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Municipal Retiree Health Care Costs Significantly Underfunded

The Pew Charitable Trusts recently revised a 2017 issue brief titled “State Retiree Health Care Liabilities: An Update.” This 50-state survey of retiree healthcare liabilities reviews how prefunding policies and reducing benefits may help states effectively manage the increasing costs associated with “other post-employment benefits” (OPEB).

The largest portion of OPEB liabilities comes from retiree health care costs. Between 2010 and 2013, OPEB liabilities decreased from $660 billion to $628 billion due to lower-than-expected health claims. However, health care costs have continued to rise since 2014, resulting in states being more burdened by costly retiree health care benefits.

Between 2010 and 2015, the average annual health care premiums for single coverage increased by 24%. Average premium costs for family coverage has increased by 61% over the last ten years. As such, the percentage of total compensation that employers spend on health care costs has also risen. Over the next ten years, the Centers for Medicare & Medicaid Services projects a 70% increase in national health care costs, due in part to the rising number of Baby Boomer retirees.

According to the Pew report, states have set aside only $46 billion to fund a total of $696 billion in other post-employment benefits as of 2016. This represents an average funding level of only 6.6 percent, or $6.60 set aside for every $100 in OPEB liabilities.

In fact, only eight states that reported OPEB liabilities funded 30% or more of those costs. Another eleven states funded between 10% and 29% of their OPEB costs, and ten more states funded less than 10% of their OPEB costs. Nineteen states did not set aside any assets to cover their OPEB costs. Two states (Nebraska and South Dakota) do not report OPEB liabilities in their state financial reports.

States may be able to combat the increasing costs of their OPEB liabilities by prefunding policies. While most state OPEB plans operate on a pay-as-you-go basis through funding from annual appropriations, 34 states have at least one prefunded policy. In these cases, states set aside assets to pay for their share of the costs of health care benefits in the future based on their own accounting assumptions. Doing so lowers the unfunded OPEB liabilities reported by those states. By prefunding OPEB plans, taxpayers fund public employees out of a dedicated trust today rather than passing the bill along for future generations to pay out of their budgets.

All eight of the states that fund over 30% of their OPEB liabilities had at least one prefunded policy. For example, Hawaii benefited by prefunding some of its OPEB plans after passing Act 268 in 2013. Hawaii’s OPEBs are expected to be fully funded by 2045, but the state is expected to continue reporting unfunded OPEB liabilities in the meantime.

In 2045, Hawaii is projected to save up to $900 million a year by fully prefunding its OPEB liabilities rather than paying as benefits become due. Of course, the actual realized savings will depend in part on health care costs, investment returns and financial market performance.

Alternatively, states may better manage costs by reducing benefits. OPEB benefits do not typically have the stringent legal protections afforded to pension state pension plans, because they do not accrue until an employee reaches a certain age or provides the minimum years of service to qualify. Thus, states may increase the age limits and service requirements or tweak benefit levels, deductibles, copayments, and coinsurance amounts, if the state’s law allows. Other states may provide strong protections for OPEB benefits. Maryland, for example, increased the service requirement two-fold and adjusted premium contributions in order to decrease OPEB expenses.

As health care costs continue to rise and in turn increase state OPEB spending, many states may pre-fund their OPEB plans, change benefit levels, or do some combination of the two in order to meet the financial burden of these plans.

Accounting for Other Post-Employment Benefits

The Governmental Accounting Standards Board (GASB) now requires states to report liabilities for retirement benefits other than pensions in their financial statements. The changes were required from all states as of end of 2008. The increased financial transparency forced states to review the cost of their other post-employment benefits (OPEB) and address how they plan to pay for them.

Retiree health care plans are typically funded by plan sponsors on a “pay as you go” basis, meaning that monies to pay current and future health care obligations are taken from current assets and not set aside in advance. This differs significantly from pension plans governed by ERISA, which are subject to funding guidelines.

Disclaimer: While every effort has been made to ensure the accuracy of this publication, it is not intended to provide legal advice as individual situations will differ and should be discussed with an expert and/or lawyer.For specific technical or legal advice on the information provided and related topics, please contact the author.

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