FINANCE COMMITTEE

I. Introduction

1. In view of the significance of the After Service Medical Coverage (ASMC) Liability, at the 95^th Session of the Finance Committee in September 2000 the Secretariat informed members that it would submit at the current session a paper on the subject. The purpose of this paper therefore is to: (i) summarise for the Finance Committee a short history of the subject and what has been done by FAO to date on this liability; (ii) provide a statement on the current liability and where we stand on funding ASMC costs; and (iii) provide some options on the proposed way forward.

II. Background

2. After Service Benefits are the staff member entitlements which become payable at the end of service. In FAO, these comprise the following:

• Separation Payments
• Staff Compensation
• Termination Payments
• After Service Medical Coverage

3. The Organisation needs to account for the above liabilities as they are earned and to make adequate provision for their funding. The responsibility for accounting rests with the Director-General who is required under the Financial Regulations (FR XI) to maintain the Organisation's accounts including statements of assets and liabilities at the close of the financial period. The responsibility for provision of funds rests with the Governing Bodies and ultimately the Conference (FR IV) which votes the appropriations that constitute an authorisation to the Director-General to incur obligations and make payments for the purpose for which the appropriations were voted.

4. Where the earmarking of assets, from which liabilities will be paid, involves income-producing investments, the income produced reduces significantly the amount which has to be set aside from other sources. This has been the experience of the Organisation with the Compensation Plan Reserve Fund (established by Conference Resolution 49/55) and the Separation Payments Scheme (approved by the Council at its 66^th Session in 1975). In fact, according to an actuarial valuation at 31 December 1997, both of these liabilities had reached the status of being fully funded.

5. Where all costs of an After Service benefit have not been charged to the Organisation's income in the past, the amount undercharged is referred to as an unaccrued liability in respect of the past service of staff members. Where all costs of an After Service benefit have not been funded in the past, the amount underfunded is referred to as an unfunded liability in respect of the past service of staff members. The Organisation has a significant unaccrued and unfunded liability in respect of ASMC and a smaller one in respect of Termination Payments. The rest of this paper addresses the liability which has been the subject of much study by the Governing Bodies in recent years.

III. Progress to date

6. Attachment 1 provides a detailed chronological account of the steps taken since 1997 to address unrecorded and unfunded After Service Benefits by reference to the recent reports of the Governing Bodies. It will be noted that the accounting and funding aspects have already been addressed in some detail. The unaccrued ASMC liability in respect of the past service of staff members which amounted to US$ 195.1 million at 31 December 1997, is presently being accrued from 1 January 1998 over an amortisation period of 30 years. In addition, all of the current service costs of staff members are being accounted for and funded from the regular budget.

7. As regards the unfunded ASMC liability in respect of the past service of staff members which stood at US$ 195.1 million at 31 December 1997, the Finance Committee endorsed an Action Plan which was forwarded in its report to the Council and approved at its 115^th Session and subsequently by the Conference at its 30^th Session. The Action Plan requires, inter alia, that any excess in a) the investment income of the Separation Payments Scheme and Staff Compensation Plan over the related requirements, and b) the investments in the Separation Payments Scheme and the Staff Compensation Plan over the related liabilities, is earmarked for the ASMC liability for past services.

IV. The situation today

8. During the 1998-1999 biennium, the following transactions have been reflected in the accounts in accordance with the Governing Bodies' decisions following the figures reported by the Actuary:

• the accounts have been charged with the After Service Medical Cost for current staff;
• the accounts have been charged with the amortisation charge for the past service liability; and
• the investment income in excess of the requirements of the Separation Payments Scheme and the Compensation Plan of US$42.8 million has been earmarked to the After Service Medical Liability.

9. As a result of giving effect to the above Action Plan, according to the accounts of the 1998/99 biennium and the latest actuarial review at 31 December 1999, the unaccrued and unfunded liability for After Service Medical Coverage at that date, as compared with the same date two years earlier, are as follows:

10. It should be further noted that in 2000 all the investments for After Service Benefits became managed as one fund by, Fiduciary International, with Northern Trust acting as the custodian. In accordance with the decision of the Governing Bodies to earmark for ASMC the investments in the Separation Payments Scheme and the Staff Compensation Plan which exceed the related liabilities, the earmarking of investments at 31 December 2000 was as follows:

11. It can be seen from the above that the decisions of the Governing Bodies have enabled some real progress to be made in reducing the unaccrued and unfunded liabilities of the Organisation particularly with respect to ASMC.

