U.S. Postal Service: Status, Financial Outlook, and Alternative Approaches to Fund Retiree Health Benefits
Published: 2012-12-04T00:00:00

Fast Facts:

Highlights:
section_title: Why GAO Did This Study
paragraphs: PAEA required USPS to prefund its future retiree health benefits as part of comprehensive postal reform by establishing the PSRHBF along with an initial target period to fund the unfunded liability in 50 years. This requirement included annual payments to this fund from 2007 to 2016 of between $5.4 billion to $5.8 billion. USPS, its employee groups, and others have argued that this prefunding requirement is a major source of USPS's financial woes--reported by USPS as contributing $32 billion toward its $41 billion of net losses over the past 6 years. USPS defaulted on the last 2 years of PSRHBF payments totaling $11.1 billion.
As requested, this report addresses the (1) status and financial outlook of the PSRHBF, (2) impact on future annual USPS payments and unfunded liabilities of alternative approaches, and (3) key considerations for policymakers. GAO reviewed and summarized PSRHBF financial data and analyzed and compared current law requirements with five alternative approaches by developing projections based on OPM and USPS data.
section_title: What GAO Found
paragraphs: The Postal Service Retiree Health Benefits Fund (PSRHBF) covered about 49 percent of the U.S. Postal Service's (USPS) $94 billion retiree health benefit liability at fiscal year-end 2012. USPS's deteriorating financial outlook, however, will make it difficult to continue the current prefunding schedule in the short term, and possibly to fully fund the remaining $48 billion unfunded liability over the remaining 44 years of the schedule on which the 2006 Postal Accountability and Enhancement Act (PAEA) was based. The liability covers the projected benefits for about 471,000 current postal retirees and a portion of the projected benefits for about 528,000 current employees; it does not cover employees not yet hired. Under PAEA, USPS is responsible for contributing an additional $33.9 billion to the PSRHBF by fiscal year 2017, including the $11.1 billion USPS has defaulted on over the past 2 years. PAEA also requires the Office of Personnel Management (OPM) to calculate the remaining unfunded liability in 2017 and develop an initial 40-year amortization payment schedule. USPS, however, projects further declines in mail volume and revenues that may continue to limit its ability to prefund the remaining retiree health benefit liability.
GAO's analysis of maintaining current law requirements compared to five alternative approaches showed differing impacts on USPS's future annual payments and unfunded liabilities. For example, three of the approaches--1) the Administration's Approach, 2) Senate Bill (S. 1789) and 3) "Pay-as-You-Go" (no prefunding)--would reduce USPS's annual payments in the short term, thereby easing its immediate cash flow problems and financial losses. However, these approaches would increase USPS's unfunded liability, sometimes substantially, and require larger payments later. Deferring funding could increase costs for future ratepayers and increase the possibility that USPS may not be able to pay for some or all of its liability. Conversely, a fourth approach--the House Bill (H.R. 2309)--and the current law requirement would reduce USPS's unfunded liabilities more aggressively but may result in significantly higher USPS financial losses in the near future. If USPS stopped prefunding and let the existing fund grow with interest, the unfunded liability is projected to significantly increase. Under a fifth approach, if USPS stopped prefunding and used the existing fund to pay current and future premiums, the fund is projected to be exhausted by 2026. Private sector, state, local, and other federal entities are not required to prefund these benefits, though some do so to a limited extent, and most are required to recognize the future costs in their financial reporting.
GAO identified several key considerations including: (1) the rationale and consequences of prefunding such benefits; (2) trade-offs affecting USPS's financial condition, such as sizes of the annual payments and unfunded liability; (3) fixed versus actuarially determined payments; (4) targeted funding levels; and (5) assumption criteria. USPS is intended to be a self-sustaining entity funded almost entirely by postal ratepayers, but its financial losses are challenging its sustainability. GAO has testified that USPS should prefund its retiree health benefit liabilities to the maximum extent that its finances permit, but none of the funding approaches may be viable unless USPS has the ability to make the payments. USPS's default on its last two required PSRHBF payments and its inability to borrow further make the need for a comprehensive package of actions to achieve sustainable financial viability even more urgent.
section_title: What GAO Recommends
paragraphs: GAO is not making new recommendations in this report, as it has already reported on strategies and options for USPS to achieve sustainable financial viability.

section_title: Letter
paragraphs: Because of significant financial difficulties, the U.S. Postal Service  (USPS) was unable to make its statutorily required payments of $5.5  billion in fiscal year 2011 and $5.6 billion in fiscal year 2012 to prefund  retiree health benefits. The Postal Accountability and Enhancement Act  (PAEA) required USPS to make fixed annual payments to begin  prefunding the cost of future retiree health benefits accrued by current  employees and retirees. The act required annual payments (ranging  from $5.4 billion to $5.8 billion per year) from fiscal years 2007 through  2016 to be deposited into a new fund established in the U.S. Treasury  and administered by the Office of Personnel Management (OPM) called  the Postal Service Retiree Health Benefits Fund (PSRHBF). During this  period, USPS would also make annual payments for its share of health  benefit premiums for current retirees to the Federal Employees Health  Benefits Fund (this payment amounted to $2.5 billion in fiscal year 2012).Beginning in fiscal year 2017, USPS’s share of health benefit premiums  for retirees is to be paid from the PSRHBF rather than by USPS. PAEA  further required that beginning in fiscal year 2017, USPS’s contributions  to the PSRHBF are to be based on actuarial calculations performed by  OPM. USPS’s actuarially determined annual contribution to the PSRHBF  is to consist of a payment for the cost of future benefits attributable to  employee service during the fiscal year, plus a payment to fund the  remaining unfunded retiree health benefit liability over a statutorily  determined amortization schedule that initially extends 40 years to 2056.
USPS, employee organizations, and other stakeholders have argued that  the prefunding requirement is a major contributor to USPS’s financial  decline—contributing $32 billion towards its $41 billion of net losses over  the past 6 years —and that Congress should relieve USPS from these  prefunding requirements or substantially reduce them. As of the end of  fiscal year 2012, OPM estimated that USPS’s total health benefit liability   was approximately $94 billion—of which  for future and current retirees$48 billion was unfunded and $46 billion was in the PSRHBF. We have  previously reported that USPS cannot be financially viable until Congress  and USPS address the cash flow problems that limit its immediate  prefunding capability while also addressing how to pay for the long-term  cost of USPS’s unfunded retiree health benefit liability. Projected declines  in mail volumes and revenues will continue to exacerbate USPS’s  difficulties in paying for the cost of its retiree health benefits.
Several approaches proposed by the Administration (Administration) and  congressional committees offer alternatives that would revise USPS’s  prefunding payments and affect the amount of funds deposited in the  PSRHBF to make future retiree health premium payments. In addition,  USPS’s Office of Inspector General (OIG) has analyzed a proposal to  suspend prefunding and let the existing fund grow with interest. Some  have also suggested that prefunding is unnecessary, inadvisable, or  unfair. You requested that we review the PSRHBF and study the effects  of multiple proposals to revise the payment structure for funding retiree  health benefits, which include reducing or deferring payments in the short  term, as well as eliminating prefunding altogether. This report (1)  describes the status and financial outlook of the Postal Service Retiree  Health Benefits Fund, (2) analyzes how alternative approaches for  funding retiree health benefits could affect future USPS payments and  unfunded liabilities, and (3) determines key considerations for  policymakers assessing the alternative approaches.
USPS has also proposed withdrawing from the Federal Employees  Health Benefits Program (FEHBP) and administering its own health care  plan for its employees and retirees. This report looks at retiree health  benefits funding options assuming that USPS continues to participate in  FEHBP under current provisions. We will be issuing a separate report on  USPS’s proposal to administer its own health care plan.
To describe the status and financial outlook of the PSRHBF, we reviewed  and summarized USPS financial data regarding payments made to the  fund, interest earned from such contributions, overall fund balance, and  retiree health benefit liability. We also reviewed our prior work and  reviewed and summarized reports and data from USPS and others on  how USPS’s financial condition has changed since 2006. We reviewed  relevant statutes, proposed legislation, and sections of the President’s  budget request for fiscal year 2012 pertaining to USPS’s health and  pension benefit programs. We also interviewed USPS and OPM officials  on the status and financial outlook of the PSRHBF. To analyze how  alternative proposals for funding retiree health benefits could affect future  USPS payments and unfunded liabilities, we analyzed and compared  current law requirements and five alternative approaches. The alternative  approaches included an approach contained in a bill passed by the  Senate, an approach contained in a bill approved by a House committee,  an Administration proposal, an approach analyzed by the USPS OIG, and  a pay-as-you-go method with no prefunding. We obtained data from  USPS on current and projected full-time employee (FTE) counts and  compensation. In addition, we met with OPM officials to discuss actuarial  assumptions and the methodology for projecting future actuarial costs  and premium payment levels under different sets of assumptions, using  the workforce projections provided by USPS. We used the projections  provided by OPM and USPS to calculate, for each of the alternative  approaches to prefunding, USPS’s required payments and the PSRHBF’s  unfunded liability through fiscal year 2040. To determine key factors for  policymakers to consider when assessing alternative approaches, we  used our own actuarial judgment and expertise. In addition, for  comparison purposes we examined the prefunding requirements and  prefunding behavior of private-sector entities, state and local  governments, and other federal entities. We also looked at how these  other entities, as well as USPS, recognize the cost of these benefits in  their financial reporting based on relevant accounting standards  promulgated by the Financial Accounting Standards Board (FASB),  Governmental Accounting Standards Board (GASB), and Federal  Accounting Standards Advisory Board (FASAB). For more information on  our scope and methodology, see appendix I.
We conducted this performance audit from May 2012 to December 2012  in accordance with generally accepted government auditing standards.  Those standards require that we plan and perform the audit to obtain  sufficient, appropriate evidence to provide a reasonable basis for our  findings and conclusions based on our audit objectives. We believe that  the evidence obtained provides a reasonable basis for our findings and  conclusions based on our audit objectives.
subsections: section_title: Background
paragraphs: USPS, an independent establishment of the executive branch, is intended  to be a financially self-sufficient entity that covers its expenses almost  entirely through postal revenues. In April 2001, we placed USPS on our   First, in the short term, USPS’s ability to  high-risk list for two reasons.continue to fulfill its mission on a self-supporting basis was threatened  because of projected annual losses of $2 billion to $3 billion, severe cash  flow pressures, and debt approaching its statutory borrowing limit without  any debt reduction plan. Second, in the long term, increasing retirement- related expenses threatened to reduce USPS’s future cash flows and  place upward pressures on postal rates.
