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Year in Review: Retiree health care costs are a hidden $17 billion pension bomb

By   /   December 25, 2012  /   No Comments

By Eric Boehm | PA Independent

Editor’s Note: This story appears today as part of the PA Independent’s Year in Review series. This week, we will re-post several of our top stories from 2012. The article below was originally published on June 22, 2012.

HARRISBURG — Pennsylvania is just starting to come to terms with a $40 billion unfunded pension liability, but lurking in the background is a $17 billion liability for retiree health care.

Even worse, the state has only put away 1 percent of the money needed to cover the health costs.

Instead of trying to fund the accounts ahead of time, as they do with pensions, the state handles these costs on a pay-as-you-go system directly from the budget, which should concern both state workers and taxpayers, said James McAneny, executive director of the state Public Employees Retirement Commission, which reviews and audits state and municipal pension plans.

“It’s another one of those benefits that people wanted to promise without having a way to pay for it,” he said.

These other post-employment benefits — referred to as “OPEB” by pension gurus — are available to any state employee who has worked in the system for at least 20 years, allowing them to continue to collect the same health benefits during their retirement they got while working.  Public school teachers have similar programs that are governed by local collective bargaining agreements with school districts.

Pennsylvania’s $17 billion liability — which was reported in a new analysis from the Pew Center on the States, a national public policy think tank — fails to include the costs of retiree health care at the municipal level.

McAneny estimates that another $5 billion in liabilities exist there, mostly in Philadelphia and Pittsburgh, which have the state’s largest contingent of municipal public-sector workers.

Pennsylvania isn’t alone when it comes to this second pension bomb. Nationally, the picture is much the same.

David Draine, a senior researcher for the Pew Center on the States, likened some states’ pay-as-you-go approach with OPEB to a credit card holder who makes the minimum payment while continuing to run up charges on the card.

Far too many states have not responsibility managed the cost of retirement benefits, effectively running up the cost for taxpayers,” he said.

According to the Pew report, 17 states have absolutely no money set aside to pay those costs, and only seven states have at least 25 percent of their retiree health-care costs covered.

Unlike pension funds, which contain an investment component along with the contributions from state workers and from taxpayers, the OPEB accounts are funded directly from state budget — meaning no investment component exists to help defray the costs.

Experts agree that even amazing investment returns over the next decade will not save Pennsylvania and other states from facing mounting costs in their underfunded pension plans, but solid returns from investments will help to offset at least some of the cost.

Not so with OPEB, which gets only contributions from workers, with taxpayer dollars filling in the rest.

The state has set aside virtually no money to pay for those benefits, which leaves nothing to take the edge off the $17 billion liability.

Health-care costs account for the much of the expenses contained in OPEB, so the figure is likely to rise as the number of retirees in the system grows.

State workers with more than 20 years of service qualify for the benefits, and contribute 5 percent of their pay toward the cost. In return, workers are able to retain full health-care benefits from the time they retire until age 65, at which point the benefits decrease and become a supplemental Medicare benefit that continues for the rest of their lives.

Rick Dreyfuss, a retired actuary and pension expert for the Commonwealth Foundation, a free market think tank here, said part of the problem is that workers’ contributions are based on their level of pay rather than the cost of the benefits they will receive.

“You just don’t see that in the private sector,” Dreyfuss said.

There, workers make contributions toward health insurance as a percentage of the cost of the benefits they will receive.

The other problem, Dreyfuss said, is the state has not even made an attempt to set aside funds to pay their share of the retirees’ health care.

If the benefits are earned by workers during their careers and awarded during retirement — as pensions are — then the state should have some obligation to contribute to the cost of those benefits so workers can know they will receive the promised benefits at retirement.

In Pennsylvania’s pay-as-you-go OPEB system, those costs are paid on an annual basis as part of payroll, which is handled by the state Office of Administration.

While taxpayers need to be aware of this secret cost-driver that will hit both state and local budgets in coming years, state workers should also have cause to be concerned, because OPEB benefits may not be protected in the same way as are pension promises.

“They don’t have nearly the same legal protections that pension benefits have,” Dreyfuss warned.

Theoretically, for now, the state could decide to simply flip the switch tomorrow and end those benefits without paying the obligation, as long as the courts agree.

For now, it’s not clear if they do, McAneny said.

“There’s a mixed bag of lower court decisions out there,” he said. “The legal protections are still very unsettled.”

Draine said policy makers nationwide are starting to realize they have to address the cost of retiree health care, in addition to the traditional pension liabilities.

The pain will certainly be greater for states that have a history of kicking the can down the road on funding these promises,” he said.

Lawmakers in Harrisburg are gearing up to reform the state pension systems sometimes in the next year, as the $40 billion unfunded liability starts to hit home in state and school district budgets.

But the looming OPEB issue is still off their radar.

State Rep. Glenn Grell, R-Cumberland, who sits on the board of the state’s Public School Employees Retirement System, told PA Independent this week the focus for now is on the main pension liability, but the extra OPEB costs are another reason the state must spend prudently.

The important part for this budget cycle is that we not spend every cent that we may have, knowing that those issues have to be dealt with in the next fiscal year,” he said.

Grell predicted a “concerted effort” in July and August to try to focus on long-term pension reform in the General Assembly.