V. The next steps

12. The Organisation is now correctly accounting and budgeting fully for the current service costs of all employees for all After Service Benefits. The question therefore is what is being done, and what more can be done, to regularise the situation in order to complete the accounting and funding for unaccrued and unfunded liabilities in respect of past service. There are two parts to the accounting and funding problem for After Service Benefits in FAO:

1. Accruing for the After-Service Benefits Liability

13. In preparing its financial statements the Organisation follows the UN accounting standards (UNAS) and generally accepted accounting standards in the form of the International Accounting Standards. UN accounting standards are still at the embryonic stage and less complete than IAS. With respect to expenditures, UNAS generally requires the accrual of expenditures. With respect to After Service Benefits they require that organisations either accrue fully for the related expenditures or if not that they disclose the unaccrued amounts in the notes to the financial statements. IAS require the accrual of all expenditures and for After Service benefits there is no exception. The relevant standard which is applicable for financial statements produced starting with 1999 does, however, recognise a transitional measure where an organisation can record the unaccrued liability resulting from the application of the standard over a period of 5 years.

14. In FAO's case, because of the size of the unaccrued liability for ASMC reported by the consultant Actuary, a thirty-year period was originally chosen for recording this unaccrued liability in the accounts. However, the subsequent decision of the Governing Bodies to transfer the excess of income over the requirements of the Separation Payments Scheme and Compensation Plan to the ASMC Liability has made possible a shorter amortisation period. In fact, this decision has already resulted in the recording of 35% of the liability in the first biennium. Accordingly no further accounting action is proposed.

2. Funding for the After Service Benefits Liability

15. In line with UN Accounting Standards, FAO accounts for its long-term investments at historical cost. In fact, UNAS require that long-term investments are stated in the financial statements of organisations at their historical cost. IAS has a similar requirement with two exceptions allowing for the market value to be substituted for cost: a) where the business of the organisation is to trade investments, or b) where the investments are held by a separate entity and are beyond the control of the organisation, such as a pension fund. Neither of these conditions apply in the case of FAO's After Service Benefits investments.

16. At the end of 2000, while the investments are shown on the balance sheet, the market value of the After Service Benefits investments exceeds their cost by some US$ 28.3 millions as can be seen from the table below. Moreover, Conference Resolution 10/99 requires that where investments exceed the liabilities of the Separation Payments Scheme and the Staff Compensation Plan, they should be earmarked to cover the ASMC after-service liabilities. Accordingly, the Director-General believes that the footnote to the financial statement should be modified to note that the difference between the balance sheet value of the after-service portfolio at cost and the value at market, represents funding earmarked for accrued liabilities for after-service benefits. The footnote would, in effect, show the following financial position with respect to the assets and liabilities related to after-service payments.

17. After Service Medical Costs. The above presentation reduces the unfunded liability for after-service medical costs to something on the order of US$ 71 million, depending on the market value of the portfolio at the balance sheet date.

18. The issue going forward with respect to ASMC funding is whether:

1. the portfolio should be sold and repurchased. The advantage of this approach is that it would create US$ 28.3 million in capital gains investment income which under the Action Plan referred to in paragraph 7 above would then be applied to the after-service liability. This would reduce the unfunded obligation from US$ 102.5 million to US$ 70.9 million. The disadvantages of this approach are that it would cost FAO about 1 to 2 basis points for bonds sold and repurchased and 6 to 7 basis points for equities, plus about US$15,000 in transaction costs paid to the portfolio manager, or a total cost of about US$60,000. Moreover, as the cost of the repurchased portfolio would approximate today's market value any deterioration in the market value below cost would require to be provided for with a consequent charge to the General Fund.
2. leave the portfolio as is but value it at market using IAS accounting standards and define it as a trading portfolio. The advantage of this approach is that it would achieve the same effect as in option (i) above without the costs paid to the portfolio manager. However, there would be the same disadvantage going forward in that the value of the funding for this liability would go up and down with the market creating unrealised gains or losses in the General Fund or in a separate equity account.
3. continue with the present arrangements as described in this paper in paragraphs 6 and 7. The advantage of this approach is that it avoids the disadvantages of the options (i) and (ii) above. Its disadvantage is that it does not accelerate the resolution of the unfunded liability. On the other hand it is noteable that the present arrangements have achieved a measure of success as explained in paragraphs 9 to 11 above.

19. The Director-General considers that option (iii) above is probably the more suitable approach but invites the views of the Finance Committee on all of these options.