We have been reporting on USPS’s financial challenges, including those  related to funding its retiree health benefit liability, over the past decade.  In May 2002, the Comptroller General testified that USPS had about $100  billion in liabilities, including an estimated $49 billion in unfunded retiree  health benefit liability. Unlike pension liabilities, USPS had been funding  its retiree health benefit liability on a pay-as-you-go basis—an approach  in which USPS paid its share of premiums for existing retirees, with no  prefunding for any future premiums expected to be paid on behalf of  current retirees and workers. In May 2003, the Comptroller General  testified that USPS’s accounting treatment—which reflected the pay-as- you-go nature of its funding—did not reflect the economic reality of its  legal liability to pay for its retiree health benefits, and that current  ratepayers were not paying for the full costs of the services they were  receiving. Consequently, the pension benefits being earned by USPS  employees—which were being prefunded—were recovered through  current postal rates, but the retiree health benefits of those same  employees were not being recognized in rates until after they retired. The  Comptroller General testified that without a change, a sharp escalation in  postal rates in future years would be necessary to fund the cost of retiree  health benefits on a pay-as-you-go basis.
Two laws, enacted in 2003 and 2006, reformed USPS’s pension liabilities  and required it to prefund retiree health benefits:
The Postal Civil Service Retirement System Funding Reform Act of  changed USPS funding of its Civil Service Retirement System  (CSRS) pension liabilities (based on “dynamic assumptions” )  while retroactively transferring responsibility for funding the cost of  CSRS benefits attributable to the military service of postal  employees from the U.S. Treasury to USPS;  required USPS to escrow the reduction in annual CSRS payments  resulting from the funding changes in the act (about $3 billion);  and  required USPS to report to Congress on how it could use the  CSRS savings realized after fiscal year 2005. USPS proposed to  Congress in 2003 that the responsibility for funding the cost of  CSRS benefits attributable to the military service of postal  employees be transferred back to the U.S. Treasury and that it  use the resulting savings to prefund its retiree health benefit  liability.
PAEA, enacted in 2006,transferred all responsibility for costs related to CSRS military  service credit from USPS back to the U.S. Treasury, both  retroactively and prospectively; this included all CSRS military  service costs for postal employees since the inception of the  Postal Service in 1971; established the PSRHBF to begin prefunding the health benefits  of current and future postal retirees and transferred about $20  billion of “start-up” funds into the PSRHBF ($3 billion from the  discontinued CSRS escrow—as USPS’s annual CSRS payment  was suspended—and $17 billion from the surplus in the CSRS  fund);  required USPS to make annual payments ranging from $5.4 billion  to $5.8 billion per year into the PSRHBF from fiscal years 2007  through 2016 to begin prefunding its retiree health benefit liability;  and  required OPM to calculate the remaining unfunded liability in 2017  and each subsequent year, and to calculate an amortization  payment based on an amortization period that extends to 2056 or,  if later, 15 years from the then-current fiscal year.
As a result, in 2007 USPS began prefunding its retiree health benefits as  its CSRS pension liability was significantly reduced and its annual CSRS  payment was suspended. USPS stated in its 2007 Annual Report that  such prefunding was a farsighted and responsible action that placed  USPS in the vanguard of both the public and private sectors in providing  future security for its employees, and augured well for its long-term  financial stability, but also acknowledged that the required payments   Contrary  would be a considerable financial challenge in the near term.to statements made by some employee groups and other stakeholders,  PAEA did not require USPS to prefund 75 years of retiree health benefits  over a 10-year period. Rather, pursuant to OPM’s methodology, such  payments would be projected to fund the liability over a period in excess  of 50 years, from 2007 through 2056 and beyond (with rolling 15-year  amortization periods after 2041). However, the payments required by  PAEA were significantly “frontloaded,” with the fixed payment amounts in  the first 10 years exceeding what actuarially determined amounts would  have been using a 50-year amortization schedule.
We testified in April 2007 that we had removed USPS from our high-risk  list due in part to USPS’s financial improvements resulting from these  congressional actions. From fiscal years 2003 to 2005, USPS’s annual pension expense declined by $9 billion. USPS had repaid over $11 billion  of outstanding debt, reported $5.4 billion in cost savings and record high  net incomes, and delayed rate increases from fiscal year 2003 until  January 2006.
Since fiscal year 2007, however, USPS has experienced significant  financial challenges. USPS’s gap between expenses and revenues has  grown significantly, as shown in figure 1. In addition, USPS’s outstanding  debt to the U.S. Treasury increased from $2.1 billion at fiscal year-end  2006 to its current statutory-borrowing limit of $15 billion. In fiscal year  2009, we returned USPS to our high-risk list due, in part, to a projected  loss of $7 billion—and an actual loss of over $8.5 billion—in fiscal year  2010. For fiscal year 2012, USPS had a net loss of almost $16 billion,  which included $11.1 billion for required PSRHBF prefunding payments   Furthermore, USPS’s future financial outlook  that USPS did not make.is bleak as it projects further declines in mail volume and revenue by  fiscal year 2020.
USPS projects that First-Class Mail—which is highly profitable and  generated about 44 percent of USPS’s revenue in fiscal year 2012—will  decline in volume by about 42 percent by fiscal year 2020, as shown in  figure 2. During the economic downturn, there has been an accelerated  diversion of business and individual mail to electronic alternatives, and  some businesses have left the mail entirely. USPS further projects that an  economic recovery will not bring a corresponding recovery in mail volume  because of continuing social and technological trends that have changed  the way that people communicate and use the mail. USPS has several  initiatives to generate new revenue; however, such efforts are unlikely to  generate enough revenue in time to offset the projected decline in mail  volume.cost-saving initiatives to achieve financial stability.
Limited increases in revenue require USPS to seek aggressive  consolidating its mail processing and transportation networks; $5 billion in compensation and benefits; and $8.5 billion through legislative changes, such as moving to a 5-day  delivery schedule.
At the same time, USPS’s plan would also reduce the overall size of the  postal workforce by roughly 155,000 career employees, with many of  those reductions expected to result from attrition. USPS reports in the  plan that half of its current career employees—283,000 employees—will  be retirement eligible by 2016. In March 2010, USPS presented a detailed  proposal to the Postal Regulatory Commission (PRC) to move from a 6- day to a 5-day delivery schedule to achieve its workforce-reduction and  cost-savings goals. USPS projected that its proposal to move to 5-day  delivery by ending Saturday delivery would save about $3 billion annually  and would reduce mail volume by less than 1 percent. However, on the  basis of its review, PRC estimated a lower annual net savings—about  $1.7 billion after a 3-year phase-in period—as it noted that higher revenue  losses were possible. In February 2012, USPS updated its projected net  savings from 5-day delivery to $2.7 billion after a 3-year implementation  period.
As noted earlier, USPS has also proposed withdrawing from the Federal  Employees Health Benefits Program (FEHBP) and administering its own  health care plan for its employees and retirees. This report looks at retiree  health benefit funding options assuming that USPS continues to  participate in FEHBP under current provisions. Adoption of any of the  funding approaches analyzed in this report would not by itself preclude  USPS from continuing to pursue its proposal to administer its own plan.  If  USPS’s proposal was adopted and if it was expected to result in cost  savings, these projected savings would be reflected in a lower liability, a  lower unfunded liability, and lower prefunding contributions than  otherwise.  We will be issuing a separate report evaluating USPS’s proposal to administer its own health care plan.
Related to whether USPS should prefund retiree health benefits, some  stakeholders have argued that such prefunding is primarily responsible  for USPS’s dismal financial condition and is unfair, arguing that no other  entity is required to conduct such prefunding. According to a 2011 OPM  Inspector General (OIG) report, however, postponing prefunding  (deferring payments until later) is financially risky.General reported that future USPS customers (ratepayers) will have to  pay for expenses that the USPS is incurring today and added that  deferring payments will likely hurt the USPS’s ability to compete in the  future and affect its ability to improve its financial situation. The report  added that USPS would lose the benefit of the interest that its deposits  into the funds would have otherwise earned. This interest would have  reduced USPS’s future unfunded liabilities for these benefits.  Consequently, postponing prefunding would require the USPS to make  larger contributions in the future.
section_title: Status and Financial Outlook of the PSRHBF
paragraphs: At the end of fiscal year 2012, OPM estimated that USPS’s total retiree  health benefit liability was almost $94 billion, whereas the PSRHBF  balance was about $46 billion (49 percent), leaving USPS with an  unfunded liability of about $48 billion. Approximately half of the $94 billion  liability is for retired annuitants and their survivors while the other half is  for current career employees. At fiscal year-end 2012, USPS had about  471,000 annuitants and survivors who were receiving retiree health  benefit coverage and about 528,000 career-employees who could  become eligible for such coverage when they retire.current employees is a portion of the ultimate liability for their future  retiree benefits; the liability accrues steadily over their working years,  from zero at date of entry into FEHBP to the full liability at retirement.  Contrary to some claims, there is no liability held, nor contributions made,  for any future employees who have yet to be hired or yet to be born.
PSHRBF’s balance comes from three sources. USPS’s annual prefunding  payments have accounted for $17.9 billion, or 39 percent, of the PSRHBF  balance as of September 30, 2012.The remaining balance consists of  about $20 billion transferred from USPS’s excess CSRS funds (referred  to as “start-up funds” in figure 3 below) when the PSRHBF was created in  2007 and approximately $7.8 billion in earned interest (see figure 3).
Because of USPS’s financial difficulties, however, USPS has not made all  of its required prefunding payments. Under PAEA, USPS is still  responsible for contributing an additional $33.9 billion to the PSRHBF by  fiscal year 2017 as shown in table 1, including $11.1 billion that USPS  has defaulted on over the past 2 years. Originally due at the end of fiscal  year 2011, USPS’s $5.5 billion required retiree health prefunding payment  was delayed until August 1, 2012. USPS missed that payment as well  as the $5.6 billion that was due by September 30, 2012.
While the PSRHBF balance covered about 49 percent of USPS’s retiree  health benefit liability at fiscal year-end 2012, USPS’s deteriorating  financial outlook will make it difficult under current requirements for USPS  to continue prefunding the remaining unfunded liability in the short term,  and possibly to continue funding the remaining unfunded liability over the  next several decades, as required under PAEA.
section_title: USPS’s Future Payments and Unfunded Liabilities Vary Widely Based on Approaches to Fund Retiree Health Benefits
paragraphs: We considered current law (PAEA) requirements against five alternative  approaches for funding the costs of retiree health benefits, each of which  involves tradeoffs that could impact USPS’s short-term cash flow, its  future financial condition, different generations of postal ratepayers, and  over a million postal employees and retirees. We compared the current  law prefunding requirements as well as approaches that have been  proposed in (1) a bill passed by the House of Representative’s Committee  on Oversight and Government Reform, (“House Bill”), (2) in the  President’s fiscal year 2012 budget request (“Administration Approach”),  . In addition, some  and (3) in a bill passed by the Senate, (“Senate Bill”)postal stakeholders have argued that prefunding is unnecessary or  inadvisable altogether, so we also examined the effects of implementing  two variations on a “Pay-as-You-Go Approach.”
subsections: section_title: PSRHBF Funding
paragraphs: We obtained data and projections from USPS and OPM, and built on this information by  performing additional calculations and projections. Methodology and assumptions are  presented in more detail in appendix I. addition to making its share of premium payments for existing retirees  and beneficiaries, which OPM has estimated will rise from about $2.5  billion to about $3.8 billion per year between fiscal year 2011 and fiscal  year 2016. Beginning in fiscal year 2017, the current law switches to an  “actuarial approach” for the remaining funding, under which USPS’s share  of premium payments for existing retirees and beneficiaries is paid from  the PSRHBF rather than by USPS, and USPS makes annual payments to  the PSRHBF consisting of two components:   1.  the actuarially determined cost of future benefits attributable to  employee service during the fiscal year (known as the annual  “normal cost”), and   2.  the actuarially determined amount that, as calculated by OPM,  would be projected to fully fund the remaining unfunded liability  over an amortization period ending in the later of fiscal year 2056  or 15 years subsequent to the then-current fiscal year.
