oversight

U.S. Postal Service: Status, Financial Outlook, and Alternative Approaches to Fund Retiree Health Benefits

Published by the Government Accountability Office on 2012-12-04.

Below is a raw (and likely hideous) rendition of the original report. (PDF)

                United States Government Accountability Office

GAO             Report to the Chairman, Committee on
                Oversight and Government Reform,
                House of Representatives



                U.S. POSTAL
December 2012



                SERVICE

                Status, Financial
                Outlook, and
                Alternative
                Approaches to Fund
                Retiree Health
                Benefits




GAO-13-112
                                                December 2012

                                                U.S. POSTAL SERVICE
                                                Status, Financial Outlook, and Alternative
                                                Approaches to Fund Retiree Health Benefits
Highlights of GAO-13-112, a report to the
Chairman, Committee on Oversight and
Government Reform, U.S. House of
Representatives



Why GAO Did This Study                          What GAO Found
PAEA required USPS to prefund its               The Postal Service Retiree Health Benefits Fund (PSRHBF) covered about 49
future retiree health benefits as part of       percent of the U.S. Postal Service’s (USPS) $94 billion retiree health benefit
comprehensive postal reform by                  liability at fiscal year-end 2012. USPS’s deteriorating financial outlook, however,
establishing the PSRHBF along with              will make it difficult to continue the current prefunding schedule in the short term,
an initial target period to fund the            and possibly to fully fund the remaining $48 billion unfunded liability over the
unfunded liability in 50 years. This            remaining 44 years of the schedule on which the 2006 Postal Accountability and
requirement included annual payments            Enhancement Act (PAEA) was based. The liability covers the projected benefits
to this fund from 2007 to 2016 of               for about 471,000 current postal retirees and a portion of the projected benefits
between $5.4 billion to $5.8 billion.
                                                for about 528,000 current employees; it does not cover employees not yet hired.
USPS, its employee groups, and
                                                Under PAEA, USPS is responsible for contributing an additional $33.9 billion to
others have argued that this prefunding
requirement is a major source of
                                                the PSRHBF by fiscal year 2017, including the $11.1 billion USPS has defaulted
USPS’s financial woes—reported by               on over the past 2 years. PAEA also requires the Office of Personnel
USPS as contributing $32 billion                Management (OPM) to calculate the remaining unfunded liability in 2017 and
toward its $41 billion of net losses over       develop an initial 40-year amortization payment schedule. USPS, however,
the past 6 years. USPS defaulted on             projects further declines in mail volume and revenues that may continue to limit
the last 2 years of PSRHBF payments             its ability to prefund the remaining retiree health benefit liability.
totaling $11.1 billion.                         GAO’s analysis of maintaining current law requirements compared to five
As requested, this report addresses             alternative approaches showed differing impacts on USPS’s future annual
the (1) status and financial outlook of         payments and unfunded liabilities. For example, three of the approaches—1) the
the PSRHBF, (2) impact on future                Administration’s Approach, 2) Senate Bill (S. 1789) and 3) “Pay-as-You-Go” (no
annual USPS payments and unfunded               prefunding)—would reduce USPS’s annual payments in the short term, thereby
liabilities of alternative approaches,          easing its immediate cash flow problems and financial losses. However, these
and (3) key considerations for                  approaches would increase USPS’s unfunded liability, sometimes substantially,
policymakers. GAO reviewed and                  and require larger payments later. Deferring funding could increase costs for
summarized PSRHBF financial data                future ratepayers and increase the possibility that USPS may not be able to pay
and analyzed and compared current               for some or all of its liability. Conversely, a fourth approach—the House Bill (H.R.
law requirements with five alternative          2309)—and the current law requirement would reduce USPS’s unfunded
approaches by developing projections
                                                liabilities more aggressively but may result in significantly higher USPS financial
based on OPM and USPS data.
                                                losses in the near future. If USPS stopped prefunding and let the existing fund
What GAO Recommends                             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
GAO is not making new                           pay current and future premiums, the fund is projected to be exhausted by 2026.
recommendations in this report, as it           Private sector, state, local, and other federal entities are not required to prefund
has already reported on strategies and          these benefits, though some do so to a limited extent, and most are required to
options for USPS to achieve
                                                recognize the future costs in their financial reporting.
sustainable financial viability. In
commenting on a draft of this report,           GAO identified several key considerations including: (1) the rationale and
USPS and the USPS Office of                     consequences of prefunding such benefits; (2) trade-offs affecting USPS’s
Inspector General stated that USPS              financial condition, such as sizes of the annual payments and unfunded liability;
could not afford to prefund. USPS has           (3) fixed versus actuarially determined payments; (4) targeted funding levels; and
stated that any discussion of                   (5) assumption criteria. USPS is intended to be a self-sustaining entity funded
PSRHBF’s outlook must consider                  almost entirely by postal ratepayers, but its financial losses are challenging its
USPS’s proposed health plan. GAO is             sustainability. GAO has testified that USPS should prefund its retiree health
currently reviewing this proposal.              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
View GAO-13-112. For more information,
contact Frank Todisco at todiscof@gao.gov or    payments. USPS’s default on its last two required PSRHBF payments and its
Lorelei St. James at stjamesl@gao.gov or call   inability to borrow further make the need for a comprehensive package of actions
(202) 512-2834.                                 to achieve sustainable financial viability even more urgent.
                                                                                          United States Government Accountability Office
Contents


Letter                                                                                    1
               Background                                                                 4
               Status and Financial Outlook of the PSRHBF                                12
               USPS’s Future Payments and Unfunded Liabilities Vary Widely
                 Based on Approaches to Fund Retiree Health Benefits                     15
               Short-term Effects                                                        19
               Long-term Effects                                                         22
               Key Considerations for Assessing Funding Approaches                       40
               Concluding Observations                                                   48
               Agency Comments and Our Evaluation                                        50

Appendix I     Objectives, Scope, and Methodology                                        55



Appendix II    Projected Results Using Senate Bill Assumption Basis                      62



Appendix III   Comments from the U.S. Postal Service                                     68



Appendix IV    Comments from the U.S. Postal Service, Office of
               Inspector General                                                         69



Appendix V     GAO Contact and Staff Acknowledgments                                     72



Tables
               Table 1: PSRHBF Payments and Fund Status as of September 30,
                        201214
               Table 2: Key Features of Current Law and Alternative Approaches
                        for Prefunding USPS Retiree Health Benefits                      18
               Table 3: Estimated Annual Payments and Unfunded Liabilities in
                        the Short Term (Fiscal Years 2013 to 2020) under Current
                        Law Assumption Basis                                             20
               Table 4: Estimated Annual Payment and Unfunded Liability in the
                        Long Term (in Fiscal Year 2040, the Last Year of the
                        Projection) under Current Law Assumption Basis                   23


               Page i                                          GAO-13-112 U.S. Postal Service
          Table 5: Key Differences between the Two sets of PSRHBF
                   Funding Assumptions, as of September 30, 2011                      32
          Table 6: Sensitivity of Fiscal Year-end 2011 Unfunded Liability to
                   One-Percentage-Point Change in Medical Inflation
                   Assumption                                                         37
          Table 7: Estimated Annual Payments and Unfunded Liabilities in
                   the Short Term (Fiscal Years 2013 to 2020) under Senate
                   Bill Assumption Basis                                              62
          Table 8: Annual Payment and Unfunded Liability in the Long Term
                   (in Fiscal Year 2040, the Last Year of the Projection) under
                   Senate Bill Assumption Basis                                       64


