High Noon in the Accounting Department: States Confront GASB 45

HIGH NOON IN THE ACCOUNTING DEPARTMENT: STATES CONFRONT GASB 45

Volume 28, Issue 499 September 17, 2007

Matthew Gever

A new accounting rule for state and local governments is forcing them to calculate how much they’ll have to pay for the health care of future retirees. The costs will be enormous, and paying for them will be difficult.

The rule in question is Statement 45 of the Governmental Accounting Standards Board (GASB), a non-profit entity that sets accounting standards for state and local governments. Although it has no enforcement powers, many accounting and bond rating firms expect governments to follow GASB standards, which gives the group substantial power.

GASB 45—which went into effect in June—changes the accounting standards that state and local governments will use for measuring the costs of post-employment benefits other than pensions. For state governments, most of these costs will be for health care.

Currently, many state and local governments pay for retiree health-care benefits on a pay-as-you-go basis, according to an analysis of GASB 45 by the financial services firm Credit Suisse. When a state government pays for retiree benefits on this basis, it recognizes the cash going out the door and records a corresponding cost. One problem with this method is that the obligation to provide future benefits to current and retired employees is not reported anywhere in financial statements, which means the government understates its liabilities and expenses.

Under GASB 45, state governments will be required to determine actuarial accrued liability, i.e., the present value of the future benefits that have been promised to and earned by its employees. This is the first time that many of these governments will be disclosing this obligation, Credit Suisse notes.

The change is purely a reporting requirement: GASB has no authority to require that states actually make contributions to pay for promised retiree benefits.

“This is not a new liability. What is new is the requirement that governments accurately and fully disclose these commitments,” echoed New York First Deputy Comptroller Thomas Sanzillo in testimony before the Assembly.

Nevertheless, the newly revealed numbers are daunting, especially when it comes to accounting for the costs of retiree health services for retiring baby boomers. Also, workers are living longer and therefore spending more time in retirement. For example, in 1950, the average time in retirement was 11.5 years, compared to 18 years by 2003, according to the Government Accountability Office. This demographic explosion could wind up leaving states with an unfunded liability of up to $558 billion. Again, while GASB 45 requires states to disclose their liabilities, it does not require any specific actions to deal with them.

Problems in the Garden State

The amounts of underfunding will vary from state to state, Credit Suisse notes. In California, New Jersey and New York, health care and other non-pension benefits could be underfunded by more than $50 billion. In contrast, three states—Mississippi, Nebraska and Wisconsin—appear not to have any unfunded liabilities. In North Dakota and Wyoming, the estimated underfunding is less than $100 million.

New Jersey Governor John Corzine says his state has an unfunded liability for retiree health benefits approaching $80 billion. The Garden State’s debt “dwarfs every other problem in New Jersey today,” said Assemblyman Richard Merkt, who noted that the debt could lead to an extra $6 billion to $7 billion in state spending per year for the next 25 years. “If not promptly faced, it will inevitably trigger massive tax hikes, huge cuts in public service or even state bankruptcy.”

Governor Corzine has proposed a series of reforms to try to rein in the costs of retiree health, which the Legislature has taken up and passed in the form of AB 5005. Retirees currently do not pay any portion of their health-care premiums; the legislation would require retirees to contribute 1.5 percent of their base salaries toward their chosen coverage plans. Additionally, retirees would no longer be able to choose their own doctor, but would select from a network of doctors with whom the state would negotiate fees. However, retirees enrolled in preventive wellness programs would be exempt from both of these requirements.

The bill also would raise the retirement age from 55 to 60 for all new state employees. Fiscal analysts estimate that these provisions would save the state $58 million in the upcoming fiscal year, not including the impact of the wellness programs, which haven’t been created yet.

Union Power

Other states have looked to prefunding retiree benefits, which involves setting aside funds now to cover future obligations. Currently, only 13 states have such trust funds, according to Credit Suisse. In 2004, the Maryland legislature set up a trust fund (SB 548) in order to prefund retiree benefits. Ohio has so far been the most aggressive in putting away money, setting aside $12.8 billion, which will prefund 93 percent of future health-care obligations, according to Christopher DeRose, executive director of the Ohio Public Employees Retirement System (OPERS). The state also increased the expected contributions toward health premiums of employees and retirees with less than 30 years on the job. “OPERS continues to substantially prefund its health-care program,” he said.

Some private-sector firms have eliminated or significantly reduced retiree benefits in order to deal with rising future costs. For example, in 1988, 66 percent of large firms (200+ employees) offered retiree health benefits. In 2006, that percentage was down to 35, according to a study by the Kaiser Family Foundation. Unlike governments, private firms are required to prefund retiree benefits.

Some fear that governments may follow the same road and simply drop retiree benefits. However, as stated in GASB 45 itself, “as a practical matter, it is unlikely that an employer could terminate a plan to avoid the related obligation without potentially suffering adverse consequences or incurring compensating cost in some way.”

Additionally, many state and local employees are unionized, which could present a challenge if governments attempt to restructure their benefit packages. About 36 percent of government employees are unionized, compared to just over 7 percent of private industry workers, according to the Bureau of Labor Statistics, and these workers would likely challenge any benefit changes. “Governments have been managing their obligations pretty well up to now, and GASB is only asking for bookkeeping changes,” said Gerald McEntee, president of the American Federation of State, County and Municipal Employees. “So if they try to use GASB to justify cutting retiree health care, we will fight them all the way.”

For more on GASB 45, legislators and staff may access NCSL’s LegisBrief.