PARIS, 4 August 2008 Original: English REPORT BY THE DIRECTOR-GENERAL ON ALTERNATIVE FUNDING MECHANISMS FOR UNFUNDED LIABILITIES OF STAFF BENEFITS

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1 Executive Board Hundred and eightieth session 180 EX/35 PARIS, 4 August 2008 Original: English Item 35 of the provisional agenda REPORT BY THE DIRECTOR-GENERAL ON ALTERNATIVE FUNDING MECHANISMS FOR UNFUNDED LIABILITIES OF STAFF BENEFITS SUMMARY Further to 34 C/Resolution 73, this document explains the current situation in respect of benefits accruing to employees and in particular after service health insurance (ASHI) which is by far the most significant liability for the Organization. It goes on to describe possible ways of funding the liability taking into account proposals already made by the United Nations system. The financial and administrative implications are indicated in paragraphs 31 and 32. Action expected of the Executive Board: paragraph 35. proposed decision in

2 180 EX/35 Introduction 1. At its last session, following the examination of the accounts of UNESCO for the period ended 31 December 2005 together with the External Auditors report, the General Conference under paragraph 6 of 34 C/Resolution 73 requested: the Director-General to undertake an actuarial study on the unfunded liabilities of staff benefits and to propose alternative funding mechanisms, having regard to the actions already undertaken in the United Nations system, and to report thereon to the Executive Board at its 180th session. 2. Staff (or employee) benefits are wide-ranging in the United Nations system and in addition to the regular monthly benefits such as salary, dependency allowance, rental subsidy, etc. They incorporate various longer term benefits such as annual leave, repatriation grants, termination indemnity, pension and after service health insurance (ASHI). For UNESCO, the most significant of these long-term employee benefits is ASHI. Pension benefits are handled separately by the United Nations Joint Staff Pension Fund. 3. Currently ASHI is treated in the Organization on a pay-as-you-go basis meaning that charges are recorded when medical claims are submitted by staff and retirees. No attempt is made to recognize a charge which takes account of the rights accruing to individuals based on the period of employment and which are due until death and, in the case of dependants, beyond. 4. It is clear that the regular monthly benefits, backed by actual payments, are adequately treated in the financial records of the Organization. However, the longer term benefits, which by definition are paid later (and in the case of ASHI many years later) are not reflected in the body of the financial statements which is something that will need to be rectified with the adoption of International Public Sector Accounting Standards (IPSAS) in For the time being, in accordance with United Nations System Accounting Standards (UNSAS), the significant unrecorded liabilities in respect of employee benefits are included in the notes to financial statements. At 31 December 2007 liabilities in respect of annual leave, termination and repatriation grants amounted to $44 million and the liability for ASHI amounted to $614 million, together, giving a total of $658 million. 5. The issues relating to employee benefits have been on the agenda of many organizations within the United Nations system for several years now. The first issue is that of recording the true annual charge and full liability in the Financial Statements in a more transparent manner and in line with best practice. This will be done by UNESCO at the time of IPSAS adoption in The second and more difficult issue is the question of funding the long-term liability, in other words what should be done now or in the medium term in order to set aside sufficient funds to meet those significant liabilities which will crystallize in the future. 6. At its fifteenth session in March 2008 the High-Level Committee on Management (HLCM) agreed that the HR Network working group set up to examine the question of long-term care (including ASHI) for employees would discuss its findings with the FB Network owing to the significant financial implications. The United Nations system and the case of the United Nations 7. As mentioned above all organizations are confronted with the question of funding long-term employee benefits. Currently IFAD is the only organization in the United Nations system that has fully recognized and funded its liability. Some organizations, including FAO, WHO and WFP, have recorded the liabilities and also taken significant steps towards securing most of the funds required to cover such liabilities.