Figures
          Figure 1: USPS Net Operating Profit and Loss, Fiscal Years 2006 to
                   2012                                                                 9
          Figure 2: USPS’s First-Class Mail Volume Forecast, Fiscal Years
                   2013 to 2020                                                       10
          Figure 3: USPS Retiree Health Benefits Fund’s Sources as of
                   September 30, 2012                                                 13
          Figure 4: Estimated Annual Payments for Different Approaches
                   from Fiscal Year 2013 to Fiscal Year 2020 under Current
                   Law Assumption Basis                                               22
          Figure 5: Estimated Annual Payments (as a Percentage of
                   Compensation) for Different Approaches from Fiscal Year
                   2013 to Fiscal Year 2040 under Current Law Assumption
                   Basis                                                              26
          Figure 6: Estimated Unfunded Liability (as a Percentage of USPS’s
                   Annual Compensation Costs) for Different Approaches
                   from Fiscal Year-end 2012 to Fiscal Year-end 2040 under
                   Current Law Assumption Basis                                       28
          Figure 7: Estimated Funded Ratios for Different Approaches from
                   Fiscal Year-end 2012 to Fiscal Year-end 2040 under
                   Current Law Assumption Basis                                       29
          Figure 8: Estimated Annual Payments for Modified Senate
                   Prefunding Approach from Fiscal Year 2013 to Fiscal Year
                   2020 under Current Law Assumption Basis and Senate Bill
                   Assumption Basis                                                   34
          Figure 9: Estimated Annual Payments (as a Percentage of
                   Compensation) for Modified Senate Prefunding Approach
                   from Fiscal Year 2013 through Fiscal Year 2040 under




          Page ii                                           GAO-13-112 U.S. Postal Service
         Current Law Assumption Basis and Senate Bill
         Assumption Basis                                                 35
Figure 10: Estimated Annual Payments for Different Approaches
         from Fiscal Year 2013 to Fiscal Year 2020 under Senate
         Bill Assumption Basis                                            63
Figure 11: Estimated Annual Payments (as a Percentage of
         Compensation) for Different Approaches from Fiscal Year
         2013 to Fiscal Year 2040 under Senate Bill Assumption
         Basis                                                            65
Figure 12: Estimated Unfunded Liability (as a Percentage of USPS’s
         Annual Compensation Costs) for Different Approaches
         from Fiscal Year-end 2012 to Fiscal Year-end 2040 under
         Senate Bill Assumption Basis                                     66
Figure 13: Estimated Funded Ratios for Different Approaches from
         Fiscal Year-end 2012 to Fiscal Year-end 2040 under Senate
         Bill Assumption Basis                                            67




Page iii                                        GAO-13-112 U.S. Postal Service
Abbreviations

CSRDF             Civil Service Retirement and Disability Fund
CSRS              Civil Service Retirement System
DOD               Department of Defense
FASAB             Federal Accounting Standards Advisory Board
FASB              Financial Accounting Standards Board
FEHBP             Federal Employees Health Benefits Program
FERS              Federal Employees Retirement System
FTE               full-time employees
GASB              Governmental Accounting Standards Board
IG                Inspector General
OIG               Office of Inspector General
OPEB              other post-employment benefits
OPM               Office of Personnel Management
PAEA              Postal Accountability and Enhancement Act (2006)
PRC               Postal Regulatory Commission
PSRHBF            Postal Service Retiree Health Benefits Fund
PVB               present value of future benefits
SFFAS 33          Statement of Federal Financial Accounting Standards
                    No. 33
S&P               Standard & Poor’s
USPS              U.S. Postal Service




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Page iv                                                     GAO-13-112 U.S. Postal Service
United States Government Accountability Office
Washington, DC 20548




                                   December 4, 2012

                                   The Honorable Darrell E. Issa
                                   Chairman
                                   Committee on Oversight and Government Reform
                                   House of Representatives

                                   Dear Mr. Chairman:

                                   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. 1 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. 2 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). 3
                                   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


                                   1
                                    Originally due at the end of fiscal year 2011, USPS’s $5.5 billion retiree health benefit
                                   payment requirement was delayed until August 1, 2012. Pub. L. No. 112-74, § 632, 125
                                   Stat. 786, 928 (Dec. 23, 2011). USPS missed that payment as well as the $5.6 billion that
                                   was due by September 30, 2012.
                                   2
                                    Pub. L. 109-435, § 803, 120 Stat. 3198 (Dec. 20, 2006).
                                   3
                                    For the purposes of this report, payments made by USPS refer to payments from the
                                   Postal Service Fund. The Postal Service Fund is a revolving fund established in the U.S.
                                   Treasury for the deposit of all revenues, interest, appropriations, proceeds from borrowing,
                                   or any other receipts from USPS’s operations. The Fund is available to USPS to carry out
                                   the purposes, functions, and powers of USPS. 39 U.S.C. § 2003.




                                   Page 1                                                      GAO-13-112 U.S. Postal Service
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. 4

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 5—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
for future and current retirees 6 was approximately $94 billion—of which
$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.




4
  Pursuant to PAEA, no later than June 30, 2017, OPM is required to compute, and by
June 30 of each succeeding year, to recompute, a series of annual installments which
provide for the liquidation of any liability or surplus by September 30, 2056, or within 15
years, whichever is later. 5 U.S.C. § 8909a(d)(2)(B). OPM told us it calculates these
payments by determining the amount that, if contributed every year, 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.
5
 The $41 billion dollars in net losses for fiscal years 2007 through 2012 are those reported
by USPS in its financial reporting, which is on an accrual basis and not a cash basis.
However, USPS reports its retiree health benefits cost in a manner that its reported
expense for these benefits is equal to its required cash payments, as discussed later in
this report.
6
 The retiree health benefit liability represents the actuarial present value of the cost of the
portion of future retiree health premiums for which USPS is responsible and that are
attributable to past service; this liability reflects all such projected future costs for current
retirees and beneficiaries and a portion of such projected future costs for current workers.
Actuarial present values of this type, whether for retiree health benefits or pension
benefits, are variously referred to as a “liabilities,” “accrued liabilities,” or “obligations,”
often depending on the user of the term (e.g., actuaries, accountants, or lawyers) and the
context (e.g., financial reporting, statutes, or media). Throughout this report, we use the
terms “liability” to refer to this actuarial present value of future costs attributable to past
service and “unfunded liability” to refer to the excess of this liability over the amount of
funds in the PSRHBF.




Page 2                                                          GAO-13-112 U.S. Postal Service
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


Page 3                                            GAO-13-112 U.S. Postal Service
             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.


             USPS, an independent establishment of the executive branch, is intended
Background   to be a financially self-sufficient entity that covers its expenses almost
             entirely through postal revenues. In April 2001, we placed USPS on our
             high-risk list for two reasons. 7 First, in the short term, USPS’s ability to
             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.



             7
              GAO, U.S. Postal Service: Transformation Challenges Present Significant Risks,
             GAO-01-598T (Washington, D.C.: Apr. 4, 2001).




