Facing the Challenge of Retiree Health Care: Liabilities and Responses of State and Local Governments-A conference summary

Chicago Fed Letter, May 2008 by Mattoon, Richard H

Martinez described a two-part strategy for meeting the CPS's pension and OPEB commitments. The system continues to fund its pension liability, but it is using a pay-as-you-go method for its OPEB liability. The real cost driver for OPEB is retirees under the age of 65 (who are not qualified for Medicare), and this population is growing by roughly 1,500 per year. Another problem is proposed state legislation that will add to the cost of both pension and health care plans. Martinez said that the system is always fighting a defensive battle to prevent plan expansions that are granted by the state legislature. Another significant driver is the shifting state cap for retiree health care costs. Under the current statute, retiree health care costs are capped at $65 million. However, in practice, the legislature has raised this cap frequently, and a goal of the CPS is to see that the cap is maintained. Based on current projections, the CPS will reach the $65 million cap in fiscal year 2008. Finally, finding efficiencies for the retiree health plan will be an important component in funding OPEB.

Brian Caputo, director of finance, City of Aurora, IL, described the city's experience in attempting to meet its OPEB liability. The city has a population of 170,000, a $400 million annual budget, and 1,000 employees. Aurora began implementing GASB statement No. 45 at the end of 2004. It chose to implement the GASB standards early in an effort to promote good financial management and to provide a clearer financial picture to aldermen, the mayor, and the city's unions. The city even developed a cost simulation model in an effort to forecast what policy changes would do to the city's future finances.

Aurora has taken an active role in working with its actuary. It has provided participant data, as well as cost and contribution data. In addition, the city adopted an investment return assumption of 3.25% for 2005 and 2006 and increased it to 7% for 2007 and afterward. Aurora also developed a health care cost inflation trend measure, starting at 10% for 2005 and forecasted to fall gradually to 8% for 2009 and afterward.

Aurora's unfunded liability for OPEB as of December 31, 2006, totals $183.6 million. The ARC for Aurora is $18.5 million in 2008, and this compares with the current pay-as-you-go costs of $4 million. However, if the city fails to pay at the ARC, the pay-as-you-go cost will rapidly accelerate. In response, the city has set up an OPEB trust. The trust's board includes both city officials and retired employees. The board has a limited focus that includes receiving city and retiree contributions, investing money on hand, and paying claims. The board can also hire an investment manager or consultant.

Caputo concluded that it will be necessary to ramp up contributions to fund OPEB and that this will also have a significant impact on government operations, given the magnitude of the unfunded liability. Issuing OPEB bonds could provide some immediate relief, but Caputo stated that doing so might also strain other capital needs of the city; the city government would need to explore such options in the context of its realistic bonding capacity.