Current law requires OPM to base its actuarial calculations of prefunding  requirements on the actuarial assumptions used by OPM for its financial  reporting. We will discuss the relevance of this current law assumption  basis later in this report.
As discussed earlier, USPS did not make the required 2011 and 2012  payments to the PSRHBF, totaling $11.1 billion. We modeled a modified  version of current law assuming that these missed payments are  eliminated by legislation and that the current law payment schedule  resumes with the payment of $5.6 billion due at the end of fiscal year  2013. We refer to this schedule as “Modified Current Law Approach” in  our presentation of results.
The three alternative prefunding approaches we examined differ from  current law in the following respects.
The House Bill (H.R. 2309) reduces the fixed payment due at the end  of fiscal year 2011 from $5.5 billion to $1.0 billion, making up the  difference in higher fixed payments in fiscal year 2015 and fiscal year  2016. Starting in fiscal year 2017, the House Bill’s actuarial approach  for determining prefunding is the same as current law. As with our  modeling of current law, because the 2011 and 2012 payments have  already been missed, we modeled a modified version of the House  Bill in which the House Bill’s 2011 and 2012 payments are eliminated  by legislation and the House Bill’s payment schedule commences in  fiscal year 2013. We refer to this schedule as “Modified House  Approach” in our presentation of results.
The Administration Approach restructures and generally reducesrequired fixed prefunding payments in each fiscal year from 2011  through 2016. It also calls for USPS’s share of premium payments for  existing retirees and beneficiaries to begin to be paid from the  PSRHBF right away, rather than beginning in fiscal year 2017. As a  result, total USPS payments prior to fiscal year 2017 (prefunding plus  any required payment of premiums) are significantly lower under the  Administration Approach than under current law or the House Bill  (and, consequently, would be somewhat greater after fiscal year 2017  to make up for this). Starting in fiscal year 2017, the Administration’s  actuarial approach for determining prefunding is the same as current  law and the House bill. As with current law and the House Bill, we  modeled a “Modified Administration Approach” that eliminates its 2011  and 2012 payments by legislation and commences payment in 2013.
The Senate Bill (S. 1789) differs from current law, the House Bill, and  the Administration Approach in three key aspects. First, the Senate  Bill eliminates the fixed prefunding payments and begins an actuarial  approach to prefunding right away (which we modeled to begin at the  start of fiscal year 2013). Second, the Senate Bill uses a target of  funding 80 percent of the liability, instead of the 100 percent funding  targeted by current law and the other approaches. Third, the Senate  Bill directs OPM to use actuarial assumptions consistent with those  used by OPM to determine funding for USPS’s share of liabilities in  the federal civilian pension programs. These pension-funding  assumptions are selected by OPM, with advice from an independent  Board of Actuaries. As discussed further in the next section and later  in this report, this assumption basis specified in the Senate Bill differs  from the assumption basis specified in current law and retained in the  House Bill and Administration proposal. We refer to the Senate Bill  provisions as “Modified Senate Approach” in our presentation of  results.
Key features of current law and these alternative approaches are  summarized in table 2. In addition, we also modeled two variations on a  Pay-as-You-Go Approach, discussed in a subsequent section of this  report.
Our analysis shows that, over the short-term period ending in fiscal year  2020, the Modified Current Law and House Approaches would decrease  USPS’s unfunded liability for retiree health benefits, while the Modified  Administration and Senate Approaches would increase the unfunded  liability. This is mainly the result of significantly higher contributions under  the Modified Current Law and House Approaches in fiscal years 2013  through 2016. Over the longer term through 2040, there are significant  differences in the projected unfunded liability among the various  approaches. The Modified Current Law, House, and Administration  Approaches are projected to eliminate most of the unfunded liability over  that period; the Modified Senate Approach is projected to leave a larger  portion of the liability still unfunded because of its lower funding target,  while the two Pay-as-You-Go Approaches we examined would lead to  very large unfunded liabilities.
It should be understood that projections of this type, especially longer  term projections, contain a significant degree of uncertainty. Nonetheless,  given the magnitude of the retiree health benefit liabilities and the  importance of being able to pay for these benefits, reasonable projections  of the associated costs and liabilities provide essential information for  enabling responsible stewardship of USPS resources.
Our comparison of the four prefunding approaches was complicated by  the fact that the Senate Bill calls for selecting assumptions based on  different criteria than current law, the House Bill, and the Administration  Approach. Assumptions represent estimates of future economic and  demographic trends, and while initial assumptions may differ, only one  scenario can actually occur, and assumptions generally change over time  to reflect emerging experience. Accordingly, to compare the four  prefunding approaches, we modeled them under uniform assumptions— first using the current law assumption basis, presented in this section, and  then using the Senate bill assumption basis, presented in appendix II. We  also discuss the underlying differences between these two assumption  bases, and present some comparative results, in the section below on  “Sensitivity to Assumptions.” Our overall findings were not materially  affected by the choice between these two assumption bases.
section_title: Short-term Effects
paragraphs: For a short-term outlook, we projected USPS’s required payments  (prefunding contributions as well as premium payments for current  retirees, when applicable) and the amount of unfunded liability in fiscal  years 2013 through 2020.under the Modified Current Law and House Approaches would be  significantly greater than under the Modified Administration and Senate  Approaches. For example, estimated total payments over this period  under the Modified Current Law Approach would be 48 percent greater  than under the Modified Senate Approach. In particular, payments over  the 8 years would total about $58 billion under Modified Current Law and  $61 billion under the Modified House Approach, versus $44 billion under  the Modified Administration Approach and $39 billion under the Modified  Senate Approach. Higher payments mean a lower unfunded liability at the  end of the period, and vice versa. Thus, at the end of fiscal year 2020, the  Modified Current Law and House Approaches are projected to result in  unfunded liabilities of $39 billion and $35 billion, respectively, whereas the  Modified Administration and Senate Approaches are projected to result in  unfunded liabilities of $59 billion and $64 billion respectively. Thus, in the  short term through fiscal year 2020, the unfunded liability is projected to  decrease under the Modified Current Law and House Approaches and  increase under the Modified Administration and Senate Approaches (see  table 3).
section_title: Long-term Effects
paragraphs: We extended our projection of USPS’s required payments and the  amount of unfunded liability to fiscal year 2040. While the uncertainty of a  projection increases with the length of the projection period, a longer  projection period allows potential longer-term implications of different  approaches to emerge—effects that might not be observable under a  short-term projection. Since dollar amounts in fiscal year 2040 are not  fully comparable to dollar amounts today, it is helpful to “normalize” such  long-term projections to make the results more comparable across time  periods. In table 4 we show projected payments and unfunded liability in  fiscal year 2040 in three different ways: (1) as nominal (unadjusted) dollar  amounts; (2) in constant (inflation-adjusted) 2012 dollars; and (3) as a  percentage of USPS’s projected 2040 modified employee compensation  costs (which for convenience we refer to as “compensation”). We also  show the projected funded percentage—or the ratio of PSRHBF assets to  USPS’s liability for retiree health benefits.
Showing payments and unfunded liability amounts as a percentage of  compensation provides a sense of the size of USPS’s retiree health care  costs relative to the size of USPS’s operations. Projecting compensation  does require an additional assumption regarding compensation growth  and therefore introduces additional uncertainty into the projection.
Nonetheless, increases over time in projected payments and unfunded  liabilities as a percentage of compensation can be indicative of a likely  greater strain on USPS’s resources. For example, unfunded liability as a  percentage of compensation will rise to the extent that USPS is operating  with a reduced workforce.
As seen in table 4, in comparing the projections under Modified Current  Law and the three alternative modified approaches, the differences in the  projected payment required in fiscal year 2040 are not large, with the  dollar amount of the projected payment ranging from $11.5 billion to  $12.9 billion across the four approaches ($5.9 billion to $6.7 billion in  constant dollars). The more significant differences in the annual  payments, across the four approaches, occur in the short-term period  covering fiscal years 2013 through 2016. There are, however, significant  differences in the projected unfunded liability in fiscal year 2040. The  Modified Senate Approach results in a projected unfunded liability of  about $67 billion; this compares to unfunded liabilities of $22 billion under  the Modified Administration Approach, $9 billion under Modified Current  Law, and $7 billion under the Modified House Approach. This projected  unfunded liability under the Modified Senate Approach amounts to $34  billion in constant dollars and 83 percent of projected annual  compensation. For the Modified Administration Approach, the projected  unfunded liability is $11 billion in constant dollars and 28 percent of  projected compensation. The corresponding results under the Modified  Current Law and House Approaches are significantly smaller. For  example, as a percentage of projected compensation, the projected  unfunded liability is 12 percent and 8 percent under the Modified Current  Law and House Approaches, respectively.
A primary reason for these differences is that the Senate Approach uses  a target funded percentage of 80 percent, whereas the other three  approaches use a target of 100 percent. By fiscal year 2040, the funded  percentage is projected to have reached 73 percent under the Modified  Senate Approach, versus 91 percent under the Modified Administration  Approach, 96 percent under Modified Current Law, and 97 percent under  the Modified House Approach.
It is important to note that reaching a 100 percent funded percentage—  that is, the unfunded liability is fully paid off and PSRHBF assets equal  the liability—would not mean that USPS would have no further prefunding  payments to make. USPS would continue to have to pay the “normal  cost” each year into the fund, reduced by amortization of any surplus that  might develop if experience is more favorable than assumed, or  increased if less favorable such that the funded percentage falls back  under 100 percent. As mentioned earlier, the normal cost is the actuarially  determined cost of future benefits attributable to employee service during  the fiscal year, a cost that increases the liability each year. Failure to  continue to make such contributions into the fund each year would mean  a failure to pay for the cost of then-current employee service; the likely  result would be PSRHBF assets again falling short of the liability, thereby  creating a new unfunded liability. Under any of the approaches modeled,  by fiscal year 2040, roughly 80 to 90 percent of USPS’s required payment  would consist of this normal cost.
subsections: section_title: Short- and Long-term Effects Combined
paragraphs: Combining the short-term and long-term projection results, figure 5  illustrates projected annual payments, as a percentage of projected  compensation, for each fiscal year from 2013 through 2040. The largest  differences among the four approaches occur from fiscal year 2013  through fiscal year 2016. Under the Modified House Approach, estimated  required payments are in excess of 20 percent of compensation in all 4 of  these years, climbing to 28 and 29 percent of compensation in fiscal year  2015 and fiscal year 2016. Under Modified Current Law, estimated  required payments are also in excess of 20 percent of compensation in  each of these years, peaking at 23 percent of compensation in fiscal year  2016. In contrast, under the Modified Administration Approach, estimated  required payments start at just 3 percent of compensation in fiscal year  2013 before climbing to 13 to 14 percent of compensation in the ensuing  three years. Under the Modified Senate Approach, estimated required  payments round to a steady 11 percent of compensation in each of these  first 4 years.