             Page 4                                                   GAO-13-112 U.S. Postal Service
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. 8 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. 9

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
      2003: 10
      •  changed USPS funding of its Civil Service Retirement System
         (CSRS) 11 pension liabilities (based on “dynamic assumptions” 12)




8
 GAO, U.S. Postal Service: Moving Forward on Financial and Transformation Challenges,
GAO-02-694T (Washington, D.C.: May 13, 2002).
9
 GAO, U.S. Postal Service: Key Postal Transformational Issues, GAO-03-812T
(Washington, D.C.: May 29, 2003).
10
    Pub. L. No. 108-18, 117 Stat. 624 (April 23, 2003).
11
   CSRS is a defined benefit, contributory retirement system for certain federal employees.
It was replaced by the Federal Employees Retirement System (FERS) for federal
employees who first entered covered service on and after January 1, 1987.




Page 5                                                      GAO-13-112 U.S. Postal Service
          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, 13
      • 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; 14
      • 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

12
  The 2003 Act required USPS to contribute the employer’s share of the “dynamic normal
cost” (which is a normal cost computed using “dynamic assumptions”). The normal cost is
the annual growth in pension liabilities resulting from an additional year of service by plan
participants. “Dynamic assumptions” are defined as economic assumptions that are used
in determining actuarial costs and liabilities in a retirement system and in anticipating the
effects of long-term future investment yields, future increases in rates of basic pay, and
future rates of price inflation. Pub. L. No. 108-18, § 2(a)(3) (Apr. 23, 2003). The prior-
funding methodology had used “static assumptions,” which did not project future pay or
cost-of-living increases and used a fixed interest-rate assumption.
13
    Pub. L. No. 109-435, 120 Stat. 3198 (Dec. 20, 2006).
14
  This shift created a postal actuarial funding surplus in CSRS of $17 billion, which was
transferred to the PSRHBF. In addition, PAEA suspended USPS employer contributions to
CSRS. Beginning in fiscal year 2017, if OPM determines a postal supplemental liability
exists in CSRS, USPS must commence making annual employer contributions to CSRS in
the following fiscal year.




Page 6                                                       GAO-13-112 U.S. Postal Service
         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. 15

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
would be a considerable financial challenge in the near term. 16 Contrary
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. 17 From fiscal years 2003 to 2005, USPS’s annual


15
  OPM told us it calculates these payments by determining the amount that, if contributed
every year, 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. Therefore, for years subsequent to 2041, OPM would calculate an
amortization amount that would be sufficient to liquidate the unfunded liability (or surplus)
over the next 15 years. For example, in 2050, OPM would calculate an amortization
amount that would be sufficient to liquidate the unfunded liability (or surplus) by 2065. This
“rolling” amortization approach would never fully liquidate the unfunded liability (if
experience matched the actuarial assumptions), but could be expected to approach full
funding sufficiently closely.
16
  USPS, United States Postal Service Annual Report 2007, (Washington, D.C.: Nov. 15,
2007).
17
  GAO, U.S. Postal Service: Postal Reform Law Provides Opportunities to Address Postal
Challenges, GAO-07-684T (Washington, D.C.: Apr.17, 2007).




Page 7                                                        GAO-13-112 U.S. Postal Service
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. 18 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
that USPS did not make. 19 Furthermore, USPS’s future financial outlook
is bleak as it projects further declines in mail volume and revenue by
fiscal year 2020.




18
 39 U.S.C. § 2005(a)(2).
19
 Even though USPS did not make these payments, it recorded a loss for the obligation to
make these payments, which remains outstanding.




Page 8                                                   GAO-13-112 U.S. Postal Service
Figure 1: USPS Net Operating Profit and Loss, Fiscal Years 2006 to 2012




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. 20 Limited increases in revenue require USPS to seek aggressive
cost-saving initiatives to achieve financial stability.




20
 We have ongoing work reviewing USPS’s efforts in these areas.




Page 9                                                 GAO-13-112 U.S. Postal Service
Figure 2: USPS’s First-Class Mail Volume Forecast, Fiscal Years 2013 to 2020




In February 2012, USPS announced a plan that included a goal of
achieving $22.5 billion in annual cost savings by the end of fiscal year
2016. The plan included changes in USPS’s mail processing and
transportation networks and other cost-saving initiatives, as follows:

•   $9 billion in network operations, of which $4 billion would come from
    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




Page 10                                               GAO-13-112 U.S. Postal Service
cost-savings goals. 21 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. 22 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. 23 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




21
  USPS’s annual appropriations acts have required USPS to provide 6-day delivery of
mail at not less than 1983 levels. See e.g., Pub. L. No. 112-74, 125 Stat. 786, 923 (Dec.
23, 2011).
22
  PRC noted that USPS improperly deflated mailers’ reported volume-reduction
projections and that the reported declines should not have been reduced, and determined,
based on USPS’s survey data, that it is likely to lose almost $600 million in net revenue
because of mailer response to the proposal. See Postal Regulatory Commission, Advisory
Opinion on Elimination of Saturday Delivery, Docket No. N2010-1 (Washington, D.C.: Mar.
24, 2011).
23
  As discussed later in this report, under some of the prefunding approaches,
contributions would be lower than otherwise only in fiscal years 2017 and later, when
contributions are determined on an actuarial basis.




Page 11                                                     GAO-13-112 U.S. Postal Service
                       (deferring payments until later) is financially risky. 24 OPM’s Inspector
                       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.


                       At the end of fiscal year 2012, OPM estimated that USPS’s total retiree
Status and Financial   health benefit liability was almost $94 billion, whereas the PSRHBF
Outlook of the         balance was about $46 billion (49 percent), leaving USPS with an
                       unfunded liability of about $48 billion. Approximately half of the $94 billion
PSRHBF                 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. 25 The liability for
                       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).


                       24
                        OPM Office of Inspector General, A Study of the Risks and Consequences of the USPS
                       OIG’s Approaches to Change USPS’s Funding of Retiree Benefits (Washington, D.C.:
                       February 28, 2011).
                       25
                         OPM officials told us that not all USPS career employees are in FEHBP, such as those
                       employees covered through another plan, (e.g., a spouse’s employee health plan) or
                       those who simply do not participate in FEHBP. Officials added that USPS’s participation
                       rate of eligible employees is generally about 90 percent.




                       Page 12                                                   GAO-13-112 U.S. Postal Service
Figure 3: USPS Retiree Health Benefits Fund’s Sources as of September 30, 2012




Note: Start-up funds included about $3 billion from the CSRS escrow and about $17 billion from a
surplus in the CSRS fund.


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. 26 USPS missed that payment as well
as the $5.6 billion that was due by September 30, 2012.




26
  Pub. L. No. 112-74, § 632.




Page 13                                                           GAO-13-112 U.S. Postal Service
Table 1: PSRHBF Payments and Fund Status as of September 30, 2012

 Dollars in billions
                 a
 CSRS start-up                                                                                    $20


 USPS prefunding payments made
      Fiscal year 2007                                                                           $5.4
      Fiscal year 2008                                                                           $5.6
                         b
      Fiscal year 2009                                                                           $1.4
      Fiscal year 2010                                                                           $5.5
      Total USPS prefunding                                                                     $17.9


 PSRHBF earned interest                                                                          $7.8


 PSRHBF balance                                                                                 $45.7
 Retiree health benefit liability                                                               $93.6
 Unfunded liability                                                                             $47.8


 USPS outstanding mandated prefunding payments to PSRHBF
                     c
 Fiscal year 2011                                                                                $5.5
                     d
 Fiscal year 2012                                                                                $5.6
 Fiscal year 2013                                                                                $5.6
 Fiscal year 2014                                                                                $5.7
 Fiscal year 2015                                                                                $5.7
 Fiscal year 2016                                                                                $5.8
 Total                                                                                          $33.9
Source: USPS.

