1.  What are OPEB benefits?

Besides monthly pension payments, many California public employees receive health, dental, or other benefits that are funded in part by their former employer when they retire. These health, dental, and other benefits are often referred to as "other post-employment benefits" (OPEB). OPEB benefit packages are not always the same for different retired public employees. Employees of different governmental entities (the state, universities, cities, counties, school districts, and other public entities) often receive different levels of benefits. In some cases, governments offer no OPEB benefits to their retirees. Retiree health benefits comprise the largest category of OPEB benefits and thus the term “retiree healthcare” is often used interchangeably with OPEB.

2.  Why are retiree health costs an issue now?

Across the country, in both the public and private sectors, employer costs for retiree health benefits have been rising rapidly. Two main factors are attributed to these cost increases. First, healthcare premiums have been rising at an incredible rate over recent years. Second, the workforce is aging, as life expectancy is lengthening, increasing the number of retirees receiving these benefits. In states like California, recent changes in public pension systems have increased incentives for public employees to retire earlier, further contributing to an increase in the number of retirees receiving health benefits.

Historically, nearly all governments have paid for health benefits for their retired employees on a pay-as-you-go basis each year. Generally, no funds have been set aside to address future benefit obligations. For governments, however, when retiree health costs rise faster than tax revenues, a larger and larger percentage of governmental revenues must be devoted to providing retiree health benefits. This means that less money is available to provide services to the public and to pay current governmental employees.

3.  What is GASB 45?

The Governmental Accounting Standards Board (GASB) is a non-profit entity that sets accounting standards for state and local governments in the United States. GASB is similar to the professional boards that set accounting standards for private sector entities and the federal government.

Under GASB 45, at some point during the next few years, governmental entities will be required to release financial statements that include an actuarial valuation of unfunded retiree health liabilities. The GASB Statement 45 is an accounting standard, not a legal requirement for governments to change anything about current public retiree health benefits or their funding. Nevertheless, under state and local laws, as well as bond agreements, most governments must release financial statements that comply with GASB rules, such as GASB 45, each year.

The provisions of GASB Statement 45 took effect at the start of 2007. Over the next several years, state and local governments must compile data about their retiree health and similar benefits and have an actuary calculate the unfunded liabilities that have accrued to provide those benefits to current and future retirees. Governments already collect such information for their pension systems.

4.  What is an unfunded liability?

An unfunded liability exists when a governmental or corporate entity has an obligation to provide payments or benefits to groups of individuals, but has set aside no money to fund that obligation. Unfunded liabilities for retirement systems are estimated by actuaries. Actuaries make assumptions about a pension system's investment returns, the life expectancy of public employees, and future public employee salary increases to estimate the future costs of benefits that have been earned by current and past public employees. Simply, the unfunded liability is the amount of extra money that would need to be set aside today and invested by the pension system to cover the future costs of all promised benefits earned to date by members of that pension system.

Under GASB 45, for the first time, governments will calculate unfunded retiree health liabilities. Because most governments have never set aside any funds to address future retiree health obligations, the unfunded liabilities could potentially be huge, but will vary greatly from entity to entity, depending on benefit structures, demographics, and other circumstances unique to each entity.

5.  What is required to comply with GASB 45?

The new accounting rule dramatically increases the amount and quality of information included in government financial reports with respect to retiree health and other retiree benefits. Local entities, working with their accountants and actuaries, must take a series of steps that include quantifying the unfunded liabilities associated with retiree health benefits. Results of the actuarial valuations must be reported in government audits and updated regularly. The accounting standard sets deadlines requiring large governments to comply beginning with release of their 2007-08 financial reports. Smaller governments will implement GASB 45 in the following two years.

Under GASB 45, government financial statements will list an actuarially determined amount known as an annual required contribution, or ARC. This contribution, with regard to health and related benefits, is comprised of the following two costs:

The normal cost is the amount that needs to be set aside in order to fund future retiree health benefits earned in the current year.

The unfunded liability cost is the amount needed to pay off existing unfunded retiree health liabilities over a period of no longer than 30 years.

6.  How does the retiree healthcare issue relate to pensions?

Retiree health benefits, like pension benefits, are a form of deferred compensation, or compensation earned by employees during their working years, but paid to individuals after they retire. Pension systems typically are funded by governments paying normal costs each year, as employees earn this type of deferred compensation, and the funds are invested so that they generate returns and grow until required to be paid to the employees after retirement. This is known as “pre-funding,” and pension accounting standards focus on how well retirement systems are pre-funded.