From fiscal year 2017 through fiscal year 2040, the estimated required  contributions are closer together across the four approaches, ranging  from 11 to 17 percent of compensation. The projected payments are  somewhat higher under the Modified Administration Approach than under  the Modified Current Law or House Approaches, in order to make up for  the differences in payments from fiscal year 2013 through fiscal year  2016. The projected payments under the Modified Senate Approach  follow a slightly different trajectory because of the approach’s 80 percent  funding target, but fall within the same range.
Figure 6 illustrates the projected unfunded liability, as a percentage of  projected USPS annual compensation costs, as of the end of each fiscal  year from 2012 through 2040. For each approach modeled, the projection  starts at the estimated unfunded liability of 108 percent of compensation  as of the end of fiscal year 2012. In the short term, the unfunded liability  as a percentage of compensation trends down under the Modified House  Approach and Modified Current Law Approach because of their relatively  high required early payments, while the unfunded liability as a percentage  of compensation trends upward under the Modified Administration  Approach and, for a somewhat longer period, under the Modified Senate  Approach. In the longer term, the unfunded liability as a percentage of  compensation trends down under all four approaches.
By the end of the projection period in fiscal year 2040, the vast majority of  the unfunded liability, measured as a percentage of compensation, is  projected to be eliminated under the Modified House and Modified  Current Law Approaches, while a smaller majority of it is projected to be  eliminated under the Modified Administration Approach. A larger  unfunded liability as a percentage of compensation is projected to be  retained under the Modified Senate Approach because of its 80 percent  funding target.
Figure 7 illustrates the funding gap by another measure, the funded  ratio—that is, the percentage of the liability that is covered by PSRHBF  assets. This figure illustrates how a divergence emerges from fiscal year  2013 to fiscal year 2016 between the Modified House and Current Law  Approaches on the one hand, and the Modified Administration and  Senate Approaches on the other hand. By the end of the projection  period, the funded ratio is projected to be just short of the 100 percent  target under the Modified House and Modified Current Law Approaches,  slightly further away from 100 percent under the modified Administration  Approach, and, under the Modified Senate Approach, approaching its  lower 80 percent funded ratio target.
The annual prefunding payments that have been made since prefunding  commenced in 2007—and that would continue to be made under any of  the four prefunding approaches examined here—can be broken down into  two components: a portion to pay for the cost of future benefits  attributable to the current year of employees’ service (the “normal cost”),  and the remainder, which pays down part of the unfunded liability. One of  the rationales for prefunding is to pay for benefits as they are earned— during the working years—rather than later after the workers have retired  and are no longer generating revenue for the enterprise. Further, this  serves the purpose of assigning full costs of current employee  compensation to current ratepayers, rather than to future ratepayers. A  complicating factor is what might be called the “legacy” unfunded liability,  i.e., the existing unfunded liability that conceptually should have been  paid by ratepayers in prior years but was not. There is no obvious answer  as to who should be responsible for the legacy unfunded liability, which  ultimately comes down to a policy decision. The approach in PAEA  spreads the cost of USPS’s legacy unfunded liability over 50-plus years of  then-future postal ratepayers.
To illustrate the portion of prefunding requirements that are attributable to  legacy costs, we found that across the four different prefunding  approaches that we examined, legacy costs would account for anywhere  from 39 percent to 53 percent of the prefunding requirement in fiscal year  2017, tapering down to anywhere from 8 percent to 18 percent by fiscal  year 2040.
section_title: Sensitivity to Assumptions
paragraphs: Measurements of actuarial costs and liabilities, as well as projections of  such measures into the future, are subject to inherent uncertainty, and  depend on a combination of economic and demographic assumptions as  to future experience. Current law requires OPM to determine the value of  USPS’s retiree health benefit liability based on actuarial assumptions that  are consistent with those used by OPM for its financial reporting of  liabilities for federal employee benefits. These assumptions are to be  used to determine USPS’s funding requirements beginning in fiscal year  2017, when current law switches from a fixed-payment prefunding  requirement to actuarially determined prefunding requirements. When the  current law was enacted, this approach to selecting actuarial assumptions  was consistent with the approach used by OPM for determining funding  requirements for USPS’s participation in the CSRS and FERS pension  programs.
In 2008, the Federal Accounting Standards Advisory Board (FASAB),  which promulgates financial reporting standards for the federal  government, issued Statement of Federal Financial Accounting Standards  No. 33 (SFFAS 33), which, beginning in 2010, specified particular, new  methodologies for the selection of economic assumptions for valuing  various post-employment benefits for financial reporting purposes. As a  result, the assumptions used by OPM for financial reporting for federal  employee benefits—and by extension under the current law, for  determining USPS’s future prefunding requirements for retiree health care  benefits—became different from the assumptions used by OPM to  determine USPS’s funding requirements for CSRS and FERS. The House  and Administration Approaches retain the current law assumption basis  for determining USPS’s prefunding requirements; the Senate Approach  would switch the determination of USPS’s prefunding requirements to  assumptions consistent with those now used for USPS’s funding  requirements for CSRS and FERS.
The particular assumptions that differ are with respect to the interest rate  (also known as the discount rate), the general inflation assumption, and  the medical inflation (also known as the “trend”) assumption. Table 5  shows the differences in these assumptions for the September 30, 2011,  actuarial valuations performed by OPM, which served as the basis for our  projections.
Under SFFAS 33, the discount rate assumption should reflect average  historical interest rates, over the prior 5 years or longer, on marketable  Treasury securities with maturities consistent with the cash flows being  discounted. The number of historical rates used in the calculation of this  historical average should be consistent from year to year. OPM uses a  10-year historical averaging period. Further, the discount rate, the  inflation assumption, and other economic assumptions should be  consistent with one another.assumption under SFFAS 33 using the same 10-year historical averaging  period that it uses in determining the discount rate. The selection of  assumptions is also guided by relevant Actuarial Standards of Practice,  which are promulgated by the Actuarial Standards Board.
OPM determines the general inflation  In contrast to the current law assumption basis that is now tied to a  historical averaging period, the assumptions for determining USPS’s  funding requirements for CSRS and FERS represent OPM’s estimate of  future, long-term experience, informed by advice from an independent  Board of Actuaries, and similarly guided by relevant Actuarial Standards  of Practice. These standards too require that economic assumptions be  consistent with one another.
The relationship between the two assumption bases illustrated in table 5  is not static, so that the gap between the two assumption bases, and  even which assumption base has higher rates, could change over time. It  is important to note that assumptions that are tied to historical averages— as is the case under the current law assumption basis since the  promulgation of SFFAS 33—can potentially diverge significantly from  either current economic circumstances or from the current long-term  economic outlook. The assumption criteria in SFFAS 33 were designed to  accomplish financial reporting objectives rather than funding objectives.
In selecting the medical inflation assumption, OPM relies on a model  developed by the Society of Actuaries. This model ties medical inflation  to the general inflation assumption (among other factors), so that a higher  expected general inflation rate implies higher expected medical inflation.
As mentioned earlier, we modeled all four modified prefunding  approaches in two ways: first, as if they all used the current law  assumption basis, and second, as if they all used the Senate bill  assumption basis. Our findings and conclusions are not materially  different under the two different assumption bases. Figure 8 compares  the dollar amount of estimated USPS payments, in each fiscal year from  2013 through 2020, under the Modified Senate Approach to prefunding,  using both the current law assumption basis and the Senate bill  assumption basis. These dollar payment amounts differ by just 2 percent  in aggregate over the period, and by not more than 4 percent in any  particular year.
Figure 9 compares estimated USPS payments under the Modified Senate  Prefunding Approach, over the entire projection period from fiscal years  2013 through 2040, as a percentage of projected USPS annual  compensation costs, again under both the current law assumption basis  and the Senate bill assumption basis. The difference in the average  payment percentage is just 0.7 percentage point, with the difference  never exceeding 1 percentage point in any year.
Because of the closeness of the results using the two assumption bases,  we have chosen to present numerical results across all four prefunding  approaches using the current law assumption basis in the main body of  this report. Appendix II contains comparable numerical results using the  Senate bill assumption basis. The primary reason for similar results under  the two assumption bases is that the effects of differences in particular  assumptions are offsetting to a certain extent. For example, the discount  rate of 5.75 percent under the Senate bill assumption basis is more  optimistic than the discount rate of 4.90 percent under the current law  assumption basis. However, a higher discount rate suggests higher  inflation and medical inflation; the higher medical inflation offsets much of  the benefit of the higher discount rate.
The two different inflation assumptions were also incorporated into our  projection of USPS’s annual compensation costs, which we extended  based on a 10-year forecast of workforce and compensation provided to  us by USPS. More information on these data and projections is provided  in appendix I. We did not otherwise analyze variations in the workforce  and compensation assumptions, as a more extensive analysis of  assumption variations was beyond the scope of our study.
As USPS notes correctly in its fiscal year 2011 Form 10-K report,  “Because calculation of this  liability involves  several areas of judgment, estimates of the liability could vary significantly  depending on the assumptions used.” In comparing the effects of the  current law assumption basis versus the Senate bill assumption basis, we  noted that differences in the discount rate and medical inflation  assumptions have offsetting effects, so that the aggregate difference  between the two assumption bases is not large. If, however, one of the  assumptions were to change without an offsetting change in another  assumption, the impact would be larger. OPM provided information on the  sensitivity of the liability to variation in the medical trend alone, holding  other assumptions constant. OPM’s most recent measure of USPS’s  liability for retiree health benefits would have been 16 percent higher if the  medical trend assumption had been one percentage point higher in all  years (i.e., in table 5 above, 6.5 percent instead of 5.5 percent in the first  year, etc.), and would have been 13 percent lower if the medical trend  assumption had been one percentage point lower. Moreover, because the  unfunded liability is equal to the difference between the liability itself and  the amount of assets, a given percentage change in the liability can  produce a larger percentage change in the unfunded liability. If the 2011  liability had been 16 percent higher, the unfunded liability would have  been 31 percent higher; if the liability had been 13 percent lower, the  unfunded liability would have been 26 percent lower. Thus, the $46 billion  unfunded liability as of September 30, 2011, varies from $34 billion to $60  billion over this range of alternative assumptions. See table 6 below.
Arguments have been made that requiring USPS to prefund its retiree  health care benefits is unnecessary, unfair, or inadvisable, so we also  examined the effects of a Pay-as-You-Go Approach. Under pay-as-you- go funding, each year USPS would only pay its share of premium  payments for then-existing retirees and beneficiaries—there would be no  prefunding.
