1. NASACT Conference Presentation to: August 14, 2007 Case Studies in OPEB Financing Elizabeth Yee, Vice President

2. Public Sector OPEB Obligations are The Norm ___________________________ Source: Mercer National Survey of Employer-Sponsored Health Plans, 2005. Public vs. Private Sector OPEB Liabilities The public sector offers retiree coverage at almost 3x the rate of the private sector 1

3. Demographics Drive the Agencies OPEB Exposure – Sample Municipal OPEB Data Annual Number of State Retirees (Historical & Projected) ___________________________ Source: Buck Consultants. Approval of Enhanced Benefits Cumulative Number of State Retirees (Historical & Projected) An aging workforce is leading to retirement rates over next 20 years which is far in excess of historical retirement rates 2

4. What Do Rating Agencies and Other Credit Arbiters Say? "You can't ignore the problem. You can't let the OPEB number grow to infinity over time. You need to develop a feasible plan to address the liability. Arguing that you only need to continue with the PAY- GO and failure to address the OPEB liability is unacceptable." Parry Young, Standard & Poors "If you decide you want to continue Retiree Health Benefits as a priority, then make a plan and fund it. If you decide that Retiree Health Benefits are not a priority, then don't make a plan, and you don't have to fund it. But don't maintain Retiree Health Benefits with no plan and no funding." Ken Kurtz, Moodys Investor Services Rating agencies are focused on OPEB given the workforce demographics It is unlikely that they will unleash wholesale downgrades, however they have incorporated OPEB and pension funding as a consideration in determining ratings Some have already noted an agencys OPEB liability in its rating report Insurers and Institutional Investors are also aware of this liability and consider it as part of their due diligence process Developing a strategy is critical for maintaining market access 3

5. GASB 45 Status Update All of our Phase 1 issuer-clients have commenced or finalized their OPEB studies in compliance with GASB 45 –Under SB 1102, Texas municipalities have the option to disclose their OPEB liabilities –Some early adopters have done a disclosure dry run in their FY 2006 financials (ex. City of New York and CPS Energy) Those who have completed their studies are evaluating their plan benefits and funding options OPEB Studies are underway 4

6. The Range of Potential Plan Benefit Adjustments is Limitless Proposed adjustments to Plan Benefits include: –Reducing available benefits/gradually eliminating benefit –Transitioning to new tiers for new employees –Freezing benefits at current level –Tying medical inflation to a quantifiable, hedge-able index –Transitioning to a specific dollar contribution –Requiring those with partners/spouses eligible for Medicare to transition out of existing plan –The GM approach – providing an upfront payment to beneficiaries –Reinstating OPEB benefits! The OPEB phenomena seems to be significantly more diverse than pensions 5

7. GASB 45 Status Update 6

8. Comparison of State Liabilities The nature of retiree health benefits varies greatly from State to State Over $10 billion Between $1 billion and $10 billion Less than $1 billion ___________________________ Source: Credit Suisse Equity Research Report, March 2007. 7

9. Addressing the OPEB Liability – A Sample Ohio –Aggressively pre-funded its OPEB plan, which has accumulated nearly $11 billion in assets against a $30 billion OPEB obligation (37% funded) –To extend the solvency of the health benefits, Ohio modified its retiree health plan so only employees with at least 30 years of service are eligible for full coverage –In addition, Ohio mandated increased contributions for active workers and employers Alabama –Increased the premium payment obligation for certain employees, including smokers and individuals who retire after a short period of service –Approved a bill to create a pair of OPEB trusts to help pay health-care costs of retired teachers ($200+ million) and state employees Maryland –Set aside $200 million for the State Employees and Retirees Health & Welfare Benefits, an OPEB trust fund –OPEB benefit payments have jumped 62% from $146 million in 2005 to $236 million in 2006 8

10. Other Approaches to Funding the OPEB Liability The Ostrich approach –Not recommended Modest annual set-asides –Right direction; limited investment earnings advantage Commitment of Future Cashflows (freed up debt service, Tobacco) Many states with sizable unfunded pension liabilities already have begun to review these liabilities to reduce costs and redeploy capital Pre-funding with taxable OPEB Bonds –There have been 4 local municipal OPEB Bond funding transactions to date –There have been no OPEB bonding transactions at a State level 9

11. Goals of an OPEB Financing Ideal: Normal Cost + UAAL Amortization < Pay-As-You Go Attaining this ideal can be challenging for some Isolate and address liability Take advantage of low interest rate environment and explore reinvestment options –GASB 45 allows funded plans to use a higher discount rate and reduce the size of the reported liability Enhance benefit security for current and future retirees Provide a predictable, manageable retiree health cost 10

12. Case Study: Peralta Community College District District Budget of $100 million Retiree Health Benefit was capped on July 1, 2004 via negotiation with Unions OPEB obligation projected to increase from $5.2 million in FY 2006 to $10.2 million in FY 2016 Net Present Value of Benefits ranges from $132 million (@ 7%) to $196 million (@ 4.5%) Debt service structured assuming 2.0% annual growth in General Fund revenues, at 6.7% of projected General Fund revenues Peralta created an indentured trust in which to deposit its OPEB bond proceeds OPEB Debt Service vs. General Fund Revenues District will contribute a constant percentage of General Fund revenues towards debt service Estimated Pay-Go Cost Debt Service = 6.7% of GF Revenues at 2% Annual Growth 11

