For many public agencies, retiree health care benefits have historically been funded on a Pay-As-You-Go (PayGo) basis—paying annual costs as they come due.
While this approach may seem manageable in the short term, rising health care costs and an aging workforce are making PayGo increasingly risky for local governments and educational entities nationwide.
Key Risks of the PayGo Approach
- Budget Pressures
Rather than reducing the liability, PayGo simply defers it—leaving agencies exposed to year-over-year cost volatility, increased pressure on annual budgets, and no dedicated funding source to absorb unexpected increases. Over time, this can strain cash flow and limit fiscal flexibility when it is needed most. - Financial Reporting Consequences
From a balance sheet standpoint, PayGo can significantly magnify reported other post-employment benefits (OPEB) liabilities. Without prefunding, accounting rules require the use of the 20-year municipal bond rate as the discount rate—often resulting in higher reported liabilities in addition to greater annual financial statement volatility due to bond market fluctuations. - Missed Investment Opportunity
Without a dedicated Section 115 trust, assets remain restricted to General Fund investment options. This eliminates the opportunity to benefit from diversified capital market investments that could help offset rising health care costs over the long-term. - Shifting the Burden
Continuing to defer OPEB costs shifts the financial burden to future taxpayers and employees. As liabilities compound, agencies may be forced to scale back benefits or divert funding away from essential services to meet retiree health care obligations.
Prefunding OPEB liabilities through a Section 115 trust offers a more sustainable path forward.
Recognized by the Government Finance Officers Association (GFOA) as a best practice, a trust allows agencies to set aside and prudently invest assets specifically for future benefits to help stabilize budgets, reduce long-term liabilities, and improve overall financial sustainability.
While prefunding requires some initial budget planning, the long-term payoff is clear. Proactive action today can help protect fiscal health for years to come.
Learn how establishing a Section 115 trust can help your agency move beyond Pay-As-You-Go and toward a more sustainable OPEB funding strategy.