Given that money has already been prefunded in the PSRHBF, we first  modeled a pay-as-you-go funding approach in which the fund would be  drawn upon to pay USPS’s share of premium payments for as long as  possible. Under this approach, no additional contributions would be made  to the fund, the fund would grow with interest, and USPS’s share of  premium payments for retirees and beneficiaries would be paid out of the  fund until the fund was exhausted. Once the fund was exhausted, USPS  would pay these premiums directly as they became due.
Our projections show that, under either of the two sets of assumptionsthe current law and Senate bill assumption bases—the PSRHBF would  become exhausted in 14 years, in 2026. USPS would have zero reported  costs for retiree health benefits until then. Beginning in 2026, USPS  would begin paying its share of premium payments. By 2040, under the  current law assumption basis, this annual cost is projected to be about  $13 billion, not much different than the annual prefunding cost in fiscal  year 2040 under the four different prefunding approaches. The big  — difference would be in the unfunded liability. Under this Pay-as-You-Go  Approach, the unfunded liability in fiscal year 2040 would be about $250  billion, which would be about $130 billion in 2012 dollars, and about 310  percent of USPS’s projected annual compensation cost. By comparison,  under the modified Senate prefunding approach, which produces the  largest unfunded liability of the four prefunding approaches, the unfunded  liability in fiscal year 2040 would be about 85 percent of projected annual  compensation cost.
In summary, once the trust fund became exhausted, annual pay-as-you- go payments would not become significantly more onerous than annual  prefunding payments, at least through the end of our projection period in  fiscal year 2040. However, the Pay-as-You-Go Approach would produce  a vastly bigger unfunded liability—which could eventually require an  escalation of postal rates or reduction in costs.
We examined a second variation of pay-as-you-go funding, an approach  that the USPS OIG analyzed and reported on in February 2012. Under  this approach, USPS would stop making prefunding payments and would  pay its share of premium payments for retirees and beneficiaries as they  become due. The existing fund would be left to grow with interest, with no  other cash inflow or outflow. The intention would be for this to continue  only until USPS’s liability was fully funded. The USPS OIG has  informally referred to this approach as the “Seal and Grow” Approach.
The USPS OIG estimated that the fund would grow from $44 billion (its  September 30, 2011, level) to $90 billion in 21 years. The USPS OIG did  not estimate the liability or unfunded liability in 21 years, but noted that  while the liability is not a static amount, and has risen over time  historically, it had not changed significantly over the prior 3 years, going  from $87 billion at fiscal year-end 2009 to $91 billion at fiscal year-end  2010 to $90 billion at fiscal year-end 2011.
Some have concluded from this analysis that USPS’s unfunded liability of  $46 billion would be eliminated in 21 years by adopting this approach.  However, our projections of the unfunded liability, which incorporate  OPM’s projections of the liability itself, show that the liability, in fact, would  increase, resulting in a significant increase in the unfunded liability rather  than its elimination. Specifically, we project that the unfunded liability  would grow from $46 billion at fiscal year-end 2011 to $86 billion at fiscal  year-end 2032 under this approach. The $86 billion estimate is equal to  $53 billion in 2012 dollars and 139 percent of fiscal year 2032  compensation (up from 96 percent for fiscal year 2011).
The USPS OIG’s projection of assets – from $44 billion to $90 billion over  21 years – represents a 3.5 percent annual return over this period. Under  our projection, using the current law assumption basis, assets grow from  $44 billion to $120 billion over this period, at the assumed return of 4.9  percent, but the liability grows from $90 billion to $206 billion, or at an  average rate of 4.0 percent per year. This projected liability growth  reflects the net effect of accretions for interest, accretions for normal cost  (with a reduced workforce), and reductions as premium payments are  made, thereby discharging a portion of the liability. The projected liability  would have to be 42 percent lower than projected for the unfunded liability  to disappear by 2032. For this to occur (in the absence of cuts to  benefits), future experience would have to be much more favorable than  predicted by the assumptions.
Nonetheless, under this Seal and Grow Approach the funded percentage  is projected to improve over time. Because premium payments are  projected to exceed normal cost for most of the projection period, the  liability is projected to grow at a slower rate than assets (as noted in the  preceding paragraph). As a result, the liability is projected to be 70  percent funded by 2040, close to the 73 percent projected funded  percentage under the Modified Senate Approach.Modified Senate Approach, the Seal and Grow Approach is projected to  result in a significant improvement in the funded percentage over the  projection period, while still leaving a substantially larger unfunded liability  relative to the Modified Current Law, House, and Administration  Approaches. Moreover, USPS’s payments under the Seal and Grow  Approach would be more backloaded than under the Modified Senate  Approach—with lower payments in the short term and higher payments  later—making it more affordable in the short term but resulting in higher  estimated unfunded liabilities in the short term as well.
section_title: Key Considerations for Assessing Funding Approaches
paragraphs: To assist Congress in considering the various funding approaches, we  identified some factors to consider in assessing what would constitute  reasonable short-term and long-term funding requirements. We also  examined the prefunding requirements of other organizations that offer  retiree health benefits to their employees. Given that USPS is intended to  be a self-sustaining entity funded almost entirely by postal revenue, we  have previously stated that USPS should prefund its retiree health benefit  liability to the maximum extent that its finances permit.
subsections: section_title: Funding Approach Considerations
paragraphs: The following considerations should be taken into account when  assessing the various funding approaches for USPS.
Consideration of whether to prefund retiree health benefits includes the  associated consequences of the potential inability to fund the remaining  unfunded liability or keep up with annual premium payments. In general,  rationales for prefunding post-retirement benefits for any enterprise,  whether for pension benefits or retiree medical benefits, can include the  following:
Achieving an equitable allocation of cost over time by paying for  retirement benefits during the employees’ working years, when  such benefits are earned. For USPS, the relevant cost allocation is  between current and future postal ratepayers. The rationale is to have  current ratepayers pay for the full cost of compensation for current  employees, including the portion of such current compensation that is  not paid until these current employees are retired. However, as noted  earlier, an additional consideration is the “legacy” unfunded liability  that was not paid by ratepayers in prior years. The conceptual  rationale for prefunding does not answer the question of who should  be responsible for a legacy unfunded liability.
Protecting the future viability of an enterprise by not saddling it  with bills later after employees have already retired. In the case of  USPS, this consideration is complicated by the organization’s financial  condition.
Providing greater benefit security to employees, retired  employees, and their beneficiaries. Funded benefits protect against  an inability to make payments later on, and can also make the  promised benefits less vulnerable to cuts. In the private sector, failure  to prefund retiree health benefits may have contributed to private  employers terminating or reducing such benefits. In the state and local  government sector, large unfunded liabilities for both retiree health  and pension benefits have led to pressure and actions to trim the  levels of these benefits. Others have contended that the mere  requirement to account for the cost of these benefits in employers’  financial reporting has led to benefits being cut. While an analysis of  the cause of retiree health benefit cuts in other sectors is beyond the  scope of our research, failure to prefund these benefits is a potential  benefit security concern.
Providing security to any other party that might become  responsible for part of the liability in the event of an enterprise’s  inability to pay for the remainder of the unfunded liability. For  example, the Pension Benefit Guaranty Corporation is responsible for  backing up private sector pension benefits when companies are  unable to do so. According to the OPM OIG, the consequences if  USPS could not pay for its retiree health benefits are unclear.
The effect of trade-offs among the different approaches on a number of  issues would need to be considered, including trade-offs affecting:
USPS’s financial condition. Protecting the future viability of USPS  by not overwhelming it with bills and unfunded liabilities for the cost of  employee benefits after these employees have already retired is  complicated by the organization’s immediate cash flow challenges  including having reached the maximum of its borrowing authority.  Prefunding payments under current law have contributed about $21  billion toward USPS’s $25 billion of net losses over the past 5 years. If  USPS continues to experience operational losses even before  factoring in prefunding requirements, prefunding would add to such  losses. As such, USPS would need to find larger cuts in operational  costs now in order to have the cash to make its short-term prefunding  payments. On the other hand, to the extent short-term prefunding  payments are postponed, greater payments would be required later,  supported by a smaller base of mail volume, with price caps further  limiting revenue. Such a scenario would produce even greater  pressure for cuts in operational costs later as well as raise concerns  about USPS’s ability to make prefunding payments, when unfunded  liabilities would be greater because of the deferral of prefunding  payments.
USPS’s OIG has stated that as an alternative to additional prefunding,  USPS’s extensive real estate holdings could provide collateral for the  remaining unfunded liability. However, USPS has stated that it does not  believe that USPS-occupied real estate would be a suitable asset within  the PSRHBF because employer-occupied real estate cannot be readily  sold to provide cash when needed to pay benefits. In addition, we  would note that in the event of USPS’s being unable to fund its liabilities,  USPS might have other debts and obligations in addition to unfunded  retiree health care liabilities for which any available real estate would be  needed.
Some comprehensive proposals to address USPS’s financial condition  have included provisions to transfer USPS’s FERS pension surplus from  the Civil Service Retirement and Disability Fund (CSRDF) to USPS; such  a transfer could be viewed as a short-term source for some of the  required PSRHBF prefunding payments. However, the most recent  estimate of this surplus is significantly lower than the two prior estimates.  We have previously reported on options and considerations with regard  to this surplus. Use of any FERS surplus would not be a long-term  solution to address USPS’s financial outlook and operational imbalances.
Size of the annual payment and the unfunded liability. More near- term funding reduces payments and the amount of the unfunded  liability later, while less near-term funding produces larger unfunded  liabilities and requires higher funding payments later.
The unfunded liability can also be viewed in a larger context. From fiscal  years 2007 through 2010, USPS contributed a total of $17.9 billion to the  PSRHBF. Over this same period, USPS increased its debt to the U.S.  Treasury from $2.1 billion at fiscal year-end 2006 to $12.0 billion at fiscal  year-end 2010, an increase of $9.9 billion. Thus, from fiscal year-end  2006 to 2010, USPS made payments to the PSRHBF of $17.9 billion  while borrowing an additional $9.9 billion from U.S. Treasury.
Allocation of costs between current and future postal ratepayers.
More near-term funding assigns more cost to current postal  ratepayers that is reflected in rates, while less near-term funding  assigns more cost to future ratepayers. As noted above, a  complicating factor is the existing unfunded liability, which  conceptually should have been paid by prior ratepayers but was not.  Instead, this legacy cost is being spread among current and future  ratepayers since fiscal year 2007.
Allocation of risks. Less prefunding now increases the risk that later  some party(ies) could be called upon to pick up a greater share of the  costs if USPS could not make its payments or pay off its unfunded  liability. Another risk is that the level of employee pay and benefits  may not be sustainable and could be reduced. As stated earlier,  OPM’s OIG reported that the exact consequences of these risks are  unclear.consistent allocation of costs for pay and benefits earned during  employees’ work years could provide greater benefit security to  employees, retirees, and beneficiaries.