To the extent that funds set aside each year (with assumed, future investment earnings) are insufficient to cover projected benefit costs, the system has an “unfunded liability.” Retiree health programs will now have accounting standards that are very similar. GASB 45 will result in calculation of an unfunded liability for retiree health programs similar to the comparable figure for pension systems.

The liabilities for retiree health benefits, like those for pension systems, will be determined by actuaries and accountants based on certain assumptions of future health care cost inflation, retiree mortality, and investment returns. This unfunded liability can be characterized as an amount which, if invested today, would be sufficient (with future investment returns) to cover the future costs of all retiree health benefits already earned by current and past employees.

7.  What are the generational considerations?

Retiree health benefits, like salaries, are earned during an employee’s working years. The benefits, however, are paid out after retirement. Unless enough funds (with assumed, future investment earnings) are set aside to cover normal costs of benefits while an employee is working, future taxpayers will pay all or a part of the costs of the employee’s healthcare after retirement.

For example, take a state employee earning a $25,000 salary in 1985. In addition to this salary compensation, the employee was promised in 1985 that the state would pay 100 percent of his or her health benefits during retirement (if the employee worked at least 20 years). The state, however, did not set aside any funds for those future health costs in 1985 or in any year thereafter. If that employee retires this year, taxpayers of today and the future must pay about $5,000 per year for the employee’s retirement health costs.

While these benefits were earned by the prior generation of taxpayers, the current generation of taxpayers will bear the financial burden of paying for them. In the same way, today’s state workforce is earning future retirement health benefits. Unless money is set aside for future costs, the next generation of taxpayers will be left paying this bill. Because healthcare costs are rising, public employers are offering new incentives to retire earlier, and retirees are living longer than ever before, the future costs will be much higher than the current $5,000 per year. In this way, each generation shifts a growing liability to the next generation.

8.  What can governments do about retiree health costs?

Under GASB 45, many governments may report large unfunded retiree health liabilities. Left unfunded, these liabilities may continue to result in rapidly growing costs each year and could eventually impact bond ratings. Over time, addressing the costs of these liabilities will tend to consume a larger and larger percentage of governmental revenues.

There are three basic approaches governments can take to address retiree health liabilities. Governments can either:

1. Continue to pay-as-you-go

2. Set aside money in a tax-advantaged trust in order to address part or all of the future costs of retiree health benefits (i.e. “pre-funding")

3. Change retiree health benefits in some way so as to reduce future costs.

Because of the sensitive nature of employee benefits, many public entities will face tough choices in the coming months and years. Eliminating retiree health liabilities, for example, may require setting aside large amounts of money or implementing large cuts in benefits for some or all retirees.

9.  What has been the private sector experience with retiree health liabilities?

The private sector has seen a sharp decline in retiree health coverage. Since corporations began to account for retiree health liabilities in 1990 (due to a change in business accounting standards), investors have pressured them either to fund the liabilities or drop the benefits altogether. The percentage of large private U.S. firms offering health benefits to retirees has dropped from about 66 percent in 1988 to about 33 percent in 2005.

Even companies continuing to offer benefits have cut costs in some cases by: imposing caps on the amount they will pay toward retiree health care; increasing co-payments, deductibles, and drug costs paid by retirees; aggressively bargaining with health insurers and providers; and making many other changes. Companies also may seek bankruptcy protection to restructure retirement benefits. (Local governments and school districts also can do this under state law.)

General Motors Corporation (GM), the second largest purchaser of employer health benefits in the United States, ranks behind the U.S. government and ahead of CalPERS (the third largest purchaser). As of September 2004, GM reported in financial statements that its unfunded retiree health and related liabilities exceeded $61 billion. Retiree health expenses add significantly to the costs of GM cars and trucks and are believed to have contributed to a decline in the company’s finances. Ratings of GM bonds have dropped to junk status, and some have speculated that a bankruptcy filing may be inevitable.

In October 2005, GM and the United Auto Workers (UAW) reached agreement to cut retiree health liabilities by $15 billion. The company agreed to start a new defined contribution health plan to offset other reductions in the health benefits provided to retired workers. While UAW’s rank-and-file employees approved the agreement, implementation awaits a U.S. District Court review of objections from retirees claiming that UAW lacks the authority to negotiate concessions of retiree health benefits. The retirees are claiming the benefits are contractual rights.

Have more questions?

For further information you can contact:

Maureen Toal, Vice President - Public Affairs
(800) 540-6369 x 135
mtoal@pars.org.