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Think Tank

How Should California Pay for Retiree Health Benefits?

The specter of retiree health care benefits looms large in many states. To entice employees, many states have promised to pay or help pay health care premiums after the worker has retired. Two trends — rising health premiums and long-lived baby boomers moving into retirement years — threaten to make those promises backfire.

California’s overall unfunded obligation — about $1,400 annually per capita, according to some estimates — is in the lower half of state IOUs for health coverage. Some state obligations for unfunded health premiums are as high as $8,000 per capita. But because of California’s large population, the overall obligation is considerable, and the prospect of paying those premiums poses a serious obstacle for state government.

California has a number of options, including reducing or reneging on benefits, raising taxes, cutting spending elsewhere, earmarking surplus money for unfunded health premiums, issuing bonds and doing nothing.

We asked several stakeholders how California should deal with its retiree health care obligations. We got responses from:

Three groups with considerable stakes in the issue declined to participate:

  • Gov. Arnold Schwarzenegger’s (R) office;
  • CalPERS; and
  • SEIU Local 1000, a labor union representing about 95,000 California state employees.

Don’t Count on National Health Reform

Elizabeth Kellar
President, CEO, Center for State and Local Government Excellence

It could be called the perfect storm:  just when the national economy took a deep dive, a large segment of our aging public-sector work force is reaching retirement age.  Unlike some states where aging state and local government workers have postponed retirement, in California, more people have exercised their option to retire.

Retiree health care benefits are important to recruiting and retaining employees, according to research and polling by the Center for State and Local Government Excellence. So, California, like other states, will want to continue to offer this benefit, even as it is challenged to fund it. 

One step in the right direction is that CalPERS has established a trust fund, the largest in the U.S., to help pay for its retiree health obligations. 

With health care costs rising faster than inflation, California governments will need to keep looking at options to cut costs, contain costs and share costs.  The Center’s July 2009 study, “At the Crossroads: the Financing and Future of Health Benefits for State and Local Government Retirees,” found that three states have increased the age at which benefits are available, while seven states have increased the years required to vest in the state system.  Sixteen states say they are likely to increase the years of service required to vest.

It is a tough time to be a politician as there are no easy solutions.  No one wants to raise taxes or reduce employee compensation.  Keeping promises to retirees and to those who plan to retire soon is important.  And remaining competitive with other employers and fair to newly hired public servants is equally compelling. 

Will national health care reform be the magic wand that eliminates this political and financial challenge for state and local governments? 

Probably not.  In fact, I would argue that state and local governments may be better positioned to lead some of the health care reforms.  The best managed state and local governments have, in fact, been model employers.  They have been leaders in finding ways to save health care costs through rigorously structured wellness programs, disease management and care coordination.

We’re a society that wants instant solutions, but the times call for discipline and a measured pace to deal with our financial challenges.

Stage Set for Broken Promises

Marcia Fritz
President, California Foundation for Fiscal Responsibility

According to the governor’s post-employment benefits commission, the unfunded liability for retiree health promises for California’s public-sector workers exceeded $120 billion in 2007, which was roughly $9,000 per household.  This is a staggering debt considering that it is growing each day as workers retire and health costs continue to skyrocket. 

Until recently, less than a quarter of government agencies were prefunding this obligation. More than three out of four (78%) have nothing set aside and are facing enormous costs as baby boomers retire years before they qualify for Medicare.

Some larger agencies, such as Metropolitan Department of Water of Southern California and Los Angeles Unified School District, provide full retiree health benefits for workers and their dependents after only five years of service.  Those who left their jobs years ago will find that the value of their retiree health benefits far exceeds their pension when they retire.

It is unconscionable for an agency to promise retiree health care without funding that promise while the employee is working.  To expect the next generation to pick up a debt and receive nothing in return is disingenuous.  City managers, school superintendents and others must get real and level with their employees and retirees.  Employees, retirees and their union negotiated pay and benefit packages for many years with officials they helped to elect.

Both sides should have insisted that retiree health promises be prefunded as part of those packages.  Wages and other benefits would have been lower as a result — there is only so much pie to go around — but it would have been the right thing to do morally.  The “someone else will figure it out” can kicking must stop — NOW.  If retiree health benefit funding can’t be carved out of labor agreements, then both sides should realize they are setting themselves up for a broken promise.

Pressure Affects Medi-Cal, Healthy Families

Former Assembly member Keith Richman (R-Granada Hills)

The financial burdens of retiree health benefits and pension benefits are going to impact the state of California and local governments throughout the state for decades to come.  The unfunded liabilities for public employee pensions and retiree health care exceed $200 billion throughout California.

So, the fundamental question to ask is: “What is the impact going to be on state and local government budgets, and how is that going to impact their ability to provide services other than retirement benefits?”

There is no question that the retirement costs for public employees is one of the biggest, if not the biggest, fiscal issue facing government entities in California. Throughout the state, cities and counties are currently paying about 15-20% of their operating budgets toward pension costs alone. This is expected to grow to between 20% to 25% of budgets within the next couple of years because of the drop in asset value in the pension plans.

The state contribution for state employee pensions has grown from $160 million in 2001 to $3.4 billion this year and is predicted to grow to about $5 billion in annual contributions in the next couple of years. This does not include the costs of retiree health care, which have generally not been prefunded, but are routinely paid for on a “pay-as-you-go method.”

The estimates for state employees’ unfunded retiree health care costs are around $50 billion and this assumes a low inflation rate in health care of 4% in future years. Many experts think that the unfunded liability for retiree health for state workers is closer to $100 billion and might require as much as $4 billion to $5 billion per year.

One of the most egregious examples of the impact of retiree health benefit costs is the Los Angeles Unified School District. The school district estimated its unfunded liabilities for retiree health costs exceed $10 billion and will require 18% of its entire budget on an ongoing basis to pay off over the next 30 years.

In combination with its pension obligations, it is likely the district will be paying about one-third of its total budget for retirement benefits. The “Three R’s” have now become reading, writing, and retirement benefits.

With the state likely to have pension and retiree health costs of close to $8 billion annually, there is certainly going to be ongoing pressure on other services funded by the state budget, such as Medi-Cal and Healthy Families. The $8 billion estimate is approximately 10% of the current state budget. Unless changes are made in the public employee retirement system, these fiscal pressures will continue for decades to come.