Retiree health: bigger problem than pensions?

One of the state of California’s biggest debts, health care promised current state workers when they retire, has grown to $51.8 billion — a trend a federal report says makes health care costs the top fiscal problem for state and local governments nationwide.

The new estimate from state Controller John Chiang last week was up $3.6 billion from $48.2 billion a year earlier, in part because CalPERS had used a surplus to reduce health care premiums in the period covered by the previous report.

A report issued by the U.S. Governmental Accountability Office last November predicts that state and local government budget problems in the decades ahead will “largely be driven” by health care costs.

Here’s part of the budget crunch.

During the next four decades, the GAO projects that the number of state and local government retirees throughout the nation will grow from 3 million to 5.1 million at an annual average rate of 1.3 percent.

“However, the cost of retiree health benefits is projected to grow more quickly, at an annual rate of 6.7 percent over that same period,” said the GAO report titled “State and Local Government Retiree Health Benefits.”

The cost of keeping promises to provide retiree health care was a long-ignored form of government debt. But that changed in 2004 with a new rule requiring state and local governments to report their debt or “unfunded liability” for retiree health care.

The annual report issued by Chiang last week is his third. The GAO report finding that more than $530 billion is owed by state and local governments for retiree health care is one of the first national reports.

The increasing cost of public employee pensions has been in the spotlight for years. In 2005, Gov. Arnold Schwarzenegger briefly backed a proposal to switch new public employees to 401(k)-style individual investment plans.

But pensions are not mentioned in the GAO report. The “nonhealth” expenditures of state and local government as a percentage of the economy (GDP), presumably including pensions, are projected to fall in the decades ahead, while “health” expenditures quadruple.

A report issued in 2008 by Schwarzenegger’s Public Employee Post-Employment Benefits Commission also put much of its focus on retiree health costs. Pension costs were averaging a manageable 4 percent of general fund spending, and pensions were 89 percent funded.

Of course, that was before an historic market crash punched a big hole in pension investment funds expected to provide most of the money for future pension payments, 75 percent in the case of the California Public Employees Retirement System.

Now there is worry that growing pension costs will be “unsustainable,” diverting too much money from other programs. In Los Angeles, for example, officials were told last month that retirement costs are expected to double in four years to $1.3 billion.

Current retiree health costs are not soaring like pensions, and they are a smaller part of the budget. The governor’s state budget proposal: CalPERS $3.5 billion, California State Teachers Retirement System $1.2 billion, and retiree health $1.4 billion.

In the long run, however, two things could boost retiree health costs. Pensions are a fixed amount based on final pay, years on the job and retirement age. Retiree health care is in many cases an open-ended promise to pay for a future service, whatever the cost.

Governments, and usually workers, make annual contributions to pension funds, which are invested to cover most of the pension costs. Most retiree health care is pay-as-you-go, with no money set aside for future costs.

The view that retiree health care costs, once disregarded as negligible, should be “prefunded” is not new. Two decades ago legislation by Assemblyman Dave Elder, D-Long Beach, created a retiree health care fund for state workers, but it received no money.

Treating retiree health care like a pension obligation, and making an annual contribution, yields investment earnings to help cover future costs. It’s also an attempt to pay the retirement costs of current workers now, rather than pass debt to future taxpayers.

The No. 1 recommendation by the governor’s retirement benefits commission two years ago was to prefund retiree health obligations, said to be “just as important as prefunding pension benefits.”

Controller Chiang said in a news release last week: “As I have since 2007, I urge lawmakers to reduce the impact on future generations by putting additional dollars into the annual payments so that we can invest those funds, grow that money …”

But importantly, another way that retiree health care costs differ from pensions is their legal standing. In a series of court decisions, pensions are viewed under contract law as vested rights that cannot be reduced unless replaced by something of equal value.

Retiree health care does not have similar legal protection. Last year, a federal court ruled in a San Diego suit that retiree health care was not a vested right, which some think allows benefit reductions.

The GAO report said retiree health care is being cut nationwide in several ways. Some governments are capping their annual payments, shifting the risk of higher premiums to retirees, and others require longer service to get retiree health care.

The new accounting rule requiring governments to report their unfunded liability for retiree health care is one reason public employee unions formed a coalition, Californians for Health Care and Retirement Security.

Dave Low, the group’s chairman, said the unions expected that an issue “not on anybody’s radar screen” would heat up and that opponents of public pensions would cite the big retiree health care debt as part of the problem.

“We knew it would get blown out of proportion,” he said. “It’s simply an accounting standard. Our coalition decided we should get in front of it and prepare for it.”

Low said the coalition has done polling, research and created a handbook on various ways that can be used to begin prefunding, including partial funding and pension bonds.
“Obviously, we are going through this gigantic recession, so nobody has money available to start funding,” he said. “It’s a difficult time to start that conversation.”

Low agrees that retiree health care has not had a number of court tests like pensions, but he draws no conclusion: “Whether it’s a vested right or not is unclear.”

In his view, the retiree health care debt is much the same as a $2,200 monthly payment on a home that cost $300,000. Over three decades, the total owed with interest on the mortgage may be $600,000 or more, but the “realistic” cost is the monthly payment.

Low said the homeowner does not have to list an overwhelming debt of $600,000 or more, which could prevent access to credit cards and create other problems.
Low also argues that the retiree health care costs for current workers are not being shifted to future generations.

He said the money the state is spending on retiree health care comes from funds available for labor costs. If prefunding had lowered the state payment for retiree health care, the savings would have been available at the bargaining table for other labor purposes, such as reducing furloughs and layoffs.

“So really, state employees have chosen to eat that cost in order to continue to have that benefit, and when they retire they will get the benefit,” Low said. “In the meantime, active state employees are incurring that cost. It all comes
out of the section of the budget that goes to state employees.”

While critics talk about reducing retiree health care, Low notes that retiree health care among California public employees is uneven, the result of the way labor contracts have been negotiated in the past.

The Schwarzenegger administration has said the state pays on average 85 percent of health care costs for active workers, but 100 percent for retirees. On the other hand, Low said, more than half of the school districts do not provide retiree health care.

“I have a lot of my retirees who are essentially signing their paychecks over for the (health) premiums,” said Low. He is a member of a union that represents non-teaching school employees, the California School Employees Association.