Note: Totals may not add because of rounding.
a
  The start-up included $3 billion from the CSRS escrow and $17 billion from a surplus in the CSRS
fund.
b
  USPS’s required prefunding payment was reduced from $5.4 billion to $1.4 billion in 2009. Pub. L.
No. 111-68, § 164(a) 123 Stat. 2023, 2053 (Oct.1, 2009).
c
  Originally due at the end of fiscal year 2011, USPS’s $5.5 billion retiree health benefit payment was
delayed until August 1, 2012. Pub. L. No. 112-74, § 632. USPS, however, did not make this payment.
d
  USPS did not make its $5.6 billion required payment in fiscal year 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.



Page 14                                                             GAO-13-112 U.S. Postal Service
                       We considered current law (PAEA) requirements against five alternative
USPS’s Future          approaches for funding the costs of retiree health benefits, each of which
Payments and           involves tradeoffs that could impact USPS’s short-term cash flow, its
                       future financial condition, different generations of postal ratepayers, and
Unfunded Liabilities   over a million postal employees and retirees. We compared the current
Vary Widely Based on   law prefunding requirements as well as approaches that have been
                       proposed in (1) a bill passed by the House of Representative’s Committee
Approaches to Fund     on Oversight and Government Reform, (“House Bill”), 27 (2) in the
Retiree Health         President’s fiscal year 2012 budget request (“Administration Approach”),
                       and (3) in a bill passed by the Senate, (“Senate Bill”) 28. In addition, some
Benefits               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.”

                       Our projections 29 showed that some approaches would reduce USPS’s
                       annual payments in the short term, thereby easing its cash flow problems
                       and financial losses in the near future, but would increase its unfunded
                       liability, sometimes substantially, and require larger annual payments
                       later. Other approaches would have USPS reduce its unfunded liabilities
                       more aggressively, which could result in significantly higher financial
                       losses in the near future and thereby increase USPS’s financial
                       challenges. These options must be considered within the context of
                       USPS’s financial situation and prospects. USPS officials told us that given
                       its current financial problems, USPS simply does not have the cash to
                       implement any of the prefunding options and that larger structural
                       solutions must be found to USPS’s financial viability as a self-sustaining
                       entity.

PSRHBF Funding         Current law (the 2006 PAEA) consists of distinct prefunding requirements
                       that apply first through fiscal year 2016 and then from fiscal year 2017
                       forward. Through fiscal year 2016, USPS is required to make fixed annual
                       payments 30 ranging from $5.5 billion to $5.8 billion to the PSRHBF in


                       27
                        H. R. 2309, 112th Cong. (2011).
                       28
                        S. 1789, 112th Cong. (2011).
                       29
                         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.
                       30
                         We refer to these payments as “fixed” because they are set amounts that do not vary
                       with an actuarial assessment of future retiree health care costs.




                       Page 15                                                   GAO-13-112 U.S. Postal Service
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. 31 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


31
  The increase in premium payments is driven in part by a significant number of expected
retirements. As a result, this increase in payments for retirees would be at least partially
offset by otherwise lower payments for employees, since there would be fewer of them.




Page 16                                                      GAO-13-112 U.S. Postal Service
     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 reduces 32 the
     required 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). 33 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


32
  Reductions would occur in each year except 2016, when the prefunding payment would
be slightly higher than under current law.
33
  As calculated by OPM, the amortization period would run to the later of 2052 or 15 years
from the then-current fiscal year, in contrast to the later of 2056 or 15 years from the then-
current fiscal year under current law. USPS’s share of premium payments would be paid
from the PSRHBF, instead of payments made by USPS, beginning right away (which we
modeled to begin in fiscal year 2013), instead of in fiscal year 2017 under current law.




Page 17                                                       GAO-13-112 U.S. Postal Service
                                               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. 34

                                          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.

Table 2: Key Features of Current Law and Alternative Approaches for Prefunding USPS Retiree Health Benefits

                                        Initial target year         Period when
                           Funding       for amortization premiums for current                                                  Total fixed
Approach (as                   target             schedule retirees begin being                                      prefunding payments,
modified to begin      (percentage             for funding   paid from PSRHBF                                             2013–2016 fiscal
                                                          a
in fiscal year 2013)     of liability) unfunded liability   instead of by USPS            Assumption basis                           years
Modified Current               100                   2056                       2017      Consistent with OPM                     $22.8 billion
Law Approach                                                                              financial reporting
Modified House                 100                   2056                       2017      Consistent with OPM                     $27.3 billion
Approach                                                                                  financial reporting
Modified                       100                   2056                       2013      Consistent with OPM                     $18.1 billion
Administration                                                                            financial reporting
Approach
Modified Senate                 80                   2052       Upon enactment of         Consistent with                  NA—Prefunding
                                                                                 b
Approach                                                              Senate Bill         USPS’s CSRS and                    payments are
                                                                                          FERS funding                          actuarially
                                                                                                                      determined, not fixed
                                          Source: GAO.
                                          a
                                           As calculated by OPM, the amortization schedule extends to the later of this target year or 15 years
                                          from the then-current fiscal year.
                                          b
                                           We modeled this approach based on enactment of the bill in the beginning of fiscal year 2013.

Short- and Long-term                      Our analysis shows that, over the short-term period ending in fiscal year
Effects of Alternative                    2020, the Modified Current Law and House Approaches would decrease
Approaches                                USPS’s unfunded liability for retiree health benefits, while the Modified
                                          Administration and Senate Approaches would increase the unfunded


                                          34
                                            As discussed later in this report, we modified assumptions to analyze the four
                                          prefunding approaches on a comparative basis, and also to demonstrate that the
                                          modification does not have a material effect on our findings.




                                          Page 18                                                            GAO-13-112 U.S. Postal Service
                     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.


                     For a short-term outlook, we projected USPS’s required payments
Short-term Effects   (prefunding contributions as well as premium payments for current
                     retirees, when applicable) and the amount of unfunded liability in fiscal




                     Page 19                                              GAO-13-112 U.S. Postal Service
                                               years 2013 through 2020. 35 Over this 8-year period, USPS’s payments
                                               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).

Table 3: Estimated Annual Payments and Unfunded Liabilities in the Short Term (Fiscal Years 2013 to 2020) under Current
Law Assumption Basis

Dollars in billions
                      Modified Current                Modified House          Modified Administration                 Modified
                       Law Approach                     Approach                     Approach                      Senate Approach
                                Unfunded                      Unfunded                     Unfunded                             Unfunded
                  Annual       Liability (at          Annual Liability (at         Annual Liability (at           Annual       Liability (at
                Payments        Year-end)           Payments Year-end)           Payments Year-end)             Payments        Year-end)
2013                    $8.6         $47.6               $8.6       $47.6               $1.3        $55.0              $4.4          $51.8
2014                    $8.9         $44.6               $8.9       $44.6               $5.4        $55.9              $4.5          $53.6
2015                    $9.2         $41.2              $11.5       $39.0               $5.6        $56.8              $4.5          $55.4
2016                    $9.6         $37.3              $11.9       $32.7               $5.8        $57.5              $4.7          $57.1


2017                    $5.0         $37.9               $4.8       $33.3               $6.2        $58.0              $4.9          $58.9




                                               35
                                                 All approaches discussed in the following sections, except the section on sensitivity to
                                               assumptions, are modeled under the current law assumption basis. Comparative results
                                               under the Senate bill assumption basis are discussed in the section on sensitivity to
                                               assumptions and presented more fully in appendix II.