Another consideration with regard to the timing of prefunding payments is  whether Congress wishes to continue requiring fixed prefunding  contributions that are significantly in excess, through 2016, of actuarially- determined amounts. The House Bill largely retains this Current Law  Approach, while the Senate Bill and the Administration Approach would  produce a more consistent funding pattern.
The Senate Bill targets an 80 percent funding level while the other  approaches target a 100 percent funding level. The Senate committee  report accompanying the Senate Bill stated that the committee set an 80  percent target-funding level on the presumption that USPS, if necessary,  had additional assets it could draw upon to meet its liabilities. As  previously stated, USPS’s OIG report stated that USPS’s extensive real  estate holdings could provide collateral for the remaining unfunded  liability, but we would note that in the event of USPS’s being unable to  fund its liabilities, USPS might have other debts and obligations in  addition to an unfunded retiree health benefit liability for which any  available real estate would be needed. If an 80 percent funding target  level were selected because of concerns about USPS’s ability to achieve  a 100 percent target level within a particular time frame, an additional  option could be to build in a schedule to achieve 100 percent funding in a  subsequent time period after the 80 percent level is achieved.
As discussed earlier, the issuance of SFFAS 33 had the effect of creating  a divergence between the actuarial assumptions used in determining  USPS’s funding requirements for PSRHBF and those used in determining  its funding requirements for CSRS and FERS. Another consideration is  whether Congress desires more uniform funding assumptions across  these programs. As noted, the funding assumptions for PSRHBF under  current law, which are retained in the House Bill and Administration  Approach, are now, post-SFFAS 33, based on 10-year historical  averages. Assumptions that are based on historical averages can  potentially diverge significantly from either current economic  circumstances or from the current long-term economic outlook. The  assumption criteria in SFFAS 33 were designed to accomplish financial  reporting objectives rather than funding objectives.
section_title: Comparison with Other Entities
paragraphs: We also reviewed the prefunding requirements for other organizations  that offer retiree health benefits to their employees: private sector entities,  state and local governments, and other federal entities. Although other  federal, state and local, and private sector entities generally are not  required to prefund retiree health care benefits, a few do prefund at  limited percentages of their total liability. However, most are required to  recognize the future costs of these benefits in their financial reporting if  they follow generally accepted accounting principles. Although  recognizing the cost of retiree health benefits for financial reporting  purposes is a separate issue from the question of whether to prefund  these benefits, such reporting does enhance the transparency of the cost  of these benefits. USPS accounts for these benefits using private-sector  multiemployer accounting rules, under which USPS does not recognize  the unfunded liability for these benefits on its balance sheet. In 2002,  GAO suggested that USPS reconsider its method of accounting for these  benefits.
In addition, although prefunding is not required, a number of private,  state, local, and federal entities have elected to prefund some percentage  of their retiree health benefits. For example, Standard & Poor’s (S&P)  reported that 126 of the 296 companies in the S&P 500 that offered “other  post-employment benefits” (OPEB) prefunded some percentage of the  associated liabilities, while the USPS OIG has reported that 38 percent of  Fortune 1000 companies that offer retiree health care benefits prefund  them, at a median funding level of 37 percent. Further, in November  2009, we found that 18 states and 13 of the 39 largest local governments  had set aside at least a combined $25 billion in assets to cover their  OPEB liabilities.
Although the majority of federal civilian agencies do not prefund these  benefits, a few small, civilian, federal agencies do so. In addition, the  Department of Defense (DOD) prefunds its retiree health benefits for  Medicare-eligible retirees and beneficiaries, with a 100 percent target  funded percentage. This fund was started in 2002 in reaction to rapidly  rising health care costs. The fund had assets of $166 billion as of  September 30, 2010, which represented a funding level of 38 percent.  DOD does not prefund its pre-Medicare-eligible retiree health benefits,  although its independent Board of Actuaries has recommended that it  consider prefunding these costs as well, in order to reflect the full costs of  these future benefits and promote a better understanding of the  program’s value.
While private sector, state and local government, and other federal  entities generally are not required to prefund these benefits, most are  required to recognize the future costs of these benefits on an accrual  basis as they are earned, rather than when they are paid, in their financial  reporting. Standards governing financial reporting (i.e., accounting) are  separate and apart, and under different jurisdiction, from any laws,  regulations, or rules governing prefunding.
In contrast to most other federal entities, USPS reports under private  sector (FASB) accounting standards, and follows FASB’s multiemployer  accounting rules, rather than FASB’s single-employer accounting rules, in  reporting its participation in FEHBP. These multi-employer standards  exempt employers from reporting the cost of these retirement benefits on  an accrual basis. Instead, expense for a year is set equal to required cash  payments—which currently for USPS means the sum of its required  prefunding payment and its share of premium payments that it pays  directly—while no liability is shown on the USPS balance sheet except for  any required payments that have been missed (such as the missed fiscal  year 2011 and 2012 prefunding payments). In contrast, if USPS were  following FASB’s single-employer accounting standards, USPS would  show a liability on its balance sheet for the entire unfunded liability, and  expense for a year would be an actuarially determined accrual cost  independent of whether USPS had to make a small or large prefunding  payment for that year. In 2002, the Comptroller General wrote to the  Postmaster General and, based on a reassessment of the applicability of  multiemployer versus single-employer accounting standards to USPS,  suggested that USPS reassess its accounting treatment of retiree health  benefits, and consider accounting for its retiree health benefits on an  accrual basis, meaning, to consider adopting the single-employer  accounting procedures. A basic premise behind the exemption from  accrual accounting for multiemployer plans was that the liability for an  individual employer would be difficult to determine and would be of limited  value, a premise that is not the case for USPS.
Recognizing the cost of retiree health benefits on an accrual basis for  financial reporting enhances the transparency of the cost of these  benefits even in the absence of prefunding. As a result, in situations  where prefunding requirements do not exist or are significantly relaxed or  eliminated, accrual accounting provides an important function by  recognizing the costs of these future benefits even in the absence of  prefunding. It can also be the case that a year’s accrual cost can be lower  than the amount funded. For example, the fixed payments required under  current law may well be higher than the annual accrual cost that USPS  would recognize under single employer accounting, although, again, the  full unfunded liability would be recognized on the balance sheet.
Note that there is one other significant program, federal workers’  compensation under the Federal Employees’ Compensation Act, for  which USPS’s financial reporting is based on actuarial projections of  future benefits rather than on its annual required cash payments. USPS  pays the Department of Labor each year for the cash benefits to current  beneficiaries, but USPS records a liability on its balance sheet for the  entire actuarial present value of future benefits for those who have  already been injured, and recognizes the growth in this liability as an  expense each year. This unfunded FECA liability on USPS’s balance  sheet was $17.6 billion as of September 30, 2012.
section_title: Concluding Observations
paragraphs: Timely action is essential in addressing the funding of USPS’s retiree  health benefits. We have suggested that Congress must take action to  address the uncertainty related to:   1)  USPS’s inability to meet the current retiree health prefunding  2)  reducing the unfunded retiree health benefit liability over time,  3)   determining the proper allocation of costs between current and  4)  enacting comprehensive postal reform legislation that would  improve prospects for USPS’s long-term financial viability.
USPS’s recent defaults on its retiree-health- prefunding payments and its  inability to borrow now that it has reached its $15 billion borrowing limit  create an even more urgent need for congressional action. The continued  uncertainty around resolution of USPS’s financial problems and the  funding of these payments creates uncertainty for mailers in developing  their business plans, an uncertainty that could negatively affect mailers’  willingness to use USPS’s services. As noted earlier, USPS has also  proposed withdrawing from FEHBP and administering its own health care  plan for both workers and retirees, a proposal that is the subject of our  ongoing work in another study.
Congress should also consider how quickly and to what level prefunding  of retiree health benefits should occur. As previously cited, deferrals and  lower payments in the short-term will reduce USPS’s reported financial  losses in the short-term, but would increase its unfunded retiree health  benefit liability and require larger annual payments in the future; yet at the  same time, currently required short-term payments are higher than what  would be required under the actuarial approach that begins in 2017. Both  of these points raise issues regarding fairness to future and current  ratepayers. Furthermore, postal ratepayers provide USPS with funding,  but as mail volumes decline, there may be fewer ratepayers in the future  to pay for deferred costs. In addition, the less USPS reduces its retiree  health unfunded liability, the greater the potential consequences, with  unclear impact, if USPS is ultimately unable to pay this unfunded liability.  In considering the options for USPS to address its retiree health benefit  liability, Congress should keep in mind that stopping or deferring  prefunding of these benefits would serve as short-term relief, but would  also increase the risk that USPS may not be able to make future  payments if its core business continues to decline. Therefore, we  continue to believe it is important that USPS prefund its retiree health  benefit liability to the maximum extent that its finances permit.
None of the funding approaches will be viable unless USPS has the  ability to make the required payments. Without congressional or further  USPS actions to cut postal costs, USPS will not have the finances  needed to make annual payments in the short term and reduce its retiree  health unfunded liability over the long term. USPS has stated that it will  be unable to make any prefunding payment toward reducing its retiree  health unfunded liability if it continues to experience cash flow difficulties.  While USPS may have limited control of its revenue stream because of  advances in technological communication, it is important that USPS  reduce its expenses to avoid even greater financial losses, repay its  outstanding debt, and increase capital for investment. Consequently, as  we have repeatedly stated, Congress and USPS need to reach  agreement on a comprehensive package of actions to improve USPS’s  financial viability. In previous reports, we have provided strategies and  options, to both reduce costs and enhance revenues, that Congress could  consider to better align USPS costs with revenues and address  constraints and legal restrictions that limit USPS’s ability to reduce costs  and improve efficiency. Implementing strategies and options to better  align costs with revenues may better enable USPS to be in a financial  position to prefund its retiree health benefit liability for its over one million  active and retired postal employees and their beneficiaries.
section_title: Agency Comments and Our Evaluation
paragraphs: We provided a draft of this report to USPS, the USPS OIG, and OPM for  review and comment. USPS and the USPS OIG provided comments,  which are reprinted in appendixes III and IV, respectively. USPS and the  USPS OIG did not disagree with the report’s conclusions and analysis  about the trade-offs involved with the alternative funding approaches, but  both commented that USPS cannot afford to make prefunding payments  and provided additional context. OPM had no comments but provided  technical clarifications, which we incorporated into the report as  appropriate.
USPS agreed that comprehensive reform is necessary to achieve  financial sustainability.  It also recognized its obligation to provide  effective, affordable health benefits to its employees and retirees, but said  that it does not have the financial resources to make prefunding  payments required by current law. Further, USPS said that releasing this  report is inappropriate because, in its view, the solution to managing its  health care costs is to reduce the cost of future health care coverage by  allowing USPS to sponsor its own medical plan. In response to USPS’s  comment, we noted in the report that adopting any of the prefunding  approaches analyzed in this report would not preclude USPS from  continuing to pursue its proposal to administer its own plan, and that any  resulting expected cost savings would be reflected in a lower unfunded  liability and lower actuarially determined prefunding payments than  otherwise. As USPS noted, we are currently reviewing USPS’s proposal  to administer its own plan.