20. Termination Payments. The Director-General appreciates that although considerable progress has now been made by FAO towards addressing its unfunded liabilities the present solutions still leave some way to go. In particular attention has been given to what was the most significant unfunded liability, ASMC. However, given the progress on ASMC the Director-General believes that it might now be appropriate to address the underfunding for Termination Payments and, in particular, that the same funding mechanism under Conference resolution 10/99 (see penultimate paragraph of attachment for wording of the resolution) could be extended to cover this liability too in the event that the liability for ASMC becomes fully funded one day. The Director-General therefore invites the views of the Finance Committee on this suggestion. If the Committee endorses this course of action then a draft Conference resolution will be submitted to it at the September session for endorsement and onforwarding to the Council and Conference for their approval.

Attachment 1

AFTER SERVICE MEDICAL COVERAGE

87^th Session of the Finance Committee

1. At its 87^th Session in April 1997, the Finance Committee considered the report of the Consulting Actuary on end of service and post retirement benefits at 1 January 1996 and the related unaccrued liability. As regards its funding, the Committee noted that urgent action should be taken and that this would have important related budget implications for 1998-99 and thereafter. As regards accrual, upon request of the Committee, the External Auditor confirmed that a 30-year amortisation period to record the liability in the accounts would be acceptable for audit purposes.

2. The Committee therefore recommended certain courses of action in this connection which may be summarised as follows:

• Funding of After Service Medical Coverage (ASMC)
1. Given the difficulty inherent in establishing the liability of individual Trust Fund donors, the FAO should assume responsibility for the accumulated liabilities on Trust Fund programme;
2. The FAO should seek payment from UNDP and IBRD for the posts they had funded;
3. The Committee recommended that FAO obtain payment from IFAD, ICCROM and others for their share of the actuarial deficit within the FAO-operated benefits programme;
4. Provision for the service costs of current employees should henceforward be made for all programmes commencing from 1 January 1998;
• Accounting for ASMC and Funds Management
5. Amortisation of the unaccrued liability should commence from 1 January 1998 over a period of 30 years for the portion of the actuarial deficit relating to each programme after considering the merits of an equal instalments amortisation basis versus fixed percentage of salary basis, and including the amount of the actuarial deficit relating to Support Costs and Trust Funds;
6. Effective 1 January 1998 combine all separation plans into one fund for management and reporting purposes and maintain separate accounts for the After Service Medical Coverage Plan and the three remaining plans;

112^th Session of the Council

3. At its 112th Session in June 1997 the Council reviewed the report of the 87^th Session of the Finance Committee and noted the results of the actuarial study on the cost of After Service Medical Coverage. Its conclusions were as follows:

• Funding of ASMC

4. While the Council recognised that full service costs for current employees should be included in the budget, it also recognised that certain questions remained outstanding, in particular, regarding the responsibility for that part of the accumulated liability that related to staff funded by other institutions. The Council requested the Director-General to continue to explore solutions to covering the accumulated liability so as to minimise the negative effects on the substantive output of the Organisation, taking into account other approaches being adopted in the UN system. The Council, therefore, concluded that the Finance Committee should again consider the matter at its September session where it should address the proposals of the Director-General in the context of the full Programme of Work and Budget 1998-99.

• Accounting for After Service Medical Coverage

5. The Council agreed on the need to correctly account for such costs.

88^th Session of the Finance Committee

6. At its 88^th Session in September 1997, the Finance Committee was updated on developments which had taken place since its 87^th Session in April 1997 in order to obtain its advice on the various funding alternatives proposed by the Secretariat following the 112^th Session of the Council in June 1997.

• Funding of ASMC
1. Service Costs of Current Employees

7. In line with the Council's guidance that the full cost of medical benefits for current employees be funded from the budget, it was proposed to adjust the standard costs in the 1998/99 budget to include the full ASMC costs of current employees which in turn would be charged to the Programme of Work and Budget. It was explained that this action would reduce the programme outputs over the 1998/99 period by about US$ 2.2 million. Moreover, while this approach responded to the guidance given by the Council, the Director-General was of the view that the reduction in the programmes of the Organisation to fund this expense was in contradiction to the Council's directive concerning the need to protect, to the maximum extent possible, the technical and economic programmes of the Organisation, and therefore, respectfully requested that the US$ 2.2 million be added to the budget.