                                               Page 20                                                      GAO-13-112 U.S. Postal Service
Dollars in billions
                      Modified Current                Modified House              Modified Administration                      Modified
                       Law Approach                     Approach                         Approach                           Senate Approach
                                Unfunded                      Unfunded                         Unfunded                                   Unfunded
                  Annual       Liability (at          Annual Liability (at             Annual Liability (at                Annual        Liability (at
                Payments        Year-end)           Payments Year-end)               Payments Year-end)                  Payments         Year-end)
2018                    $5.2         $38.4               $5.0         $33.9                  $6.4          $58.3                $5.1            $60.5
2019                    $5.4         $38.8               $5.2         $34.4                  $6.6          $58.6                $5.3            $62.2
2020                    $5.7         $39.2               $5.4         $34.7                  $6.8          $58.7                $5.5            $63.8
Total                  $57.7             NA             $61.1            NA                $44.1              NA              $39.0                NA
Payments
Average                 $7.2             NA              $7.6            NA                  $5.5             NA                $4.9               NA
Annual
Payment
                                               Source: GAO.

                                               Note: Totals may not add because of rounding. Annual payments consist of any prefunding payments
                                               to the PSRHBF, and, where applicable, USPS’s share of premium payments for existing retirees and
                                               beneficiaries (see descriptions of the different approaches). Unfunded liabilities are the amounts as of
                                               the end of the fiscal year, and start at an estimated value of $50.1 billion as of September 30, 2012,
                                               under all four approaches. Subsequent to the development of these projections, USPS reported the
                                               actual unfunded liability as of September 30, 2012, to be $47.9 billion.


                                               The higher payments required under the Modified Current Law and
                                               Modified House Approaches are concentrated in fiscal years 2013
                                               through 2016, prior to the switch to an actuarial basis in fiscal year 2017.
                                               These payments in fiscal years 2013 through 2016 are significantly higher
                                               than those that would be calculated under the specified actuarial
                                               approach. 36 For example, the payments that USPS would have to make
                                               in fiscal year 2016 under the Modified House Approach, $11.9 billion, is
                                               more than double the following year’s payment of $4.8 billion, when the
                                               actuarial approach begins. Similarly, under Modified Current Law, the
                                               estimated 2016 payments would be almost double the 2017 payments. In
                                               contrast, payments under the Modified Administration and Senate
                                               Approaches are more affordable and consistent over the period. Figure 4
                                               illustrates these patterns over the fiscal years 2013 through 2020.



                                               36
                                                  There is no single actuarial approach, but an actuarially determined contribution will
                                               typically consist of a normal cost—which reflects future costs attributable to the current
                                               year of employee service—plus an amortization payment to pay down the unfunded
                                               liability. The size of the amortization payment will vary with the length of the amortization
                                               period selected. A longer amortization period requires lower annual payments but over a
                                               longer period. A shorter amortization period requires larger amortization payments but
                                               over a shorter period.




                                               Page 21                                                             GAO-13-112 U.S. Postal Service
Figure 4: Estimated Annual Payments for Different Approaches from Fiscal Year 2013 to Fiscal Year 2020 under Current Law
Assumption Basis




                                        In summary, these projections illustrate: (1) the inverse trade-off between
                                        payment requirements and unfunded liability (higher payments mean
                                        lower unfunded liability; lower payments mean higher unfunded liability)
                                        and (2) possible patterns for required payments (e.g., front-loaded,
                                        consistent, or back-loaded). These options must be considered within the
                                        context of USPS’s financial situation and prospects.


                                        We extended our projection of USPS’s required payments and the
Long-term Effects                       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



                                        Page 22                                               GAO-13-112 U.S. Postal Service
                                             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 37 (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.

Table 4: Estimated Annual Payment and Unfunded Liability in the Long Term (in Fiscal Year 2040, the Last Year of the
Projection) under Current Law Assumption Basis

Dollars in billions
                      Modified Current Law                     Modified               Modified Administration              Modified Senate
                           Approach                         House Approach                   Approach                        Approach
Fiscal Year             Annual    Unfunded               Annual       Unfunded             Annual       Unfunded         Annual       Unfunded
2040                   Payment     Liability            Payment        Liability          Payment        Liability      Payment        Liability
Nominal $                 $11.8         $9.4                 $11.5           $6.5             $12.9          $22.1           $12.5         $66.5
Constant $                 $6.1         $4.8                  $5.9           $3.4               $6.7         $11.4            $6.4         $34.2
Percentage of
Compensation                 15          12                     14               8                16             28             16             83
Funded
percentage                  NA           96                    NA              97                NA              91            NA              73
                                             Source: GAO.

                                             Note: Annual payment is prefunding payment to the PSRHBF. Unfunded liability is as of the end of
                                             the fiscal year. Constant dollar amounts were derived by converting the projected 2040 nominal dollar
                                             amounts into 2012 dollars, using an inflation assumption based on the current law assumption basis.
                                             Compensation was projected by GAO based on information provided by USPS. Additional information
                                             on methodology and assumptions is presented in appendix I.


                                             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. 38



                                             37
                                               Compensation costs consist of projected employee salary and wage costs plus
                                             employee benefit costs exclusive of retiree health benefits, worker’s compensation, or any
                                             forecasted contract negotiations savings.
                                             38
                                               We assumed compensation growth would vary across the two assumption bases
                                             because of the different underlying inflation assumptions. Further details of the projection
                                             are contained in appendix I.




                                             Page 23                                                           GAO-13-112 U.S. Postal Service
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


Page 24                                            GAO-13-112 U.S. Postal Service
                       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.


Short- and Long-term   Combining the short-term and long-term projection results, figure 5
Effects Combined       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




                       Page 25                                          GAO-13-112 U.S. Postal Service
                                        follow a slightly different trajectory because of the approach’s 80 percent
                                        funding target, but fall within the same range. 39

Figure 5: Estimated Annual Payments (as a Percentage of Compensation) for Different Approaches from Fiscal Year 2013 to
Fiscal Year 2040 under Current Law Assumption Basis




                                        39
                                          Although the Modified Senate Approach bases amortization payments on the difference
                                        between PSRHBF assets and 80 percent of the liability, the normal cost portion of
                                        required payments is based on 100 percent of the normal cost. Normal cost constitutes a
                                        higher portion of total payments towards the end of the projection period.




                                        Page 26                                                  GAO-13-112 U.S. Postal Service
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. 40 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.




40
     These projections were performed prior to the release of actual 2012 results.




Page 27                                                        GAO-13-112 U.S. Postal Service
Figure 6: Estimated Unfunded Liability (as a Percentage of USPS’s Annual Compensation Costs) for Different Approaches
from Fiscal Year-end 2012 to Fiscal Year-end 2040 under Current Law Assumption Basis




                                        Note: Under all four modified approaches to prefunding, the unfunded liability starts at the same point
                                        at September 30, 2012, and begins to diverge in fiscal year 2013 with the different approaches to
                                        prefunding.


                                        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,



                                        Page 28                                                             GAO-13-112 U.S. Postal Service
                                        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.

