What Is an OPEB Trust Fund and How Does It Work?

Other Post-Employment Benefits (OPEB) are benefits other than pensions that public sector employees receive after their employment ends. These benefits most commonly include healthcare coverage for retirees but can also cover life insurance, dental, and vision plans. To manage the future costs of these promised benefits, a government entity can establish an OPEB trust fund.

This fund is a distinct legal entity created to hold and invest assets specifically for paying future OPEB liabilities. The purpose of an OPEB trust is to pre-fund these obligations by setting money aside today to cover future costs. This structure ensures the funds are protected and used exclusively for retiree benefits, guaranteeing they are available to meet the government’s promises to its former employees.

The Rationale for Pre-funding OPEB

The main reason public employers pre-fund OPEB obligations is due to accounting standards from the Governmental Accounting Standards Board (GASB). GASB Statements 74 and 75 reshaped how these long-term liabilities are reported, mandating that governments report their total Net OPEB Liability (NOL) on their financial statements. This makes the full extent of these promises transparent to the public and credit rating agencies. Before these standards, many governments used a pay-as-you-go (PAYGO) approach, which concealed the true long-term cost by only budgeting for the current year’s payments.

An advantage of establishing a qualifying OPEB trust is its effect on the reported liability calculation. When a government pre-funds benefits through a qualifying trust, it can use a higher discount rate to determine the present value of its future benefit payments. This rate is based on the long-term expected rate of return on the trust’s investments. In contrast, a PAYGO system requires using a much lower discount rate based on a tax-exempt municipal bond index.

The choice of discount rate has a substantial impact, as a higher rate results in a lower calculated Net OPEB Liability. For instance, a plan with a well-funded trust might use a discount rate of 6% or 7%, while a PAYGO plan might use a rate of 3% or 4%. This difference can reduce the reported liability by millions of dollars, presenting a more favorable financial position on the government’s balance sheet.

Establishing an OPEB Trust

Creating an OPEB trust is a formal legal process to meet GASB requirements for a “qualifying trust.” The process involves creating a legal trust agreement that outlines the governance structure and procedures. A primary condition is that the trust must be irrevocable, meaning contributions cannot be withdrawn or repurposed. This irrevocability ensures the funds are protected from political pressures or budgetary shortfalls.

Many public entities establish these trusts under Section 115 of the Internal Revenue Code. This provides tax-exempt status, allowing investment earnings to grow without being taxed and maximizing the funds available for future benefits.

A board of trustees must be appointed, which has a fiduciary duty to act in the sole interest of plan participants. The trust document defines the board’s composition, which may include government officials, employee representatives, or independent community members. The board oversees the trust’s administration, including selecting investment managers and ensuring legal compliance.

The legal framework requires that trust assets be protected from the employer’s creditors. This separation ensures that funds for retiree benefits remain secure even if the government entity faces financial distress. This protection distinguishes a qualifying trust from a simple reserve fund, which could be accessible to creditors.

Funding and Investment Strategy

Once established, the government must develop a strategy for funding the trust and investing its assets. The funding strategy is based on the Actuarially Determined Contribution (ADC), an amount calculated annually by an actuary. If paid consistently, the ADC is projected to cover the cost of benefits earned by current employees plus a payment to reduce any unfunded liability. Adopting a formal policy to pay 100% of the ADC each year is a best practice.

Contributions to the trust primarily come from the employer, but some plans may also require employee contributions, often negotiated as part of collective bargaining agreements. The source of employer contributions can vary, ranging from annual general fund appropriations to dedicated revenue streams.

The investment of trust assets is governed by a formal Investment Policy Statement (IPS) adopted by the board. This document outlines investment objectives, risk tolerance, and strategic asset allocation, which is the planned mix of investments like stocks and bonds. For example, an IPS might set a target of 60% equities and 40% fixed income.

Most trust boards hire professional investment managers to implement the IPS, select investments, and monitor performance against benchmarks. The IPS provides clear guidelines for the manager, such as prohibiting certain high-risk investments or limiting concentration in a single company’s stock to prevent undue risk.

Trust Administration and Disbursements

The ongoing administration of an OPEB trust is guided by the fiduciary responsibilities of its board of trustees. This involves all operational aspects of the plan, from record-keeping to ensuring timely payments. The board may appoint a trust administrator, such as a municipal official or a third-party firm, to handle daily tasks.

When a retiree is eligible for benefits, a formal disbursement process begins. This requires verifying eligibility and paying for OPEB costs, like health insurance premiums, directly from the trust. The trust administrator or trustee authorizes these payments, ensuring all disbursements are legitimate and documented. A custodian bank holding the assets then executes the transactions as directed.

OPEB trusts are subject to annual reporting and audit requirements. An independent audit of the trust’s financial statements must be conducted each year to verify its financial position and activities. The results of this audit, along with a biennial actuarial valuation, are disclosed in public financial reports to provide accountability to taxpayers and plan members.