2. Accumulated liability in respect of retirees and current employees

8. As regards the Council's request that the Director-General continues to explore solutions to the accumulated liability which, for FAO, was then estimated to be US$ 154.2 million, the Finance Committee was informed that FAO had:

• written to the Chairman of the Consultative Committee on Administrative Questions dealing with Finance and Budget (CCAQ/(FB)) requesting that this subject be added to the Agenda of the Session scheduled for August 1997, with a view to commissioning a working group to make recommendations towards a systemwide solution by 1 July 1998;
• written to the concerned institutions to advise them of the situation and request their agreement to pay their respective shares of the actuarial deficit WFP/IFAD/ICCROM/UNIC) or posts funded by agencies or in order to execute projects on their behalf (UNDP/IBRD); and was planning to hold a meeting in the last quarter of 1997 with the above institutions and the Consulting Actuary in order to discuss the actuarial review, including its assumptions and findings, and the planned update of the review which would establish current figures for the liabilities of each institution;
• asked the Actuaries to update the figures in their study after the above meeting since the basis of the estimated liability was a projection based on January 1996 data. These updated figures would be used to (i) "bill" participating Agencies for their share of the unfunded liability; and (ii) combine all separation plans into one fund for management and reporting purposes, maintaining separate accounts for the After Service Medical Coverage Plan and the three remaining plans; and
• discussed on several occasions with the External Auditor the year-end accounting treatment of this liability: subject to the outcome of the CCAQ (FB) study, FAO planned to record, at the end of 1998 and each year thereafter, 1/30^th of the actuarially determined ASMC unfunded liability. In addition, FAO's financial statements would reflect, in a "Note to the Financial Statements", the unfunded portion of the liability as well as the contingent liability for other Agencies' shares.

9. With respect to funding the ASMC unaccrued liability for past services of US$ 154.2 million, it was explained to the Finance Committee that the proposal was to move forward on funding taking into account:

• the CCAQ study which would guide the UN System in coming to terms with this issue;
• options for containment of after-service medical costs;
• funds that may be set aside to meet obligations, either from budget surpluses, or as a priority allocation of arrears payments; and
• input from the UN System and the Governing Bodies on how to reconcile the differences between the general reserve deficits, arrears and the remaining unfunded liability for ASMC benefits.

10. The Committee noted the significant developments that had been made and also endorsed the ASMC funding proposals noted below:

• Service Cost of Current employees: that the full cost of medical benefits for current staff be funded from the budget in line with the Council's guidance.
• Accumulated liability in respect of retirees and current employees: that with respect to the liability for past services, the secretariat would move forward taking into account
• options for containment of after-service medical costs;
• funds that may be set aside to meet obligations, either from budget surpluses, or as a priority allocation of arrears payments; and
• input from the UN System, in particular, from the above-mentioned working group and from the Governing Bodies.

113^th Session of the Council and 29^th Session of the Conference

11. The Council reviewed the report of the Finance Committee at its 113^th Session. On this basis the Secretariat prepared the Programme of Work and Budget for 1998-99 incorporating the Council's requirement that provision should be made for the full cost of medical benefits, including after service medical coverage, for current staff, as endorsed by the Finance Committee (paragraph 167 to 169, 1998-99 PWB C97/3). The Conference approved the Programme of Work and Budget at its 29^th Session.

90^th Session of the Finance Committee

12. At its 90^th Session in September 1998, the Finance Committee, now that the funding for the cost of medical benefits for current staff had been provided for, discussed the actions to be taken to fund the liability for After Service Medical Cost in respect of past services.

13. In this connection, the Director-General intended to follow the below course of action:

• Containment of the After Service Medical Cost
• Funding
• UN System

14. For the funding the Director-General made a proposal for an action plan as follows:

1. Any income generated from the investments held in respect of the Separation Payments Scheme and Staff Compensation Plan be applied as originally foreseen to ensure the adequacy of those funds to extinguish the respective liabilities.
2. In the event that there should ever be an excess in the investment income of the Separation Payments Scheme and Staff Compensation Plan over the requirements for these funds then this should be earmarked for the After Service Medical Coverage liability for past services.
3. Following the past practice of the Governing Bodies to establish separate funds for After Service Benefits, the investments in the Separation Payments Scheme and the Staff Compensation Plan exceeding the liabilities be earmarked for an After Service Medical Coverage Fund whose establishment should be approved by Council and Conference.
4. Not withstanding the provisions of Financial Regulation 6.1 (b), any cash surplus on the General Fund will be allocated as a priority.

115^th Session of the Council and 30^th Session of the Conference

15. The Council reviewed the report of the Finance Committee at its 115^th Session. The Conference approved the Action Plan at its 30^th Session.