Figure 7: Estimated Funded Ratios for Different Approaches from Fiscal Year-end 2012 to Fiscal Year-end 2040 under Current
Law Assumption Basis




                                        Note: Under all four modified approaches to prefunding, the funded ratio starts at the same point at
                                        September 30, 2012, and begins to diverge in fiscal year 2013 with the different approaches to
                                        prefunding.


                                        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



                                        Page 29                                                            GAO-13-112 U.S. Postal Service
                             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. 41


Sensitivity to Assumptions   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.




                             41
                              These percentages are from the projections under the current law assumption basis.




                             Page 30                                                  GAO-13-112 U.S. Postal Service
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. 42 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. 43




42
   The changes were designed to reduce the year-to-year volatility in the value of the
liabilities reported by some agencies, done via the use of an historical averaging period,
as discussed in the text.
43
  In addition to the three economic assumptions discussed in this section, the valuation
and projection of retiree health benefit payments and liabilities depend on other
assumptions as well, such as assumed mortality rates. These other assumptions would
not vary between the current law assumption basis and the Senate Bill assumption basis.
We have not audited the actuarial assumptions—meaning the set of economic and
demographic assumptions—used by OPM.




Page 31                                                      GAO-13-112 U.S. Postal Service
Table 5: Key Differences between the Two sets of PSRHBF Funding Assumptions, as of September 30, 2011

                                                                     Current law assumption
                                                                   basis (also used in House
                                                             and Administration Approaches)                    Senate bill assumption basis
Basis                                                           Consistent with OPM’s financial               Consistent with USPS’s funding
                                                           reporting of actuarial value of federal          requirements for CSRS and FERS
                                                                              employee benefits
Interest rate (also known as discount                                                            4.90                                         5.75
rate)
General inflation                                                                                2.40                                         3.00
Medical inflation (also known as the    Initial rate                                             5.50                                         5.50
                     a
“trend” assumption)                     Peak rate                                                6.39                                         7.01
                                        Ultimate rate                                            4.35                                         4.96
                                            Source: GAO.
                                            a
                                             The trend assumption rises to a peak rate for 2015 and very gradually falls to an ultimate rate for
                                            2084 and later.


                                            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. 44 Further, the discount rate, the
                                            inflation assumption, and other economic assumptions should be
                                            consistent with one another. 45 OPM determines the general inflation
                                            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.

                                            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


                                            44
                                              At least two other federal agencies that value large benefit programs with liabilities for
                                            future pension, medical, or disability benefits—the Department of Defense and the
                                            Veterans’ Administration—also use a 10-year historical averaging period, for consistency
                                            across federal agencies in federal financial reporting.
                                            45
                                              For example, the level of interest rates will generally be higher or lower depending upon
                                            expectations regarding future inflation.




                                            Page 32                                                             GAO-13-112 U.S. Postal Service
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. 46 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.




46
 This model is known as the Getzen model.




Page 33                                          GAO-13-112 U.S. Postal Service
Figure 8: Estimated Annual Payments for Modified Senate Prefunding Approach
from Fiscal Year 2013 to Fiscal Year 2020 under Current Law Assumption Basis and
Senate Bill Assumption Basis




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.




Page 34                                             GAO-13-112 U.S. Postal Service
Figure 9: Estimated Annual Payments (as a Percentage of Compensation) for Modified Senate Prefunding Approach from
Fiscal Year 2013 through Fiscal Year 2040 under Current Law Assumption Basis and Senate Bill Assumption Basis




                                       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.



                                       Page 35                                             GAO-13-112 U.S. Postal Service
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 [retiree health benefits] liability involves
several areas of judgment, estimates of the liability could vary significantly
depending on the assumptions used.” 47 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.




47
  A 10-K Form is an annual report that many for-profit corporations must file with the SEC
within 90 days of the close of their fiscal year. It is a publicly available document that
contains audited financial statements and other information on a corporation’s financial
condition.




Page 36                                                    GAO-13-112 U.S. Postal Service
Table 6: Sensitivity of Fiscal Year-end 2011 Unfunded Liability to One-Percentage-Point Change in Medical Inflation
Assumption

                                                      If medical inflation                         If medical inflation
                                                  one percentage point higher                  one percentage point lower
                       Actual amount                     New amount   Percent change           New amount         Percent change
Liability                         $90.3                      $104.4              + 16                  $78.5                   - 13
Assets                            $44.1                       $44.1                —                   $44.1                    —
Unfunded Liability =
Liability - Assets                $46.2                       $60.3              + 31                  $34.4                   - 26
                                          Source: GAO.




Pay-as-You-Go Funding                     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 assumptions 48—
                                          the 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


                                          48
                                            Results presented in this section are on the current law assumption basis. Comparative
                                          results, as constant dollars and percentage of compensation, are approximately the same
                                          under the current law and Senate bill assumption bases.




                                          Page 37                                                   GAO-13-112 U.S. Postal Service
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. 49 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. 50 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




49
 Letter from USPS OIG Inspector General David C. Williams to Senator Bernie Sanders,
February 6, 2012.
50
  If the liability were to become fully funded under this approach, the fund would then
become “unsealed.” USPS’s share of premium payments would then start to be paid out
of the PSRHBF, and USPS would start making prefunding payments into the PSRHBF to
cover normal costs. As discussed earlier, the achievement of full funding does not mean
that there are no further prefunding payments.




Page 38                                                   GAO-13-112 U.S. Postal Service
from $87 billion at fiscal year-end 2009 to $91 billion at fiscal year-end
2010 to $90 billion at fiscal year-end 2011. 51

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). 52

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



51
  The liability rose to $93.6 billion at fiscal year-end 2012, a figure not known at the time of
the USPS OIG’s analysis in February 2012.
52
  This estimate uses the current law assumption basis. Under the Senate bill assumption
basis, the corresponding figure is a 2032 unfunded liability of $88 billion, which is equal to
$49 billion in 2012 dollars and 127 percent of 2032 compensation.




Page 39                                                        GAO-13-112 U.S. Postal Service
                           percentage under the Modified Senate Approach. 53 Thus, like the
                           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.


                           To assist Congress in considering the various funding approaches, we
Key Considerations         identified some factors to consider in assessing what would constitute
for Assessing Funding      reasonable short-term and long-term funding requirements. We also
                           examined the prefunding requirements of other organizations that offer
Approaches                 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.


Funding Approach           The following considerations should be taken into account when
Considerations             assessing the various funding approaches for USPS.

Rationale for Prefunding   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


                           53
                             These estimates are under the current law assumption basis. Under the Senate bill
                           assumption basis, the corresponding projected funded percentages in 2040 are 76
                           percent under the Seal and Grow Approach and 73 percent under the Modified Senate
                           Approach.




                           Page 40                                                  GAO-13-112 U.S. Postal Service
    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. 54




54
  OPM Office of Inspector General, A Study of the Risks and Consequences of the USPS
OIG’s Approaches to Change USPS’s Funding of Retiree Benefits (Washington, D.C.:
Feb. 28, 2011).




Page 41                                                GAO-13-112 U.S. Postal Service
Trade-offs   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. 55 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. 56 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


             55
               U.S. Postal Service Office of Inspector General, “Pension and Retiree Health Care
             Funding Levels: Management Advisory Report,” FT-MA-12-002 (June 18, 2012).
             56
                 FT-MA-12-002.




