Philadelphia-based PFM Advisors announced this week that its other post-employment benefits practice crossed the $1 billion mark in assets under advisement as of Aug. 31.
OPEB refers to non-pension-related benefits provided to retired government or not-for-profit employees.
The growth of PFM’s OPEB practice, which was launched in 2007 by PFM Asset Management, reflects a prudent shift by state and local governments towards long-term planning.
Jim Link, managing director at PFM who leads the practice, said interest in it has grown the past 18 months as the economy has slowly recovered from the recession that began in December 2007.
“While things are still tight in the government sector, we’ve come off the bottom of the economic malaise,” Link said. “That’s leading these governments to look at more actively setting up the investment vehicles to set aside assets to fund their OPEB liabilities.”
OPEB includes health care, dental, vision, disability, long-term care, and life insurance. The typically generous benefits traditionally were viewed as a form of compensation for salaries that historically trailed those in the private sector.
That generosity became increasingly unsustainable due to ballooning medical costs, prompting the Governmental Accounting Standards Board in 2006 to issue directives 43 and 45 calling for transparency and long-term planning.
“Basically, GASB said governments would have to account for these other benefits in a similar fashion to the way pensions are accounted for,” Link said. “And while they did not mandate 'funding of trusts’ or 'funding of investment vehicles’ to pay for these benefits down the road, they made it clear that there would be preferential accounting if you did set money aside in a dedicated fund.”
Prior to the GASB statements, the vast majority of local governments funded OPEB costs on a “pay-as-you-go” basis, according to a 2009 study by the Center for State & Local Government Excellence.
“Many governments have operated without calculating long-term costs, addressing the escalating costs of retiree health care only incrementally within the context of the annual budget process,” the study said. “Since the calculated total costs of these benefits over time was not something that had to be reported, governments could — and did — avoid addressing the issue.”
Medical costs were the biggest concern. From 1980 to 2009, medical care costs soared by 401%, compared to overall consumer price inflation of 160%, according to data from the Bureau of Labor Statistics. That rapid expansion in costs continued in the 12 months ending August, when medical service costs rose 3.2% — almost triple the 1.1% inflation pace among overall consumer prices.
The 2006 directives from GASB provided an opportunity for PFM Asset Management to expand its role with local governments.
“We began looking at the financial statement implications of these accounting changes on governments, and started to think about what we could do in our role as somebody who works to advance good governance,” said Link, who joined the firm in May 2006 after spending six years at Wachovia.
Some three years later, the division boasts about 40 clients across 11 states with roughly $550 million in discretionary managed assets and $450 million in investment consulting assets, according to internal data. It also has $85 million in committed assets for discretionary OPEB management, which it expects will be invested this year.
PFM’s mission is to provide strategic consulting to ensure that government’s non-pension benefits are competitive and sufficient enough to attract the right talent, while remaining sustainable and affordable, according to Link.
Carefully managing OPEB liabilities could be essential for some governments if they seek to continue accessing the muni market. According to the 2009 study cited above, credit rating agencies are beginning to take OPEB costs into account, which means unfunded liabilities could potentially bring down a government’s credit rating and increase its borrowing costs.
Link said a fragmented market for advising governments on these matters has allowed PFM to gain an early lead since the GASB directives were issued.
“There’s not a key national or a bunch of regional competitors,” he said. “We’re not aware of anybody that can provide the broad kind of breadth of services that we do.”
The typical OPEB portfolio managed by PFM includes 50% to 65% equities, with the rest in fixed income, Link said, noting that asset arrangement is heavily dependent on what the characteristics of the liabilities look like.
As with personal finance, the accounts closer to retirement liabilities are more heavily weighted towards fixed income.
“Most of these funds tend to have a liability stream that’s a little further out,” Link said. “As a result, they need to protect against medical inflation a little more.”
While the OPEB division has grown rapidly since inception, it remains a small fraction of PFM Asset Management’s business, which managed $35.7 billion in assets for state and local governments and nonprofit institutions as of June 30. It also provided non-discretionary advice for an additional $2.2 billion in fixed-income securities.
A related business within the PFM group of companies is PFM Financial Management — the top-ranked public financial adviser for the past 12 years. This year it has advised on 672 borrowings totaling $35.8 billion, reflecting a 16.4% slice of the market, according to Thomson Reuters.
