January 3, 2007

Retiree costs in state could hit $100 billion

Public agencies must tell liabilities for workers


By Timm Herdt, therdt@VenturaCountyStar.com
January 1, 2007

When Charles Weis took over as superintendent of the Ventura County Office of Education in 1993, he took a look at the agency's employee benefits package and envisioned a potential train wreck far into the future.

The agency was promising to pay the health insurance costs for employees after they retired, but it was putting no money aside each year to cover those distant financial liabilities and had no real idea of what those future costs might be.

"I ordered the business office staff to buy out those in the program," Weis said. "You can't allow employers to give away something they don't have to pay for 30 years."

Across California, however, government agencies have been doing precisely that for decades: promising their workers several years, or even a lifetime, of free or subsidized health insurance after they retire, but putting not a penny aside each year to pay those costs when the bills inevitably come due.

The practice remains commonplace in the public sector, even as large private employers have scrambled in recent years to pare down or scrap their retiree healthcare benefits.

A day of reckoning approaches, hastened by a new accounting regulation that takes effect in 2007.

When large government agencies close their books on the budgets they adopt in the coming year, they will have to tell the world how large the financial liabilities they have accrued after decades of, as Weis describes it, giving away a benefit that relied on future generations for payment.

Unlike pension benefits, which are funded over a worker's lifetime through annual contributions from employers and workers, retiree health insurance is typically financed on the pay-as-you-go plan, with all costs for current workers put off well into the future.

Today, the image of that looming train wreck that Weis envisioned years ago has become increasingly clear to auditors, government officials and taxpayer groups.

The state, its university systems, counties, cities, school districts, special districts, nearly all have obligated themselves to pay at least some level of health insurance premiums for a swelling pool of retirees, racking up unfunded liabilities that the nonpartisan Legislative Analyst's Office estimates could total in excess of $100 billion.

Estimates of future costs

A new regulation adopted by the Government Accounting Standards Board will require all large government agencies to close out next fiscal year's books with financial notes estimating the future costs of paying for retiree health benefits.

Phased in over three years, the regulation will eventually apply to every government entity in the nation.

The numbers are expected to be sobering in all cases, horrifying in some.

An actuarial study completed for the Los Angeles Unified School District, which pays full lifetime healthcare benefits to 32,000 retirees and 18,000 of their family members, estimated the district's unfunded liability at $5 billion. It now spends up to 4 percent of its general fund to pay retiree health benefits; if the district were to begin putting enough money aside each year to eliminate the unfunded liability over 30 years, the cost of retiree health benefits would soar to as much as 20 percent of the district's annual budget.

It works out to about $2,000 per student, says former Assemblyman Keith Richman, who recently formed a nonprofit group that will be dedicated to educating the public about the costs of paying benefits to retired government workers.

"The issue can't be ignored," Richman said. "It's an extraordinary liability. ... We all ought to be concerned. It's the biggest fiscal issue facing California."

The Government Accounting Standards Board regulation has caught the attention of government officials at all levels.

The most dramatic reaction came last month when the San Diego County Board of Supervisors voted to stop paying $30 million a year for retiree health benefits.

County officials said the new accounting rule would force them to start prepaying future liabilities, a change that would cost the county an estimated $1.8 billion over the next 20 years.

After the new accounting rule was drafted two years ago, the California School Boards Association sent a survey to 1,000 school districts asking about their retiree health benefit policies. It received more than 600 responses.

"We saw that districts were worried about it," said Suzi Rader, director of the organization's district financial services division. "We saw that it was going to be a concern."

A 2003 survey conducted by the State Teachers' Retirement System found that districts covering 57 percent of retired teachers in California pay all or a portion of their retirees' health insurance.

Dwight Stenbakken of the League of California Cities said a survey went out last month to cities across the state as the association seeks ways to assist cities with an issue "that has been coming to the forefront."

The survey, he said, will allow cities to get "a statewide handle" on the size of cities' liabilities. "I suspect it's going to be tremendously substantial," he said.

As with every issue concerning healthcare, the severity of the problem is being driven by runaway costs. When the state first began offering group health insurance to employees in 1961, the premiums were $5 per employee per month. At that price, giving the benefit to retirees didn't seem an extraordinary burden.

In recent years, however, the cost of insurance premiums has soared. Since 2000, annual increases have averaged 17 percent, and the cost of providing health benefits to retired state workers has tripled in just the last nine years, topping $1 billion this year.

Number of retirees on rise

The state pays 100 percent of the premiums for a basic HMO plan for retirees and 90 percent of the premiums for their spouses, or $738 per month for each couple. Those who choose a more expansive health plan must pay the difference between that plan's higher cost and the base price of the HMO plan.

At the same time costs are rising, the pool of retirees is climbing by about 4 percent per year and could grow even faster, as an estimated 40 percent of the state's active work force is expected to retire within the next 10 years.