The USPS OIG concurred with our analysis of the trade-offs among the  alternative funding approaches that would result in paying more now or in  the future, but stated its concern that the report needed additional context  in four areas: 1) historical, 2) financial, 3) use of other assets to satisfy the  retiree health benefit obligation, and (4) the problems with prefunding.
First, the USPS OIG stated that USPS started prefunding its retiree health  benefits as a result of the discovery that, because of external fund  management misjudgments, it was on track to seriously overfund its  pension obligations by $78 billion.  The USPS OIG also said that a  decision to turn a mistake into a second prefunding obligation created its  own problems, including a 10-year schedule of prefunding payments that  was structured toward a 100 percent funding goal, and that the  aggressive payment schedule appears to have been set based on  byzantine “budget scoring” considerations rather than actuarial  assumptions or an evaluation of USPS’s ability to make the payments.
In our report, we noted USPS’s reduction in pension contributions to the  Civil Service Retirement System occurred as a result of the Postal Civil  Service Retirement System Funding Reform Act of 2003, which switched  the actuarial basis for future contributions to “dynamic” assumptions from  the “static” assumptions that OPM projected would result in overfunding.   Further, we pointed out that the 10-year schedule of prefunding payments  for fiscal years 2007 through 2016 was not based on an actuarial  assessment, and that the remaining required payments through fiscal  year 2016 are significantly in excess of what would be calculated under  the actuarial approach that begins in fiscal year 2017.  We also noted that  USPS proposed prefunding to Congress in 2003.
Second, the USPS OIG discussed several points in a financial context.  It  said that USPS has never been able to afford a single payment—that it  has either borrowed from the U.S. Treasury to make prefunding payments  to date or that it has defaulted on them.  However, we noted in our report  that from fiscal year-end 2006 to 2010, USPS made total prefunding  payments of $17.9 billion while borrowing an additional $9.9 billion from  the U.S. Treasury.  The USPS OIG also stated that now that the USPS  has reached the limit of the amount it can borrow, it can no longer make  the payments.  We noted in our report that none of the funding  approaches will be viable unless USPS has the ability to make the  required payments, and that a comprehensive package of actions is  needed to improve USPS’s financial viability. The USPS OIG also said  that its “seal and grow” proposal was made in the context of USPS’s  urgent financial situation and was meant as a temporary—not  permanent—measure, and that we mistakenly represented it as a  permanent payment plan.  Our report actually noted that the Seal and  Grow Approach was intended to continue until USPS’s liability was fully  funded—meaning, not thereafter; we added additional wording to clarify  this point.  The USPS OIG also pointed out that USPS has substantially  funded its retiree benefit programs, with its pensions fully funded and its  retiree health benefits half funded, with enough to cover current retirees.   We did note in our report that the retiree health benefit liability is 49  percent funded and that approximately half of the liability is for current  retirees.  As for pensions, USPS reported in its most recent annual  financial report (10-K) for fiscal year 2012 that it had an unfunded pension  liability of almost $16 billion, which represented a 95 percent funded  percentage (i.e., close to fully funded), based on a projected year-end  fund balance of $285 billion and a liability of $300 billion; the prior year’s  estimate had indeed been a pension surplus.
Third, the USPS OIG stated that our report did not adequately explore the  use of other assets USPS holds as a means of satisfying its retiree health  benefit obligation. The USPS OIG noted that it has reported on two  sources of assets worth billions that could be used to cover any unfunded  obligation, including 1) an estimated $85 billion in real estate holdings and  2) surpluses in USPS’s pension funds. As we noted in our report, USPS  has stated that it does not believe that USPS-occupied real estate would  be a suitable asset within the PSRHBF because employer-occupied real  estate cannot be readily sold to provide cash when needed to pay  benefits.  We noted that in the event of USPS’s being unable to fund its  liabilities, USPS might have other debts and obligations in addition to  unfunded retiree health benefit liabilities for which any available real  estate proceeds would be needed.  We noted that we reported on options  and considerations with regard to any USPS pension surplus (in particular  regarding FERS) in a prior report.
Finally, the USPS OIG commented that our report should examine the  problems of prefunding and examine why no business or government  entity has taken advantage of prefunding, and that making prefunding  payments at the current levels will bankrupt USPS.  Our report did  discuss these issues, beginning with the section entitled, Comparison  with Other Entities.  While our report did not examine comprehensively  the reasons for other entities’ prefunding decisions, we noted that  although prefunding is not required, a number of private, state, local, and  federal entities have elected to prefund some percentage of their retiree  health benefits, as follows:
Standard & Poor’s (S&P) reported that 126 of the 296 companies  in the S&P 500 that offered “other post-employment benefits”  (OPEB) prefunded some percentage of the associated liabilities;   the USPS OIG reported that 38 percent of Fortune 1000  companies that offer retiree health benefits prefund them, at a  median funding level of 37 percent;
18 states and 13 of the 39 largest local governments had set  aside at least a combined $25 billion in assets to cover their  OPEB liabilities; and   the Department of Defense prefunds its retiree health benefits for  Medicare-eligible retirees and beneficiaries, with a 100 percent  target funding percentage, and that this fund, which was started in  2002 in reaction to rapidly rising health care costs, had assets of  $166 billion as of fiscal year-end 2010.
We also recognized USPS’s inability to meet the current retiree health  prefunding requirements along with the need for comprehensive  legislative action.  Specifically, we said, “None of the funding approaches  will be viable unless USPS has the ability to make the required payments.   Without congressional or further USPS actions to cut postal costs, USPS  will not have the finances needed to make annual payments in the short  term and reduce its retiree health benefit liabilities over the long term.”
As arranged with your office, unless you publicly announce its contents  earlier, we plan no further distribution of this report until 30 days after its  date.  At that time, we will send copies of this report to the appropriate  congressional committees, the Postmaster General, OPM, the USPS  Inspector General, and other interested parties. In addition, the report will  be available at no charge on GAO’s Web site at http://www.gao.gov.
If you or your staffs have any questions on this report, please contact  Frank Todisco at todiscof@gao.gov; Lorelei St. James at  stjamesl@gao.gov: or call (202) 512-2834. Contact points for our Offices  of Congressional Relations and Public Affairs may be found on the last  page of this report. Contact information and key contributors to the report  are listed in appendix V.
Frank Todisco   Chief Actuary    Applied Research and Methods Lorelei St. James  Director  Physical Infrastructure Issues  The undersigned meets the qualification standards of the American  Academy of Actuaries to render the actuarial findings contained in this  report.
section_title: Appendix I: Objectives, Scope, and Methodology
paragraphs: This report (1) describes the status and financial outlook of the Postal  Service Retiree Health Benefits Fund (PSRHBF), (2) analyzes how  alternative proposals for funding retiree health benefits could affect future  USPS payments and unfunded liabilities, and (3) determines key  considerations for policymakers assessing the alternative proposals or  other approaches.
To describe the status and financial outlook of the PSRHBF, we reviewed  and summarized USPS financial data regarding payments made to the  fund, interest earned from such contributions, overall fund balance, and  retiree health benefit liability. We also reviewed our prior work and  reviewed and summarized reports and data from USPS and others on  how USPS’s financial condition has changed since 2006. We reviewed  relevant statutes, proposed legislation, and sections of the President’s  budget request for fiscal year 2012 pertaining to USPS’s health and  pension benefit programs. We also interviewed USPS and OPM officials  on the status and financial outlook of the PSRHBF.
To determine the impact on USPS payments and unfunded liabilities  under alternative approaches to fund retiree health benefits, we analyzed  and compared current funding requirements and five alternatives. We  interviewed USPS officials on the USPS’s ability to meet future mandated  payments and to obtain information on current and projected employee  (FTE) levels, compensation, and revenue. In addition, we met with OPM  officials to discuss projection methodology, and assumption selection, for  using the data provided by USPS to project future premium payments,  normal costs, and liabilities. OPM provided us projections of these  amounts, which we further analyzed to project future prefunding  contributions and unfunded liabilities under the different approaches to  prefunding that we analyzed. Additional information on data,  assumptions, and methods is provided below.
To determine key factors for policymakers to consider when assessing  alternative approaches, we used our own actuarial judgment and  expertise. We also examined prefunding requirements for retiree health  benefits, and prefunding behavior, of other entities (federal, state, and  local governments and private sector). In addition, we examined financial   reporting requirements applicable to other entities for these benefits,  reviewing relevant accounting standards promulgated by the Financial  Accounting Standards Board (FASB), Governmental Accounting  Standards Board (GASB), and Federal Accounting Standards Advisory  Board (FASAB); we compared these standards to USPS’s financial  reporting for these benefits.
subsections: section_title: Additional Information on Data, Assumptions, and Methods Underlying the Actuarial Projections
paragraphs: We relied on OPM’s actuarial projections of normal cost, accrued liability  (referred to in the report, and in the remainder of this appendix, simply as  “liability”) and premium payments. We obtained data on workforce  projections from USPS, as described further below, which we projected  further and supplied to OPM for use in the projections. OPM’s valuation of  the cost of USPS’s retiree health benefit obligations entails the collection  and analysis of participant data and claims cost data, the setting of  demographic and economic assumptions, and the application of these  data and assumptions to the provisions of the benefit program. We had  extensive discussions with OPM regarding its valuation methodology and  were satisfied with the reasonableness of the approach with regard to the  issues discussed. However, we did not otherwise audit or evaluate OPM’s  actuarial assumptions, methodology, calculations, or underlying data.  Such an evaluation would have required a substantial amount of  additional work beyond the scope of our assignment, and would also  have required engaging additional actuarial resources with particular  expertise in the valuation of health care benefits. For projecting the most  recent valuation results into the future, we selected the methodology and  projection assumptions in consultation with OPM. Additional detail on  OPM’s methods and assumptions is available from OPM.
It should be understood that projections of this type contain a significant  degree of uncertainty, as discussed further in the section of the report on  Sensitivity to Assumptions. Nonetheless, given the magnitude of the  liabilities and the importance of being able to pay for these benefits,  reasonable projections of these costs and liabilities provide essential  information for enabling responsible stewardship of resources.
OPM provided us with projected normal cost and premium payments for  each year through 2040. OPM calculated and provided us with projected  liability as of three points: the end of 2010 (the measurement date of the  most recent data collection at the time of our request), the end of 2021,  and the end of 2040. We used a linear interpolation to estimate the  liability for each of the intervening years. For each future year, we  calculated the prefunding contribution, based on the normal cost and  unfunded liability, when an actuarial approach applied; rolled the assets  forward by adding the prefunding contribution and investment income and  subtracting premium payments, as applicable; calculated the next year’s  unfunded liability based on these projected assets and the projected  liability for that year; calculated the next year’s prefunding contribution  based on this new unfunded liability; and so on to the end of the  projection period. The calculation of the prefunding contribution—as well  as the applicability of fixed versus actuarially determined contributions  and whether premium payments came out of the fund—was based on the  provisions of the prefunding approaches we modeled, as described in the  main body of this report (table 2 and preceding text). Where an actuarially  determined prefunding contribution was used, it was the sum of the  normal cost and an amortization payment (mortgage-style amortization  calculation) calculated to pay off the unfunded liability in equal annual  installments. Note that under the terms of the Senate Bill, which uses an  80 percent funded percentage target instead of 100 percent, the  amortization is based on , rather than  , and 100 percent of the normal cost is added to  the amortization payment, rather than 80 percent of the normal cost.