3 180 EX/35 page 2 8. For example, in 1998 FAO started to fund its ASHI liability through increased funding from Member States to cover the annual provision of the current service cost and the amortization over 30 years of the existing liability. Most organizations, however, are in the same situation as UNESCO where neither the recording of the liability nor the securing of funds has yet been done. It is also interesting to note that, after the United Nations, UNESCO is the organization having the largest unrecorded and unfunded employee benefits liability in the system. 9. The case of the United Nations is interesting in that the amount involved is by far the most significant within the system and prior to 2006 the United Nations was in the same situation that UNESCO is in now. The following paragraphs outline the case of the United Nations with regards to ASHI. ASHI the programme 10. The ASHI programme at the United Nations extends subsidized health insurance coverage to retirees and their dependants under the same health insurance schemes as for active staff, if the eligibility requirements are met. The United Nations health benefits programmes are self-funded with insurance companies engaged as third party administrators for the general management of the plans and for the adjudication of claims. All claims paid by the third party administrators are reimbursed by the United Nations and, in addition, an administrative fee is paid. At present, expenditures relating to the United Nation s subsidy of the ASHI programme are appropriated under the Programme Budget and recorded on a pay-as-you-go basis. Commencing 31 December 2006, the United Nations liability for ASHI benefits to be paid in the future was recognized in the financial statements. At present, no assets have been segregated to provide for these ASHI benefits. ASHI the extent of the liability at the United Nations 11. Since the inception of the ASHI programme at the United Nations in 1967, the programme has grown both in terms of the number of participants and the related costs. With the growth of the programme funded on a pay-as-you-go basis, came a growth in an unrecognized liability for ASHI benefits to be paid in the future. This liability was first actuarially calculated and disclosed in the notes to the financial statements of the United Nations as at 31 December At that time, the ASHI liability was determined to be $786.8 million, participants totalled about 3,400 enrollees and the United Nations biennial cost of the subsidy was about $28.7 million. 12. Beginning in 1999, the increase in ASHI enrolment began to accelerate and as at 31 December 2007, enrollees stood at about 8,000, the 2006/2007 pay-as-you-go amount was about $102.7 million, and the most recent ASHI liability stood at $2.1 billion (actuarially determined as at 31 December 2005). Based on historical trends, it is anticipated that enrolment and the payas-you-go amount will continue to surge upwards, fuelled by demographic change, increases in the rate of medical care utilization and increases in the costs of medical treatment. A study conducted in 2006 projected these figures 25 years in the future, and anticipated that ASHI participants by the year 2031 will exceed 14,000 enrollees, pay-as-you-go requirements will be about $666 million and the ASHI liability will be approaching $5 billion. Recognition of the liabilities to support funding requests 13. The Board of Auditors in its report A/57/201 which summarized the principal findings, conclusions and recommendations contained in the audit reports on the accounts of 15 United Nations system organizations for the period ended 31 December 2001, highlighted the issue of the rapid growth in the ASHI liabilities and recommended that the United Nations and its various funds and programmes review mechanisms and targets for providing for post-employment benefit liabilities.

4 180 EX/35 page As a result, a study of the post-employment liabilities for ASHI was commissioned by the United Nations General Assembly and, in the related report (A/60/450 of 27 October 2005), the Secretary-General sought approval to recognize the liability in support of his request to fund the liability. The study highlighted that the pay-as-you-go approach was no longer prudent as it captures only a portion of the current costs attributable to the ASHI programme and does not address the accumulated liability. The study recognized the need to build a reserve to address the rapidly escalating annual requirements, so as to avoid putting undue burden on subsequent years. The United Nations General Assembly agreed to recognize the ASHI liability but, to date, no decision has been made regarding funding of the ASHI liability. The move to best practices 15. Prior to December 2006, the United Nations liability for post-employment health benefits was not recognized on the face of the financial statements but disclosed in the notes, as allowed under UNSAS. However, best accounting practices on employee benefits, including IPSAS, require that post-employment benefits be accounted for on a full accrual basis under which the liability associated with ASHI is to be recognized when the employee has provided the service in exchange for benefits to be paid in the future. 16. Further, best accounting practices have highlighted that for employee benefit programmes such as ASHI, the recording of expenses only on a pay-as you-go basis generally understates the full expenses of the programme that should be reflected in the entity s financial statements. For example, for the biennium, the actuarially determined ASHI expenses for service costs and interest costs of $84.1 million and $113.2 million respectively totalled significantly more than the pay-as-you-go amount of $79.9 million. Having considered these best practices requirements, the United Nations General Assembly, in June 2006, recognized the liabilities for ASHI which initiated recognition of the liabilities in the Organization s financial statements. This move is consistent with the IPSAS adoption strategy of phased roll-out applied by the United Nations. Potential funding sources for ASHI 17. In view of the expected continued growth of the programme and the rising level of the associated liabilities, the Secretary-General considered it prudent to adopt a funding policy that supports the process of ensuring that adequate funds are put aside to meet current plan participants and future benefit liabilities with the aim to fully fund such liabilities. The actions proposed to the General Assembly in April 2007 were as follows: 1. Initial funding of $504 million through the transfer of unencumbered balances and savings on or cancellation of prior period obligations along with transfers from existing reserves. 2. Ongoing funding: (a) (b) (c) (d) (e) Continue biennial appropriations to cover subsidy payments in respect of current ASHI participants; Establish a charge equivalent to 8% of salary costs to be applied against the budgets of which staff salaries are charged; Utilize unspent budget appropriations; Transfer any excess of actual overestimated miscellaneous income; Transfer of savings from liquidation of prior-year obligations. 3. Approve certain changes to ASHI provisions in respect of new recruits including eligibility threshold fixed at 10 years minimum participation, a theoretical 25 years of

