August 18, 2006
How States Can Handle Pension and Health Care Costs as Baby Boomers Retire
By Joe White
Nashville Bureau for NCSL
NASHVILLE – It’s a gritty choice, agreed backers of old-style and new-style pension plans: As the Baby Boomers near retirement, legislators face the thankless chore of deciding between cutting back benefits or cutting back employer contributions.
A panel of experts fielded questions from concerned lawmakers during the State Retiree Liabilities: Pensions and Retiree Health Care special briefing at the National Conference of State Legislatures' 2006 Annual Meeting. In a hurried two hours, decision makers heard from:
Robert D. Klausner, principal in Klausner & Klausner, representing public employee pension funds since he left government service in 1979.
Kathleen Harm, senior adviser to ICMA Retirement Corp., a private nonprofit administrator of public retirement system and author of A Public Employee’s Guide to Retirement Planning.
Daniel Clifton, executive director of the American Shareholders Association and chief economist for Americans for Tax Reform.
Keith Brainard, director of research for the National Association of State Retirement Administrators.
Clifton and Brainard were the main jousters, each nailing down arguments for (Clifton) and against (Brainard) changing public employee retirement plans to a “defined contribution” system. (see sidebar)
Despite their contention with each other, Clifton said near the end of the session, “Keith and I are getting closer together than it appears … it’s not a right-wing, left-wing sort of thing.”
Clifton argued that more public pension plans are moving to a blended system with some characteristics of a defined benefit system and some with defined contributions. He said, “We often hear this is a strategy of right-wing crazies,” but he argued instead that the move to defined contributions was a response by governors and legislators to “adapt to reality.”
Of the 10 recent shifts in state plan design, eight of them were to a defined contribution structure from a previously defined benefits system, Clifton said. Among the drawbacks of traditional defined benefit plans, he said, is a “perverse incentive” to increase future benefits to public employees without securing the funding for it. Demographics enhance the problem, he said. Public employees, for instance, are on average older than private sector employees. One advantage of defined contributions, he said, is that the employee’s account becomes portable and can travel from one job to the next with the worker.
The traditional defined benefit plan, which protects the employee from investment risk is still offered by about half the Fortune 500 companies, said Brainard. “They continue to operate open, defined benefit plans and some are in pretty good shape,” he said. Currently, despite allegations of impending doom, the public plans overall are funded at about 86 percent of the aggregate actuarial liability. “They have $2.8 trillion in assets,” he said, “and about $400 billion in unfunded liability.”
(Some companies are doing better than others; Kathleen Harm, of ICMA Retirement Corp, noted that Starbucks pays more for health care than for coffee beans, and General Motors finds the cost of a new Chevy has more pension contribution in it than steel.)
But regardless, Brainard said, most public systems offering the more generous defined benefit plan are in good shape. The relatively generous public retirement plans have in the past, he said, offset generally lower pay for state employees. Where they are less than 70 percent actuarially funded, it is generally the fault of the local legislative decision makers, who have failed to make required contributions to the plan, he said. Taken as a whole, he said, the systems are in far better shape actuarially than the U.S. Social Security system.
Klausner led off talking about the underpinning of state pension systems: the “contract clause” of the Constitution, which allows the state to obligate itself like any other corporation. “The issue of retirement is the largest liability” of a government, Klausner said. “Retirement law is well-settled about the obligation of government in a pension plan. In every state it’s an absolute first dollar claim” against revenues, he said.
Different states have different systems but each must abide by its own agreements, he said. In Alaska, a state employee is covered from his first day; other states do not consider themselves bound until retirement day.
State supreme courts have unanimously protected the pension plans for employees. Some states are actuarially out of joint with their obligations but are voting annual “make-up” appropriations to cover the shortfall, he said. “And there are some municipal plans in this country that have predictable dates of dissolution,” Klausner said.
Courts have not been so clear-cut on protecting retirees’ rights to continued health care, he said. Different federal district courts have held different opinions. The issue is unsettled until the U.S. Supreme Court takes it up.
Health insurance plans vary by year. “The science changes daily, and so do insurance benefits,” he said. “They don’t cover leeches anymore but do cover reconstructive surgery for women who have had a mastectomy,” he said. “Has your constitutional right to the [health] benefit been abridged if the deductible goes up?” In the highly defined Alaska state plan, he said, health care benefits are not held to be unchangeable.
Of the nine or 10 states who have considered the issue, “none has found health care to be sacrosanct,” Klausner said. Health care benefits are “not permanent, not vested and can be repealed,” he said. “Pensions are fairly well settled. … But health care: the last chapter in that book is yet to be written.”
Kathleen Harm, a 22-year veteran of the public employee retirement business, said these pressures on the health care part of the system make up a “perfect storm”:
- The Medicare system is approaching ‘bankruptcy;’
- Health care costs are increasing faster than inflation;
- The population is getting older, and living in retirement longer; and
- Accounting standards and changes in coverage are occurring.
The last point addresses GASB 106 and GASB 45, two new financial accounting standards for private businesses and for government, respectively, that will force employers to recognize the actuarial cost of a future health care provision just as they do future pension liabilities.
Harm said states’ unfunded liability for retiree health benefits runs the gamut, from California's $70 billion to Rhode Island's $630 million. Actual recognition (and publishing) of “other post employment benefits,” or “OPEB,” will result in increased public scrutiny by media and taxpayers, credit downgrades of state bonds in some instances, leading to an increased cost of borrowing—and it will certainly lead to changes in benefit design, she said.
Facing this new recognition of liability, required by the new financial accounting standards, states will be tempted to do nothing, she said. More active choices will be to:
- Raise taxes, cut services, and use “excess” funds to pre-fund those liabilities;
- Establish a retiree health care trust fund;
- Issue obligation bonds for other post employment benefits;
- Revise the benefit structure by increasing retiree cost sharing, decreasing medical benefits, imposing a stricter vesting schedule or going to a two-tiered approach.
###
This summary is provided for information purposes only. NCSL does not endorse any views it contains. |
