Focusing on Retiree Health Benefits

Categories: California Developments,OPEB/GASB 45/75
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Public Retirement Journalby Amy Brown, March 2014

Beyond the very hot topic of pension benefits, almost all public agencies offer health benefit coverage for active employees, and many provide other post-employment benefits to their retirees (aka OPEBs). OPEBs most often refer to retiree health coverage but also include any other benefit paid outside a pension system, such as dental, vision or life insurance.

With limited public attention, there’s been little talk of OPEBs of late. But that wasn’t always the case. Before Governor Jerry Brown’s 12-point pension reform plan, Governor Schwarzenegger had his Public Employee Post-Employment Benefits Commission (the PEBC). When the PEBC completed its report in 2007, it concluded that pension benefits aren’t the pressing problem – it’s OPEB prefunding that really warrants attention. (Just goes to show how quickly policy imperatives shift in Sacramento.) Is OPEB prefunding any less desirable today? Certainly not; prefunding is hands-down the most fiscally prudent means of providing OPEB benefits. Is that realistic in today’s environment? With many local governments facing financial hardship and scrambling to make legally obligated pension payments, for many it boils down to a matter of reality, legal obligations, and limited resources. There will be a cost for this however, with health care obligations escalating unabated and most governments continuing pay-as-you-go funding for retiree health care promises.

Now with some recent court rulings, there are rumblings on Wall Street that this growing obligation might also be causing increased concern for investors. Apparently, investors typically believed that if governments ever got in a really tight spot, they could walk away from OPEB obligations. In light of recent court rulings in California, investors are now worried OPEBs may be treated as a vested right.1 It’s speculated that this change in perspective could threaten to further strain city and county credit worthiness in the eyes of the credit rating agencies who have a lot to say over the cost for agencies to seek bond financing.

With retiree health obligations rapidly escalating in many jurisdictions, the focus on OPEB benefits will grow in years ahead. For example, the State’s unfunded liability for retiree health is already greater than its pension liability ($63.8 billion versus $45.5 billion). The State’s Legislative Analyst’s Office predicts that in five years, the State’s General Fund spending on pay-as-you-go retiree health costs may take more money from the General Fund than pensions.

Ruling Recap

There hasn’t been a clear and consistent pattern among all of the retiree health rulings over the past two years, which just provides greater confusion for those of us trying to read the tea leaves. It’s also noteworthy that while pension vesting is 100 percent a state court issue, the retiree health vesting question can be brought before a state or a federal court which creates a different dynamic. Here’s a brief overview of what’s been on our brain:

Supremes – In 2011, in response to a federal court request to clarify a matter of state law, the California Supreme Court said a vested right for retiree health benefits could be created by an implied contract, but there is a very high burden of proof to show the government’s intent to create such a promise.

Sonoma County – In a 2-1 vote, the federal 9th Circuit Court of Appeal blocked a cut in retiree health benefits for Sonoma County retirees until the court had the opportunity to rule on whether an implied vested right exists. While this is just a temporary ruling, the federal court prevented the cuts for now, relying on the implied vested rights doctrine established by the state Supreme Court.

Orange County – In a cost cutting move, the county separated the health risk pools for active and retired employees, saving money on the cost of covering active employees while the premium costs for pre-Medicare retirees dramatically increased. (The employer pays a fixed contribution for retirees.) The federal 9th Circuit ruled unanimously that Orange County retirees do not have an implied contract to share in the same risk pool with active employees even though this move drastically altered their out-of-pocket expenses.

San Diego – A state court of appeal upheld a cap on annual retiree health contributions the City imposed beginning in 2009. The court ruled that even though the cap on premiums fell short of covering the full cost of premiums, the City’s Municipal Code says health coverage is “subject to modification by the City and the provider of health care services, and may be modified periodically as deemed necessary and appropriate.” Based on this language, the City can modify its contributions.

San Jose – A California Superior court judge ruled in December on the retiree health care changes in voter-approved Measure B. There were a couple of retiree-health related issues: (1) Where Measure B says “no retiree health care plan shall grant any vested right…” the court interpreted this to mean that an employee has no vested right to a particular plan or a particular benefit. They do, however, have a vested right to a health care benefit of some type. (2) The Judge said there is no clear vested right to a particular plan design, so in practice, an employer could offer a bare-bones plan to employees. Without getting into too much detail, labor groups also disputed the definition of which plan is the “lowest cost plan” and how much the City owes for that coverage. For those labor groups with clarifying language in a city ordinance, the court found an express vested right. For others labor groups whose disputed issues weren’t covered by city ordinances, the court found that past practices and actuarial reports did not meet the burden of creating an implied vested right. (3) Before this measure passed, San Jose required employees to pay half of the cost of OPEBs. The court found that Measure B couldn’t require employees to pay more than half, but it could require employees to pay a portion of unfunded liabilities for those benefits.

Los Angeles – The City of Los Angeles wanted to freeze its retiree health contributions, giving employees the option of contributing 4 percent of pay toward retiree health funding or to accept a fixed $1,190 monthly employer contribution towards those benefits with no inflation increases. A California Superior Court overturned this ordinance saying that even though the City clearly reserved the right to change or modify benefits or to change conditions of entitlement, based on previous Supreme Court rulings related to pension benefits, employees have a vested right to a fluctuating system. Moving to a fixed system would be a disadvantage that would impair that right. (This decision was controversial because it relied on a precedent relative to pensions that has never before been applied to retiree health care benefits.)

We’re not attorneys, so please don’t read this as legal advice. Whether retiree health benefits are a vested right depends entirely on what’s contained in your codes or ordinances and what’s been printed in your employee benefit manuals. Based on the ruling in Los Angeles, it seems unless you’ve promised a specific contribution level and if you’ve reserved any right for modification of benefits, that right can be construed to include changes in contribution amounts. Furthermore, unless you’ve hamstrung yourself, the employer generally has the right to modify the health care plans being provided in any way they see fit. And finally, you may have latitude in requiring employees to contribute toward the prefunding of retiree health benefits without impairing the vested rights to those benefits. This all is obviously far from clear, and anyone who walks close to these lines may end up in court with their employees.

The State’s Obligation

On a related note, State Controller John Chiang, who also happens to be running for State Treasurer, is drawing additional attention to this issue with a recently released proposal to require the State to begin prefunding its retiree health obligations. In the latest actuarial valuation, obligations grew by $730 million in one year, increasing from $63.8 billion to $64.6 billion.

He’s proposing the Legislature implement a 5-year plan to start fully funding the annual obligation incurred for active employees. In this way, the State will stop digging the hole deeper by deferring the cost of benefits accrued in the current year to future generations. This sounds nice but, as you’re aware, it comes with a big price tag.

In the current fiscal year, the State is spending $1.8 billion on retiree health care premiums. Implementing full prefunding
would double that cost to $3.6 billion annually. However, if the State were to fully prefund its OPEB obligations, it would also reduce the overall unfunded liability by 34 percent, saving the State $22 billion over the long term. Chiang’s plan is slightly
less ambitious than full-funding. Chiang says the State should build up to full payment of the “normal cost” at the end of five years, which would reduce the unfunded liability over the long term by $17.7 billion.

In addition to the State coughing up more money, Chiang says PERS should continue focusing on cost savings strategies and the State should focus on employee wellness programs. With a healthier workforce, taxpayers will save.


Published by Amy Brown, the Public Retirement Journal provides a very timely source of valuable information and insight into public retirement, health care and related benefits. The Journal seeks out, and interviews, those people shaping public retirement policy and helps our readers understand just what they have planned in this field.

For more information, please visit http://www.publicretirementjournal.org




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