5 180 EX/35 page 4 service period for calculation purposes and the introduction of minimum participation requirement for dependants. 18. While the decision regarding funding was deferred by the General Assembly, the recognition of the ASHI liability in the financial statements at 31 December 2006 and the request for funding brought about a new awareness of the implications of this growing liability. The proposals regarding changes to ASHI provisions were approved. The issue of funding of the ASHI liabilities will again be presented to the sixty-third session of the General Assembly. The situation at UNESCO 19. In accordance with the Organization s standard practice and in compliance with 34 C/Resolution 73 an actuarial study was undertaken in order to calculate the ASHI liability. The rules of calculation are very detailed and require the use of a specific valuation method (Projected Unit Credit) and reasonable assumptions based on management s best estimates. Under this method, the first calculation consists of valuing the Expected Post-Retirement Benefit Obligation (EPBO) which is the benefit that the employer will pay from the retiree s date of retirement, taking into account the trend increases, the mortality table, the turnover and discount rate. Benefits at valuation date which are called Accumulated Post-Retirement Benefit Obligation (APBO), equal the benefits at retirement prorated for service at the valuation date. The amount calculated by the actuary as at 31 December 2007 is estimated at $614 million. 20. At the end of the previous biennium a similar study was carried out by another independent actuary and as at 31 December 2005 the ASHI liability was estimated at $601 million, showing a considerable increase over the calculation made at the end of There are numerous assumptions which have to be taken into account in the actuarial calculation of a long-term liability such as ASHI and minor changes to these assumptions can cause considerable variations to the final figure. For example, a change of one point in the discount rate can impact the total liability by $65 million. However, the two most recent calculations, carried out by two different reputable firms of actuaries, provide similar figures, both in excess of $600 million. 22. Payments made by the Organization in respect of claims for the last two biennia amount to $20 million for and $17 million for It is interesting to note that, as for the United Nations, the true cost based on accrual accounting (service cost plus interest cost) is significantly higher, estimated at $50 million for 2008 alone. Possible funding mechanisms for UNESCO ASHI scheme 23. The amounts paid out by the Organization represent claims actually made by members (active staff and retirees) on a pay-as-you-go basis and, as for the United Nations case described above, very few funds have been set aside to cover the long-term ASHI liability. 24. The Medical Benefits Fund, being the Staff Fiduciary Fund which operates the ASHI scheme, held reserves of $30 million at 31 December 2007, backed up by term deposits. Of the total ASHI liability of $614 million, $30 million can be considered as funded leaving a shortfall of $584 million. 25. The alternatives listed below, or a combination of these, are to be considered as possible means of funding the Organization s ASHI liability: 1. A one-time assessment on Member States for the full amount of the liability based on the most recent actuarial calculation. Given that the current estimate of this liability is roughly equivalent to the total amount of the regular programme budget, and assuming that Member States would pay on the basis of the scale of assessed contributions, each Member State will have a clear idea of its liability under this method of funding. Thereafter full funding status would be maintained through an accrual-based annual