             Page 42                                                   GAO-13-112 U.S. Postal Service
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. 57 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. 58 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


57
  GAO, U.S. Postal Service: Allocation of Responsibility for Pension Benefits between the
Postal Service and the Federal Government, GAO-12-146 (Washington, D.C.: Oct. 13,
2011). The amount of USPS’s FERS pension surplus that we cited in this report was $6.9
billion, which was according to the then-most-recent actuarial analysis as of September
30, 2009. More recent actuarial analyses put this surplus at $10.9 billion as of September
30, 2010, and $2.6 billion as of September 30, 2011. Over this same period, estimates of
USPS’s CSRS pension surplus went from a deficit (unfunded liability) of $7.3 billion as of
September 30, 2009, to a surplus of $1.6 billion as of September 30, 2010, to a deficit of
$17.8 billion as of September 30, 2011.
58
    USPS has since then reached its borrowing limit of $15.0 billion.




Page 43                                                       GAO-13-112 U.S. Postal Service
                                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. 59 Achieving reasonable postal rates from an equitable and
                                consistent allocation of costs for pay and benefits earned during
                                employees’ work years could provide greater benefit security to
                                employees, retirees, and beneficiaries.
Fixed versus Actuarially   Another consideration with regard to the timing of prefunding payments is
Determined Payments        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.

Targeted Funding Level     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. 60 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. 61




                           59
                            OPM Office of Inspector General, A Study of the Risks and Consequences of the USPS
                           OIG’s Approaches to Change USPS’s Funding of Retiree Benefits (Washington, D.C.:
                           Feb. 28, 2011).
                           60
                             S. Rep. No. 112-143, at 5 (2012).
                           61
                             As noted earlier, as long as USPS continues in operation with the retiree health plan
                           intact, additional prefunding contributions would still be needed, even after full funding was
                           achieved, for the annual growth in the liability for the cost of benefits attributable to
                           ongoing employee service.




                           Page 44                                                      GAO-13-112 U.S. Postal Service
Basis for Assumptions   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.


Comparison with Other   We also reviewed the prefunding requirements for other organizations
Entities                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. 62 In 2002,
                        GAO suggested that USPS reconsider its method of accounting for these
                        benefits. 63

                        In addition, although prefunding is not required, a number of private,
                        state, local, and federal entities have elected to prefund some percentage


                        62
                          USPS does, however, disclose the value of its liability and unfunded liability (termed
                        “obligation” rather than “liability,” as discussed earlier), and the changes in such values
                        from the prior year, in the footnotes to its financial statements and in its Management’s
                        Discussion and Analysis that accompanies the statements.
                        63
                          GAO, U.S. Postal Service: Accounting for Postretirement Benefits, GAO-02-916R
                        (Washington, D.C.: Sept.12, 2002).




                        Page 45                                                       GAO-13-112 U.S. Postal Service
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) 64 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. 65 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. 66

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. 67
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. 68

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



64
 Retiree health benefits generally make up the largest part of OPEB. The “other” in
OPEB was meant to refer to post-employment benefits other than pensions.
65
 FT-MA-12-002.
66
  GAO, State and Local Government Retiree Health Benefits, Liabilities are Largely
Unfunded, but Some Governments Are Taking Action, GAO-10-61 (Washington, D.C.:
Nov. 30, 2009).
67
 Department of Defense, Office of the Actuary, Valuation of the Medicare-Eligible Retiree
Health Care Fund (Alexandria, VA: Sept. 30, 2010)
68
  Department of Defense, Board of Actuaries, Report to the President and the Congress
on the DOD Medicare-Eligible Retiree Health Care Fund (Arlington, VA: Dec. 30, 2009).




Page 46                                                    GAO-13-112 U.S. Postal Service
separate and apart, and under different jurisdiction, from any laws,
regulations, or rules governing prefunding. 69

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. 70

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


69
  The financial reporting rules vary by sector, and are generally governed by the FASB in
the private sector, the GASB for state and local governments, and the FASAB for federal
agencies and the federal government as a whole. The particular accrual rules within each
sector vary in a number of ways, regarding such factors as actuarial methods and
assumptions, amortization periods or lack thereof, and recognition on the employer’s
balance sheet.
70
 GAO-02-916R.




Page 47                                                    GAO-13-112 U.S. Postal Service
               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.


               Timely action is essential in addressing the funding of USPS’s retiree
Concluding     health benefits. We have suggested that Congress must take action to
Observations   address the uncertainty related to:

                   1) USPS’s inability to meet the current retiree health prefunding
                      requirements,

                   2) reducing the unfunded retiree health benefit liability over time,

                   3)     determining the proper allocation of costs between current and
                         future ratepayers, 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


               Page 48                                            GAO-13-112 U.S. Postal Service
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


Page 49                                             GAO-13-112 U.S. Postal Service
                     position to prefund its retiree health benefit liability for its over one million
                     active and retired postal employees and their beneficiaries.


                     We provided a draft of this report to USPS, the USPS OIG, and OPM for
Agency Comments      review and comment. USPS and the USPS OIG provided comments,
and Our Evaluation   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



                     Page 50                                               GAO-13-112 U.S. Postal Service
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


Page 51                                           GAO-13-112 U.S. Postal Service
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. 71 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;




71
 FT-MA-12-002




Page 52                                             GAO-13-112 U.S. Postal Service
    •     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.




Page 53                                             GAO-13-112 U.S. Postal Service
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.

Sincerely yours,




Frank Todisco                                Lorelei St. James
Chief Actuary                                Director
Applied Research and Methods                 Physical Infrastructure Issues

The undersigned meets the qualification standards of the American
Academy of Actuaries to render the actuarial findings contained in this
report.




Frank Todisco, FSA, MAAA, EA
Chief Actuary




Page 54                                           GAO-13-112 U.S. Postal Service
Appendix I: Objectives, Scope, and
              Appendix I: Objectives, Scope, and
              Methodology



Methodology

              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.


              Page 55                                            GAO-13-112 U.S. Postal Service
                            Appendix I: Objectives, Scope, and
                            Methodology




Additional Information on   We relied on OPM’s actuarial projections of normal cost, accrued liability
Data, Assumptions, and      (referred to in the report, and in the remainder of this appendix, simply as
Methods Underlying the      “liability”) and premium payments. We obtained data on workforce
                            projections from USPS, as described further below, which we projected
Actuarial Projections       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


                            Page 56                                           GAO-13-112 U.S. Postal Service
Appendix I: Objectives, Scope, and
Methodology




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 [(0.80*Liability) – Assets], rather than
[0.80*(Liability – Assets)], 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


Page 57                                             GAO-13-112 U.S. Postal Service
Appendix I: Objectives, Scope, and
Methodology




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


Page 58                                            GAO-13-112 U.S. Postal Service
Appendix I: Objectives, Scope, and
Methodology




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
reasonably be adopted 1 for determining USPS prefunding requirements,
such 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



1
If authorized by statute.




Page 59                                            GAO-13-112 U.S. Postal Service
Appendix I: Objectives, Scope, and
Methodology




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, 2 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. 3 Accordingly, we used a steady 4.90 percent
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.


2
 OPM, Civil Service Retirement and Disability Fund Annual Report, Fiscal Year Ended
September 30, 2011 (issued January 2012). This report is available on request from OPM.
3
 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.




Page 60                                                         GAO-13-112 U.S. Postal Service
Appendix I: Objectives, Scope, and
Methodology




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.




