Next to Pensions, Retiree Health is the Second Elephant in the Room
New public agency accounting standards for unfunded retiree health and welfare benefit liabilities are unbalancing the balance sheets of numerous cities and other public agencies. Prior standards allowed simple disclosure of these liabilities without impacting the bottom line. Now, Governmental Accounting Standards Board (GASB) Statements 74 and 75 require public agencies to recognize net retiree liability for non-pension benefits (otherwise called “other postemployment benefits” or OPEB) as an expense on financial statements. If liabilities are not funded through an OPEB trust, or assets are not sufficient to pay for promised benefits, the rules apply very conservative assumptions that further magnify these liabilities.
GASB’s rules apply to fiscal years beginning after June 15, 2016, so most California public agencies had an effective date with the current fiscal year beginning July 1, 2016. The result is that retiree health and welfare benefits have created significant deficits for many local governments that have not set aside and invested funds to pay for them. OPEB obligations can grow out of control quickly, as these disturbing numbers demonstrate:
- OPEB liabilities for public agencies in California (including the state, cities, counties, courts, etc.) are approximately $160 billion; estimates show less than $8 billion has been set aside.
- 85% of California cities have OPEB liabilities.
- From 2008 to 2014 California OPEB liabilities grew approximately 42%.
Most agencies provide retiree health benefits on a “pay as you go” basis. This strategy has proven to be unsustainable and has been a leading factor in municipal bankruptcies. The GASB standards direct prefunding is the only prudent approach.
Local agencies will find that their independent auditors are more rigorous and proactive in scheduling actuarial valuations; unfunded OPEB liabilities will affect bond ratings; and they will face greater public scrutiny as public service cuts impact communities.
The implications of GASB 74/75 emphasize the urgency for prefunding OPEB obligation through a GASB-qualified trust. Prefunding reduces the net OPEB liability and permits contributions to be discounted using a more favorable, long-term expected rate of return.
Agencies have options to invest in a single or multiple employer trust. Larger entities with higher OPEB obligations can usually establish their own trust economically and optimize asset growth with equity investments. Smaller agencies that have lower tolerance for investment risk may decide a multiple employer trust model keeps their expenses down and reduces administrative burden. Agencies using either a single or multiple employer trust can mitigate employer fiduciary liability and avoid conflict of interest by allocating authority to a discretionary trustee who directs an independent investment manager.
Some local governments are working proactively to drastically reduce their non-pension retiree benefits liability, including garnering the participation of their bargaining groups to support mutually beneficial solutions. The California cities of Glendale and South Lake Tahoe have reduced their OPEB liabilities by 70 to 80 percent since 2014 by implementing alternative medical benefit exchanges for early and post-65 retirees. Wider options on the exchanges have allowed retirees to purchase coverage to better suit their situations, at a savings compared to the benefits offered by their former employer.
This article previously appeared in the USC Price School of Public Policy City/County Management Fellowship Newsletter.
About Nick Gedestad
Nick Gedestad, MBA, is an Account Executive at Keenan who has been helping public agencies with strategies to control GASB liabilities for over 5 years. You can reach Nick at firstname.lastname@example.org to find out more.