Calculating those two growth trends, the legislative analyst predicts that the state's annual cost for retiree healthcare will hit $1.6 billion in the 2010-11 fiscal year.

Financial analysts suggest a variety of strategies for dealing with the growing liabilities.

One approach many agencies have already adopted is to establish a multi-tier retiree benefit plan, keeping existing rules intact for current employees and creating less generous benefits for those hired after a certain date.

A report from the Ventura County Office of Education, for example, shows that the Pleasant Valley School District provides full lifetime benefits for teachers who worked for at least 10 years and retired at age 55 by June 30, 1984. The district policy provides gradually less generous benefits for those who retired after that date. The existing policy, which applies to all teachers hired after June 30, 1986, allows retirement at age 60, requires at least 15 years of service, caps benefits at $2,400 a year and stops the benefit entirely when retirees become eligible for Medicare at age 65.

Another approach that agencies can take is to prepay retiree benefits, in part by requiring monthly contributions from workers. The legislative analyst has recommended that the Legislature adopt this approach for state workers.

Stenbakken of the League of California Cities said the "state of the art" among cities is to pay as they go — paying each year's costs out of that year's budget. "Only a handful — and I mean two or three — are doing something to fund their costs up front."

Among them is the city of Simi Valley, which offers lifetime health benefits to police officers but deducts a portion of each officer's paycheck to put into a trust fund that will pay benefits after he or she retires.

Caryn Moore, an administrator in the state Department of Education's financial services division, said school districts are awakening to the need to put money aside each year to cover future retiree healthcare costs.

"To the extent that you delay annual funding, you make the problem worse," she said. "You really need to start funding this."

Weis said school districts in Ventura County might be a little ahead of the statewide curve on setting aside funds for these future liabilities.

"In our county, it's probably the rule rather than the exception," he said. "They may not be setting aside enough, but they're putting aside something."

Prefunding future benefits

Legislation enacted this year allows a number of counties, including Ventura, to start setting up accounts to prefund retiree health benefits.

Chief Executive Officer Johnny Johnston said the county already pays "a blended premium" that covers costs for both active and retired workers. An actuary has been retained to determine a precise figure, but Johnson estimated that Ventura County's unfunded liability for retiree health costs at between $15 million and $20 million, a significant, but manageable, amount.

The legislative analyst notes that prefunding future benefits will save agencies money in the long run as earnings on money deposited in trust accounts will offset direct contributions to the account.

Finally, agencies can consider eliminating retiree health benefits, although the legality of taking away a promised benefit is uncertain.

Courts have long established that retirement pensions, once promised, become a vested right that cannot be taken away from a retiree or employee. Whether retiree health benefits are a vested right is an unsettled legal question.

"You'll hear people argue everything from it's a vested right to districts can take it away whenever they want," said Rader of the School Boards Association. "That is a question that will end up in the courts, and we haven't seen any public ruling yet."

She notes that one state court outside California has ruled agencies cannot rescind promised health insurance benefits to those who have already retired, but can rescind the promise for those who have not yet retired.

Richman, who unsuccessfully crusaded for reform of retiree benefits in his six years in the Assembly, said he does not believe that the Legislature will be able to confront the issue because of the political influence of public employee unions, which do not want to see retiree benefits reduced.

Noting the strong negative reaction in 2005 when Gov. Arnold Schwarzenegger talked of reforming public employee pensions, Richman said it will be a challenge to propose reforms that won't be interpreted by the public as an attack on teachers, firefighters, police officers and other valued public employees.

He hopes that the nonprofit advocacy group he has formed will be able to able to lay the groundwork for a possible ballot initiative designed to limit taxpayers' future liabilities for paying for retiree pension and healthcare benefits.

Richman advocates an approach he says will not reduce benefits and not be punitive: raise the retirement age for public workers.

"Private sector workers are working to age 65 or 68 paying taxes so that miscellaneous government employees can retire at 55," he said.

Richman believes that there are legitimate reasons to allow police officers and firefighters to retire at 55, but if all other government workers had to wait until age 65 to start collecting benefits, the system could be made financially sound.

Workers would pay into their pension funds for 10 more years and draw 10 fewer years of benefits. In addition, current assets invested in pension funds would double over that 10-year period.

Medicare eligibility

The pension savings, Richman believes, could be enough to cover unfunded liabilities for retiree health insurance. Future costs would be substantially lower, because 65-year-old retirees would immediately be eligible for Medicare.

"I don't have any issue with offering some benefit for retiree healthcare that's a supplement to Medicare," he said.

Richman and others who have sought to shine light on the financial implications of unfunded retiree benefit expenses believe that the

Government Accounting Standards Board rule will focus the attention of policymakers and the public.

Weis, whose office is legally responsible for reviewing the finances of all school districts in Ventura County, said the new regulation will provide his auditors with important new information.

"My folks who read over the district budgets will be looking at this closely," he said. "That's the issue we'll be looking at for fiscal solvency."

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