Retiree Health Benefits
Recommendation
Reduce the liability for future retiree health costs with alternative insurance products and prefunding future obligations.
Background
The Government Accounting Standards Board (GASB) has been around for 23 years with a goal of making government financial information more useful and usable. In 2004 it issued a statement (GASB 45) on accounting and reporting of non-pension benefits for retirees.
GASB 45 offers guidance for state and local governments to report their liability for these other post-employment benefits (OPEB), the largest of which for most governments is health care. All governments will have to report their liabilities in fiscal year (FY) 2009.
The state and most local governments pay these costs from the General Fund each year. A few local governments have created reserve accounts with others considering such a move. A reserve account has three benefits. First, it puts the question of health care benefits for retirees in the proper fiscal perspective. Second, it ensures money is available to meet future needs. Third, it reduces the amount that needs to be reported.
For most governments, retiree health benefits are not yet a problem. Government payrolls have grown more in recent years than previously; those newer employees may not get counted in actuarial studies of existing liabilities because they do not qualify for the retirement benefit, but show up in studies of future years. The size of the cohort of baby-boomer employees who will become eligible could have a significant effect on government finances.
As of December 31, 2005, the state had an unfunded liability of $23.8 billion, 115 percent of General Fund spending in FY 2008. Unchecked, this liability will grow to $44 billion in 2013. Liabilities among the state's local governments, though nowhere near as large as the state's liability, range up to 70 percent of General Fund spending in Charlotte and 51 percent in Guilford County. On the other end, Cary has a liability equal to just 15 percent, and Buncombe County's liability is 8 percent of FY2008 spending.
Planning for retiree health care costs
Investors want to know. Although GASB has no authority to force governments to act on its statements, bond investors and rating agencies such as Standard and Poor's may consider a government that does not follow GASB rules a greater risk, though there is no indication yet that it would lead to a rating downgrade.
Milliman, an actuarial and consulting firm, stated, "If a sponsor's financial statements are used to assist in borrowing or are otherwise subject to scrutiny, the standard may have a significant impact. Ultimately, though, long-term plan costs are determined by plan provisions, not accounting treatments."
Regardless of what one thinks of GASB or its specific recommendations, the costs are real. If a county or municipal government does not report its liability, it must still find a way to convey its trustworthiness to investors.
Positive action will be rewarded. If a government creates a reserve fund for its OPEB obligations, it would reassure investors. This in turn could shave points from the government's cost of borrowing. Creating a reserve fund also allows a government to discount its future obligations, making them less expensive today, meaning its liability shrinks overnight.
Ways to lower the burden
A government can create a reserve account, like Winston-Salem has done. This has the immediate benefit of prefunding some of the future obligations the government will face. As the example from Cary shows, creating a trust or reserve account also reduces the government liability by discouting it at a faster rate. This, in turn, would reduce the amount the government must set aside in future years. The difference in total liability does not look large, but can cut the annual contribution by half.
Depending on the vesting requirements now in place, a government can lengthen the time of service needed to qualify for benefits. This does not address the potential liability for existing employees who do not yet qualify for retirement health benefits, but can make the upper limit of the liability a little easier to determine.
A government can also offer different plan options, such as high-deductible insurance policies with health savings accounts (HSAs) that allow employees to build assets and save for their own future medical needs. These accounts, like defined contribution pensions, lower the future liability for the government and make the employee more aware of his preparedness for retirement.
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