which means the family would need about $300,000 in savings to fill the gap. If family members live to 100, this savings need more than doubles. Social Security replaces 37 percent of income at this income level, which means personal savings would have to exceed $1.2 million to achieve full-income replacement that holds steady with inflation.
These numbers can serve as savings proxies for employees at higher education institutions that have adopted, or are considering, defined-contribution retiree health savings programs. If your institution has employer-paid, defined-benefit pension and retiree health programs, become familiar with the targets and assumptions your actuaries are using to estimate the post-retirement liabilities.
Coming Up Short
Whether public or independent, institutions of higher education will undoubtedly see changes in retirement patterns. Many workers, for example, may choose to defer retirement if they do not have defined-benefit and employer-funded health insurance. Across the older population, we are already seeing labor force participation rates rise in every age segment, as well as reduced numbers of people taking retirement when health insurance is not available. Many employers, faced with slower growth rates within the new labor force, view these as favorable trends and actively encourage "phased retirement."
One concern of the EBRI is that the GASB measurement methodology allowed for defined benefit pension plans may understate the long-term financial needs of your organization. For defined-benefit pension plans, GASB allows the investment return assumption to discount liabilities. For retiree healthcare, assumptions that health cost growth will drop to low levels within seven or eight years has been proven wrong for decades and can lead to understating costs by 100 percent or more. For these reasons it is important to regularly revisit the actuarial assumptions used in the calculation.
Financially conservative institutions should consider running a series of alternative numbers that test many different interest rates and health inflation levels. These numbers will come in handy when assessing the future capacity of employees to retire. Higher than expected health costs are already showing up in surveys as a reason for working longer and for returning to work after already having retired. Inadequate retirement savings levels can have these same effects as financial literacy increases.
More Light on Liabilities
The credit crunch of summer 2007 served as a reminder that information transparency-a goal of GASB 45-is a good thing. Better to overestimate a liability that affects whether you can maintain a program or afford retirement for 40 years, rather than take action based on an "optimistic" low estimate and later need to terminate the program or have retirees go without basic needs.
GASB 45 does not create new challenges but rather exposes challenges for employers, governing boards, legislatures, contributors, and taxpayers. Because the accounting standard requires quantification of post-retirement promises to employees, it shines a light on liabilities that frequently have not been calculated at all. View it as an opportunity to leapfrog to responsible planning by both institutions and individuals.
Dallas L. Salisbury is president and CEO of the Employee Benefit Research Institute, Washington, D.C.; e-mail: salisbury@EBRI.org.