OPM’s projections of liabilities are based on the current level of plan  health benefits and do not reflect any proposals to reduce the actuarial  value of benefits. USPS has proposed withdrawing from the Federal  Employees Health Benefits Program (FEHBP) and administering its own  health care plan for its employees and retirees. This report looks at retiree  health benefit funding options assuming that USPS continues to  participate in FEHBP under current provisions. We will be issuing a  separate report on USPS’s proposal to administer its own health care  plan.
OPM’s projections also reflect the projected changes over time in the U.S.  Treasury’s share of USPS’s retiree health benefit costs. U.S. Treasury is  responsible for the portion of USPS’s share of retiree health benefit  premiums attributable to service prior to 1971, when the Post Office  Department was transformed into the USPS. The U.S. Treasury’s share  of costs is diminishing over time as the proportion of retirees who had  pre-1971 service decreases.
One of the factors affecting future changes in USPS’s liability for retiree  health benefits is the size of its future workforce. The liability grows with  future accruals of employee service and is also affected by when  employees retire. USPS provided us with projected counts of career  employees from 2011 through 2020. USPS noted that its intermediate- term planning horizon was through 2016 and that because of the rapidly  changing nature of the mailing environment and the overall economy,  projections beyond that point are likely to have a higher margin of error.
USPS’s projection had its career-employee complement dropping, from  561,000 in 2011 and 534,000 in 2012 (representing approximate  averages over the fiscal year) to approximately 416,000 by 2016 and to  392,000 by 2020. USPS told us that it would be reasonable to assume  that the complement would stabilize at that level thereafter. We assumed  a constant career workforce of 392,000 for the remainder of the projection  from 2020 through 2040.
USPS viewed this workforce projection as its optimal, target workforce  path, assuming USPS would be able to achieve certain objectives  regarding its network and other operational issues. It noted that its ability  to achieve these reductions remains to be determined, and would be  affected by negotiations with unions and any congressional actions.  USPS also noted that its workforce projections were based on long-term  projections of mail volume. There is, of course, uncertainty regarding  future levels of mail volume.
OPM found that using its standard valuation assumptions for such factors  as employee retention and retirement, and adding in an amount of new  hires necessary to stay on target, its projection model reasonably  approximated USPS’s projected workforce path. Based on this workforce  path and the number of projected retirements and other workforce  reductions, OPM projected some new hiring to begin in 2014, and to  continue as necessary to keep the workforce constant after 2020. OPM  based new hire demographic profiles on the government-wide distribution  of recent hires, since USPS has not been hiring enough recently to have  adequate data for that purpose.
So that we could also calculate USPS payments and unfunded liabilities  as a percentage of employee compensation, USPS provided us with  projections of compensation (salary and wages and benefits) to  accompany the workforce projections, through 2020. The data provided  by USPS encompassed salary plus a portion of employee benefits; it did  not include retiree health benefits, worker’s compensation, or any  forecasted contract negotiations savings. For simplicity, we refer to these  amounts as “compensation.”
We projected these compensation amounts beyond 2020 to 2040. Since  we assumed the USPS workforce to be constant over that period, we  projected total compensation to increase by inflation plus one percent.  USPS had provided us with two sets of compensation projections through  2020: one based on USPS’s own internal inflation assumption ranging  from 1.7 to 2.2 percent annually over that period; and a second, at our  request, assuming 3.0 percent inflation. We estimated an additional  compensation projection based on 2.4 percent inflation from these data.  We used the two sets of compensation projections—one based on 2.4  percent inflation and one based on 3.0 percent inflation—for our  projections under the current law assumption basis and the Senate bill  assumption basis, respectively.
Liabilities and normal costs are based on the “Aggregate Entry Age  Normal” actuarial cost method. A per-participant normal cost rate is  determined based on an aggregate ratio of present value of future  benefits at entry age to present value of future service at entry age, with  service weighted to increase with medical inflation and with the accrual  period from entry age to assumed retirement. The normal cost rate is  computed based on the demographics and claims’ costs of the entire  FEHBP population, not just the USPS population, to reflect how the plan  actually works. OPM would need additional USPS-specific data to  determine a USPS-specific normal cost. The accrued liability is equal to  the present value of future benefits (PVB) minus the present value of  future normal costs. The PVB is just for the USPS population, but based  on demographic assumptions for the entire FEHBP population, and  without USPS-specific utilization, as this is how FEHBP premiums are  determined. The actuarial cost method is the same one used by OPM in  its financial reporting of the cost of these benefits (as required under  FASAB accounting standards) and the same one used by OPM for  determining funding requirements for the CSRS and FERS federal  employee pension programs. Other actuarial cost methods could   for determining USPS prefunding requirements,  reasonably be adoptedsuch as the projected unit credit method (which is also the method used  for single employer accounting under FASB). The actuarial cost method  determines the portion of future retiree costs that are attributable to each  year of employee service, and different methods build up the accrued  liability more or less quickly over the working years.
As discussed in the body of the report, OPM provided current and  projected liabilities, normal costs, and premium payments on two different  assumption bases: (1) the current law basis, which ties funding  assumptions to those used by OPM for its financial reporting, which in  turn is guided by the FASAB accounting standards and (2) the Senate bill  basis, which ties funding assumptions to those assumptions used by  OPM to determine USPS’s funding requirements for CSRS and FERS.  The assumptions differ with respect to discount rate, general inflation, and  medical inflation (trend). These assumptions are disclosed in table 5 in  the report. Demographic assumptions that are common to both the  current law and Senate bill assumption bases can be found in OPM’s  most recent funding valuation report for CSRS and FERS, though these  are applied on a per-participant basis in the retiree health valuation and  on a dollar-amount basis in the pension valuations. OPM also assumes  that present retiree participation rates in FEHBP, calculated by age and  gender, continue into the future.
The discount rate of 4.90 percent used for the current law assumption  basis, which is the discount rate used by OPM in its reporting at  September 30, 2011, represents the single rate equivalent to a 10-year  average of Treasury yield curves, with yield curve maturities matched to  the timing of projected payments, a methodology that satisfies SFFAS 33.  We assumed that the discount rate would remain at 4.90 percent in future  years. In fact, in each future year, a new 10-year average discount rate  will be developed, and if interest rates were to remain unchanged from  present levels, this would result in a lower future discount rate, as higher  interest rates at the beginning of the 10-year averaging period are  replaced by lower interest rates at the end of the averaging period. OPM  indicated that modeling such changes would present significant  computational difficulties. discount rate, which implies that interest rates would rise from current low  levels. In making this assumption, we noted that a steady 4.90 percent  discount rate is still significantly lower than the 5.75 percent discount rate  assumed for the Senate bill assumption basis, and so still provides useful  information regarding potential effects of variations in assumptions. We  also note that the medical inflation assumption used in the projection was  developed to be consistent with the discount rate and general inflation  assumption (the latter is also based on a 10-year average), and that  OPM’s model would produce a lower medical trend assumption if  discount rates and inflation assumptions were to decrease, offsetting  much of the effect of the lower discount rate. Also, in projecting future  premium payments, which went into projecting future liabilities, OPM did  not “restart” the trend assumption vector each year.
OPM does not normally project future liabilities. It needs to calculate current liabilities for  future payments each year, but fulfilling its mission does not require any calculation of  future liabilities. As such, OPM did not have previously developed software to do such  projections, and had to do special programming specifically for this request.
A final methodological decision that had to be made was whether the  projection assumptions should differ from the valuation assumptions. In  actuarial projections, there is a distinction between “valuation  assumptions” and “projection (or experience) assumptions.” Valuation  assumptions are those used to compute the liability and normal cost at  any point in time. Projection assumptions model what actually happens as  you move the projection forward, which might differ from the expectations  embedded in the valuation assumptions. The Senate Bill specifies a  different assumption basis than current law, the House Bill, or the  Administration’s Approach, but these specifications are referring to  valuation assumptions. While different valuation assumptions might be  used, only one scenario can actually unfold in the real world. One way to  reflect this situation in a projection would be to retain the different  valuation assumptions for the different prefunding approaches, but then to  project all the approaches under a uniform set of projection assumptions.  However, this approach would create false precision, because at some  point the valuation assumptions would change to reflect emerging  experience, and the projection would then need to incorporate additional  assumptions as to when that would happen. Accordingly, as a reasonable  approach to compare the four prefunding approaches on an apples-to- apples basis, we modeled them under uniform assumptions—first using  the current law assumption basis, with results presented in the main body  of the report, and then using the Senate bill assumption basis, with results  presented in appendix II of this report. As discussed further in the section  of the report on “Sensitivity to Assumptions,” it turns out that these two  assumption bases do not produce significant differences in basic findings  because of the offsetting effects of different discount rates and medical  inflation assumptions.
We conducted this performance audit from May 2012 through December  2012 in accordance with generally accepted government auditing  standards. Those standards require that we plan and perform the audit to  obtain sufficient, appropriate evidence to provide a reasonable basis for  our findings and conclusions based on our audit objectives. We believe  that the evidence obtained provides a reasonable basis for our findings  and conclusions based on our audit objectives.
section_title: Appendix II: Projected Results Using Senate Bill Assumption Basis
paragraphs: As discussed in the report, we projected USPS’s annual payments and  unfunded liability under four prefunding approaches (Modified Current  Law, Modified House, Modified Administration, and Modified Senate) and  under two different assumption bases: the assumption basis specified in  current law, and the assumption basis specified in the Senate bill. The  differences between these two assumption bases are described in the  report. The report presents projection results based on the current law  assumption basis. This appendix presents the corresponding results  based on the Senate bill assumption basis. As discussed in the report,  our findings and conclusions are not materially different under the two  different assumption bases.
section_title: Appendix III: Comments from the U.S. Postal Service
section_title: Appendix IV: Comments from the U.S. Postal Service, Office of Inspector General
section_title: Appendix V: GAO Contact and Staff Acknowledgments
subsections: section_title: GAO Contacts
section_title: Staff Acknowledgments
paragraphs: In addition to the individuals named above, Samer Abbas, Teresa  Anderson, Beryl Davis, John Dicken, Kim Granger, Jacquelyn Hamilton,  Hannah Laufe, Jennifer Leone, W. Stephen Lowrey, Kim McGatlin,  Jonathan McMurray, Kristi Peterson, Steve Robblee, Amy Rosewarne,  Aron Szapiro, and Crystal Wesco made key contributions to this report.