Page 61                                           GAO-13-112 U.S. Postal Service
Appendix II: Projected Results Using Senate
                                                 Appendix II: Projected Results Using Senate
                                                 Bill Assumption Basis



Bill Assumption Basis

                                                 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.


Short-term Effects under
Senate Bill Assumption
Basis
Table 7: Estimated Annual Payments and Unfunded Liabilities in the Short Term (Fiscal Years 2013 to 2020) under Senate Bill
Assumption Basis

Dollars in billions
                  Modified Current Law                   Modified House             Modified Administration                 Modified Senate
                       Approach                            Approach                        Approach                           Approach
                                  Unfunded                       Unfunded                                Unfunded                       Unfunded
                        Annual   Liability (at           Annual Liability(at             Annual         liability (at      Annual      liability (at
Fiscal year           Payments    Year-end)            Payments Year-end)              Payments          Year-end)       payments       Year-end)
2013                       8.6           44.9                     8.6      44.9                   1.3          52.3              4.3          49.3
2014                       8.9           42.0                     8.9      42.0                   5.4          53.4              4.3          51.4
2015                       9.2           38.5                    11.5      36.3                   5.6          54.4              4.4          53.4
2016                       9.7           34.5                    11.9      29.8                   5.8          55.2              4.6          55.3


2017                       4.9           35.0                     4.6      30.4                   6.3          55.6              4.8          57.2
2018                       5.1           35.5                     4.8      30.9                   6.5          55.9              5.0          59.0
2019                       5.3           35.8                     5.0      31.2                   6.7          56.1              5.2          60.7
2020                       5.6           35.9                     5.3      31.5                   6.9          56.1              5.5          62.4
Total
Payments                 $57.3            NA                    $60.7       NA               $44.4               NA           $38.2             NA
Average
Annual
Payment                   $7.2            NA                     $7.6       NA                $5.5               NA              4.8            NA
                                                 Source: GAO.

                                                 Notes: Totals may not add because of rounding.




                                                 Page 62                                                            GAO-13-112 U.S. Postal Service
                                        Appendix II: Projected Results Using Senate
                                        Bill Assumption Basis




                                        Annual payments consist of any prefunding payments to the PSRHBF, and, where applicable,
                                        USPS’s share of premium payments for existing retirees and beneficiaries (see descriptions of the
                                        different approaches). Unfunded liabilities are the amounts as of the end of the fiscal year, and start
                                        at an estimated value of $47.3 billion as of September 30, 2012, under all four approaches.
                                        Subsequent to the development of these projections, USPS reported the actual unfunded liability as
                                        of September 30, 2012, to be $47.9 billion.



Figure 10: Estimated Annual Payments for Different Approaches from Fiscal Year 2013 to Fiscal Year 2020 under Senate Bill
Assumption Basis




                                        Page 63                                                              GAO-13-112 U.S. Postal Service
                                              Appendix II: Projected Results Using Senate
                                              Bill Assumption Basis




Long-term Effects under
Senate Bill Assumption
Basis
Table 8: Annual Payment and Unfunded Liability in the Long Term (in Fiscal Year 2040, the Last Year of the Projection) under
Senate Bill Assumption Basis

Dollars in billions
                      Modified Current law               Modified House              Modified Administration               Modified Senate
                           Approach                        Approach                         Approach                         Approach
Fiscal year            Annual      Unfunded              Annual      Unfunded            Annual        Unfunded           Annual       Unfunded
2040                  Payment       Liability           Payment       Liability         Payment         Liability        Payment        Liability
Nominal $                 $12.7        $10.4                 $12.4         $7.3              $14.1          $24.1             $13.8         $79.4
Constant $                 $5.6         $4.5                  $5.4         $3.2               $6.2          $10.6              $6.0         $34.7
Percentage of
Compensation                 13              11                13              8                15              25               15             84
Funded
percentage                  NA               96                NA            97                NA               92              NA              73
                                              Source: GAO.

                                              Notes: Annual payment is prefunding payment to the PSRHBF. Unfunded liability is as of the end of
                                              the fiscal year. Constant dollar amounts were derived by converting the projected 2040 nominal dollar
                                              amounts into 2012 dollars, using an inflation assumption based on the Senate bill assumption basis.
                                              Compensation was projected by GAO based on information provided by USPS. Additional information
                                              on methodology and assumptions is presented in appendix I.
                                              “Compensation” is used as a shorthand expression to represent employee salary and wage costs
                                              plus employee benefit costs exclusive of retiree health benefits, workers’ compensation, or any
                                              forecasted contract negotiations savings.




                                              Page 64                                                           GAO-13-112 U.S. Postal Service
                                        Appendix II: Projected Results Using Senate
                                        Bill Assumption Basis




Figure 11: Estimated Annual Payments (as a Percentage of Compensation) for Different Approaches from Fiscal Year 2013 to
Fiscal Year 2040 under Senate Bill Assumption Basis




                                        Page 65                                              GAO-13-112 U.S. Postal Service
                                        Appendix II: Projected Results Using Senate
                                        Bill Assumption Basis




Figure 12: Estimated Unfunded Liability (as a Percentage of USPS’s Annual Compensation Costs) for Different Approaches
from Fiscal Year-end 2012 to Fiscal Year-end 2040 under Senate Bill Assumption Basis




                                        Note: Under all four modified approaches to prefunding, the unfunded liability starts at the same point
                                        at September 30, 2012, and begins to diverge in fiscal year 2013 with the different approaches to
                                        prefunding.




                                        Page 66                                                             GAO-13-112 U.S. Postal Service
                                        Appendix II: Projected Results Using Senate
                                        Bill Assumption Basis




Figure 13: Estimated Funded Ratios for Different Approaches from Fiscal Year-end 2012 to Fiscal Year-end 2040 under Senate
Bill Assumption Basis




                                        Note: Under all four modified approaches to prefunding, the funded ratio starts at the same point at
                                        September 30, 2012, and begins to diverge in fiscal year 2013 with the different approaches to
                                        prefunding.




                                        Page 67                                                            GAO-13-112 U.S. Postal Service
Appendix III: Comments from the U.S. Postal
              Appendix III: Comments from the U.S. Postal
              Service



Service




              Page 68                                       GAO-13-112 U.S. Postal Service
Appendix IV: Comments from the U.S. Postal
              Appendix IV: Comments from the U.S. Postal
              Service, Office of Inspector General



Service, Office of Inspector General




              Page 69                                      GAO-13-112 U.S. Postal Service
Appendix IV: Comments from the U.S. Postal
Service, Office of Inspector General




Page 70                                      GAO-13-112 U.S. Postal Service
Appendix IV: Comments from the U.S. Postal
Service, Office of Inspector General




Page 71                                      GAO-13-112 U.S. Postal Service
Appendix V: GAO Contact and Staff
                  Appendix V: GAO Contact and Staff
                  Acknowledgments



Acknowledgments

                  Frank Todisco, (202) 512-2834 or todiscof@gao.gov
GAO Contacts      Lorelei St. James, (202) 512-2834 or stjamesl@gao.gov


                  In addition to the individuals named above, Samer Abbas, Teresa
Staff             Anderson, Beryl Davis, John Dicken, Kim Granger, Jacquelyn Hamilton,
Acknowledgments   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.




(544179)
                  Page 72                                        GAO-13-112 U.S. Postal Service
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