13. Case Study: East Side Union High School District OPEB Debt Service vs. General Fund Revenues 0.86% of GF Revenues at 2% Annual Growth District had a $28.1 million OPEB UAAL District issued $32.1 million of taxable OPEB Bonds with a 30-year maturity and established a GASB 45 compliant Trust to fund UAAL and 2006-07 payment Debt service was structured to grow at 2% per year, replicating expected General Fund growth –Debt service is prepaid by September 1 st –Rate Stabilization Fund will hold any voluntary deposits and can be used to pay debt service or retiree costs District makes monthly pay-go payments, Trust will reimburse District annually Investments are governed by an Investment Policy and funds are managed by an independent 3 rd party Bond Placement Results – Geographic Distribution 12

14. Case Study: County of Oakland, Michigan Closed VEBA program which was 35% funded as of 2006 with an UAAL of approximately $480 mm Effective January 1, 2006 County switched from a DB to a DC plan where County pays a fixed cash amount to retirees Oakland Countys Plan – Fully fund VEBA –Sell $500 mm in 20-year taxable general obligation bonds at 5.5% –$42 mm annually vs. paying $55 mm ARC ($12.8 mm savings) –County will invest $500 mm taxable proceeds through the VEBA Trust fund at 7.5% over 20-year period (net gain of $150 mm NPV) Transaction structured as Trust Certificates, which are supported by the assets of the trust rather than the full faith and credit of the County In July 2007, $556,985,000 Taxable COP Series 2007 was issued competitively with a short 7-year par call to fund OPEB UAAL 13

15. Risk / Return Analysis is Key to Asset Allocation Decisions Past data illustrate volatility vs. return trade-offs among asset classes 100% Bonds 100% Stocks 20% Stocks / 80% Bonds 50% Stocks / 50% Bonds 80% Stocks / 20% Bonds U.S. Stock/Bond Portfolios 1975-2005 ___________________________ Source: Callan Associates. Stocks represented by S&P 500. Bonds represented by the Lehman Brothers Intermediate Government/Credit Bond index. The challenge is to invest an OPEB Trust so that it produces sufficient investment income in the near- term while still generating equity-like returns over the long term 14

16. Twenty-years of Best-Performing Assets Show Variability No one asset class consistently outperforms ___________________________ Source: Lehman Brothers Asset Management. YearBest-Performing Asset Class (Domestic)Total Return 1986Long-Term Government Bonds24.5% 1987U.S. Treasury Bills5.5 1988Small Company Stocks24.9 1989Large Company Stocks31.5 1990Intermediate-term Government Bonds9.7 1991Small Company Stocks46.1 1992Small Company Stocks18.4 1993Small Company Stocks18.9 1994U.S. Treasury Bills3.9 1995Large Company Stocks37.4 1996Large Company Stocks23.1 1997Large Company Stocks33.4 1998Large Company Stocks28.6 1999Small Company Stocks21.3 2000Long-Term Government Bonds21.5 2001Long-Term Government Bonds10.7 2002Long-Term Government Bonds17.8 2003Small Company Stocks47.3 2004Small Company Stocks18.3 2005Large Company Stocks4.91 15

17. There are Numerous Policy and Fiscal Issues to Discuss One size does not fits all It is pretty clear that few entities will have the ability to fund the ARC in the near-term OPEB-Catch 22 – rating agencies say its too early to make adjustments and issuers wont make adjustments until forced by the rating agencies Valuations are only as good as their assumptions Many agencies are using the State Pension Plans retirement rate OPEB benefits are diverse and long-term medflation can produce uneven outcomes What level of proof might the market need to accept that these liabilities are not vested? Although benefits are not constitutionally or statutorily protected, they still are subject to meet and confer with good faith bargaining requirements, few can be unilaterally reduced, and the practical reality is that employees and retirees are voters, too Implied subsidy issue may warrant bifurcation from UAAL Bond funding is not a panacea but may offer a useful tool for managing these UAALs –Benefits = the discounting associated with prefunding and the reshaping opportunities OPEB Bonds present similar benefit/risks as POBs, although reinvestment challenges seem greater given prevailing near-zero funding ratios 16

18. Lehman Brothers is an Active Participant in the OPEB Discussion National Federation of Municipal Analysts May 2006 IMN National Municipal OPEB Conference May 2006 and April 2007 Bond Buyer OPEB Liability Conference March 2006 and March 2007 IMN California Public Finance Conference April 2006 California Debt & Investment Advisory Commission September 2006 Peralta Community College District $153,749,832.25 Taxable 2005 Limited Obligation (OPEB) Bonds December 2005 National Association of State Auditors, Comptrollers and Treasurers August 2006 February 2006 State Association of County Retirement Systems 2006 California Association of County Treasurers & Tax Collectors Annual Conference June 2006 ACWA May 2006 Spring Conference $32,050,000 East Side Union High School District November 2006 Taxable 2006 Limited Obligation (OPEB Bonds) 2006 State Controllers Annual Conference for County Auditors April 2006 Standard & Poor s OPEB Conference September 2005 & September 2006 Western Interstate Region Conference May 2006 New York State Association of Counties January 2006 IMN New England Public Finance Conference October 2006 $556,985,000 County of Oakland, MI OPEB Financing July 2007 17

19. Lehman Brothers OPEB Contacts 18