6 180 EX/35 page 5 charge being included as part of the regular budget. This option would have the advantage of earning interest which would reduce the overall charge in future years. 2. The development of a dedicated long-term funding strategy designed to result in full funding of the liability after a set number of years based on specific assessments on Member States. A period chosen between 10 to 15 biennia would seem appropriate given the amount involved and the nature of the liability. This would be based on additional specific contributions over and above the assessed contributions to the regular programme. 3. The application of an additional charge against salary costs on all budgets with a view to accumulating over time sufficient funds to achieve full funding. The lower the percentage the greater the length of time would be required to meet the objective. Under this method, without additional specific funding, it can reasonably be considered that the time required to achieve full funding would be far greater than 15 biennia. Should this option be accepted, the sums required should be additional to the regular budget requirements in order not to impact programme implementation adversely. 4. Retain all resources eligible for distribution to Member States within the Organization rather than returning them to Member States. Since its 24th session, the General Conference has decided that all resources eligible for distribution to Member States would be allocated to the incentive scheme for prompt payment of contributions. Over the last 10 biennia a total of $50 million has been made available to the scheme. Based on this trend, this method alone would not yield sufficient funds to achieve the level of funding required within a reasonable time frame. 26. At its 34th session (34 C/Resolution 73), the General Conference decided to extend the scheme until the end of this current biennium and requested the Director-General to further examine these arrangements and to submit his findings to the Executive Board at its 182nd session. The Director-General will take into account the unfunded liabilities when presenting his report. Other UNESCO employee benefits 27. As stated earlier, other liabilities for employee benefits including accumulated unused annual leave, termination and repatriation benefits (grants and travel), are of lesser significance when compared to the ASHI liability. However, they must not be neglected and, like ASHI, will need to be recognized simultaneously with the ASHI liability in the financial statements. 28. For the regular programme, UNESCO currently funds these terminal benefits on a pay-asyou-go basis. 29. However, for posts funded under extrabudgetary funds (FITOCA, Associate Experts, some institutes and other proprietary funds), a terminal payments fund (TPF) has been established to cover for terminal costs. At 31 December 2007, the TPF, together with equivalent reserves in certain category 1 institutes, had accumulated reserves of $20 million which may be considered as a start to the funding of these employee benefits. It has been estimated that this liability amounts to some $44 million as at 31 December 2007 covering staff members funded from both the general fund and extrabudgetary funds. 30. Given the relative insignificance of these amounts compared to the ASHI liability no additional funding measures are proposed to cover these other employee benefits for the regular programme. However, the full liability will be recognized and the funding mechanism for extrabudgetary financed posts will remain intact as of current, at least for the transition period.

7 180 EX/35 page 6 Financial and administrative implications 31. The following table shows the status of recognition by the Organization of employee benefits and the indicative amounts for which funding is required. Liability Treatment of liability 1. ASHI Amount of $614 million established by actuarial study. To be recognized. 2. Annual leave and Repatriation grants Amount of $44 million established by estimation but only partially recognized in financial statements. To be fully recognized. 3. Repatriation travel and removal costs To be recognized. 4. Staff Compensation Fund, death grants Partial recognition in the financial statements. To be fully recognized. 5. Home leave, Education grants To be recognized. 6. Separation payments scheme To be recognized. 7. Estimated liability for ASHI, unused annual leave and repatriation grants as at Total = $658 million Estimated liability for ASHI, unused annual leave and repatriation grants as at Total = $658 million 32. As can be deduced from the above table, there is a significant difference of $607.4 million between the liability and the corresponding reserves or funds. This figure does not include amounts for other employee benefits as indicated which have either been partially funded or not recognized as at 31 December Their quantification is to be considered as work in progress before the IPSAS adoption date. Conclusion 33. This paper attempts to highlight both the importance of and the difficulties surrounding the funding of ASHI for the Organization. As requested, the issue has been examined within the United Nations context and it is understood that no major decision has yet been made by that Organization regarding the funding of its own significant liability. 34. The recording of the UNESCO liability on the accruals basis and in accordance with IPSAS will be completed in The Organization may take a bold but necessary step and start funding the liability through one or several of the alternative means outlined above on the basis that the sooner a funding strategy is initiated, the better. Alternatively the Organization may decide to await the outcome of further discussions which will take place at the United Nations and then harmonize its own solution with that of the United Nations. Action expected of the Executive Board 35. In view of the above, the Board may wish to adopt a decision on the following lines: The Executive Board, 1. Recalling 34 C/Resolution 73 with regard to an actuarial study on unfunded liabilities of staff benefits and to propose alternative funding mechanisms thereof,

8 180 EX/35 page 7 2. Takes note of the background information provided in document 180 EX/35 and in particular the development and progress made by the United Nations New York in identifying sources of funding for employee benefits; 3. Also takes note of the IPSAS requirement for the Organization to recognize the employee benefits liability for the first time in its financial statements, effective 1 January 2010; 4. Acknowledges that by full recognition of this liability the accounts of the Organization will result in a significant overall negative equity; 5. Invites the Director-General to consider proposing concrete funding measures in the framework of document 36 C/5. Printed on recycled paper