OPEB Report and More Reform

The Governor certainly appears to mean what he said about sprinting to the finish line. The latest reform that the Legislature will be grappling with is how to deal with the costs of retiree health care at the state and municipal level. This issue is a gigantic sword pointed at the fiscal heart of municipalities throughout the Commonwealth, with unfunded liabilities amounting to billions of dollars. With that in mind the Governor, Legislature, and stakeholders put together the OPEB Commission to deal with the issue, and make recommendations.

A good place to start might be with the obvious question: What the hell is OPEB? It is “other (than pension) post-employment benefits”. For our purposes it is the obligation of both the State of Massachusetts and its localities to provide health care to its retirees. That obligation, coupled with our “pay as you go” method for dealing with it, has left municipalities with a huge future obligation and no methodology for paying it. Some years ago the same issue existed for our pension system, which was also on a pay as you go system. That has been modified so that both the Commonwealth and localities are on a mandatory schedule set by actuarial calculation to become fully funded on pension obligations. (Yes that schedule has been fiddled with, but lets not get diverted.) Newer accounting requirements (GASB 45)now force communities to list the present value of OPEB obligations, with a calculation included called ARC (Annual Required Contribution) that is the number required to pay current obligation as well as amortizing a portion of the unfunded liability. But that is just a number to look at, since most municipalities are still on the “pay as you go”system, and no municipality (that I am aware of) is on a fully funded ARC. Is there anything to worry about here? The numbers please! From the OPEB Commission report:

In Massachusetts, the OPEB liability for state and local government amounts to approximately $46 billion- a liability larger than the unfunded pension liabilities in the Commonwealth- and budgetary spending for retiree health benefits exceeds $1 billion.

That is a substantial amount of future liability, with very little pre-funded, leaving a huge burden for future taxpayers. A study by the Massachusetts Taxpayers Foundation estimated that the top 50 cities in the Commonwealth currently pay about $500 million in retiree health care costs, and would be required, if put on a full funding schedule, to come up an additional $700 million annually. (The so called ARC payment would be $1.2 billion.) Yes you read that number right. Another number to dwell on is the Massachusetts Municipal Association estimate that between 2001 and 2010 retiree health care spending rose from 13.5% to 20% as a share of municipal budgets. (And folks wonder where, at the local level, tax dollars are going!)How about more numbers on where our money is going? From 2002 to 2009 health care costs for the 50 largest municipalities in Massachusetts grew by 85%, while property tax revenues grew by 42%. (So the next time you hear someone railing about bad budgeting and fiscal issues just lean over and say READ THE NUMBERS. It is HEALTH CARE bankrupting us, and nothing else.) And again that spending does not include ANY pre-payments to deal with the enormous unfunded liability. How did we get here, and how do we get out from under? The Commission talks about the drivers of OPEB liability, which are the loose standards for benefit eligibility, the richness of the benefit once qualified, and the spiraling cost of health care. The standards for eligibility mirror those that qualify folks for pension eligibility. So as an example a municipal employee in Group 1 may retire at age 55 after ten years of service, and would be eligible for retirement health benefits. From the Massachusetts Taxpayers Foundation Report titled “Retiree Health Care: The Brick That Broke Municipalities’ Back”:

After only 10 years of service, employees are entitled to lifetime health care benefits upon retirement.
By contrast, the pension system tailors benefits to years of service so an individual who works for 30 years receives a much greater benefit than one with 10 years of service. Retirees are eligible for health care benefits as early as age 55, 10 years before they qualify for Medicare.The state mandates that municipal employees must work only 20 hours per week to be eligible for the same benefits as full-time employees. Such part-time employees also need to have only 10 years of service to receive retiree benefits, so a part-time employee must work the equivalent of only five years of full-time service to obtain lifetime retiree health care benefits. State law requires that retiree health benefits include spouse and dependent coverage which costs more than twice as much as individual coverage. At local option, spouses retain lifetime coverage upon the death of a retiree.

So the Commission, armed with data on eligibility, costs, and huge future liabilities that will eventually crush municipalities has come forward with a set of recommendations in an attempt to at least partially right the system. Eligibility standards would be raised, with benefits varying depending on total years of service. The Massachusetts Municipal Association summarized some of those recommendations:

The governor is endorsing the commission’s recommendation that the minimum age for benefits be increased by five years (to age 60 for Group 1 retirees) and that the years-of-service requirement to receive the minimum benefit be increased by 10 years, to 20 years.

In order to recognize the accomplishment of career employees, the commission recommends pro-rating benefits based on years of service. An employee retiring after 20 years of service would receive 50 percent of the “maximum available benefit” – in other words, the health insurance premium contribution offered by the municipality would be no less than 50 percent. An employee retiring at 30 years would receive 100 percent of the “maximum available benefit.”

The commission made recommendations for two additional benchmarks, at 23 and 27 years of service.

Current retirees would be exempt from all proposed changes. The changes would apply to current and future employees unless there is a specific “grandfather” clause.

In an effort to be fair to employees who are close to retirement, the commission recommended a number of grandfathering and phase-in provisions.

Employees who are at least 50 years old with at least 20 years of service and employees who are 60 years old with nine years of service would be exempted from the reforms. Teachers enrolled in Retirement Plus, a provision implemented in 2001 that requires teachers to contribute an extra 2 percent to their pensions, would be able to retire at age 57, three years before their Group 1 colleagues, if they have hit the statutory maximum of 80 percent of their pension.

In order to recognize the impact these changes would have on future retirees, the commission recommended a three-year moratorium, beginning on Jan. 1, on changes to the premium contribution split. On average, municipalities pay 75 percent of the premium for retiree health insurance, with a minimum of 50 percent.

The commission also recommended that communities be required to cover health insurance for surviving spouses at a minimum level of 50 percent. Approximately 40 municipalities in Massachusetts don’t contribute to the premium for surviving spouses. If the additional cost of covering these surviving spouses exceeds 50 percent of the savings from the OPEB reforms, the state would cover the difference.

Lastly, the commission recommended a series of best practices and possible future reforms, including amending Chapter 32B, Section 9A1/2, which allows communities to charge back other communities for a portion of a retiree’s health insurance, to make the process easier to use; and changing procedures of the State Retirement Benefits Trust Fund to make it more accessible to municipalities.

As a best practice, the commission report recommended that municipalities periodically put retiree health insurance out to bid.

The commission, interested in the fiscal sustainability of its proposed reforms, included provisions for periodic review, using a benchmark of “sustainable spending growth.” If growth exceeds a benchmark of 4 percent for the state and 3.25 percent for municipalities, measures would kick in to help further control costs.

Back in February of 2011 the Tribune wrote an editorial talking about the dangers to municipalities of the OPEB liabilities. OPEB liabilities locally are enormous, and would require major increases in spending to satisfy a full funding schedule. From that Tribune editorial:

A more realistic, and much more painful, scenario came from Methuen Mayor William Manzi, where the city’s liability is about $210 million. He said a study showed that the city could fund its obligations in 30 years if it started by setting aside $4.3 million in 2009 and added more than $4 million every year until 2038.

Some of the OPEB liabilities of local cities:

Lowell: $432,752,000
Methuen: $209,816,000
Haverhill: $299,042
Lawrence: $323,977,000

It is a major problem, with staggering implications for local and state government. The recommendations of the Commission for these changes were endorsed by the organized labor representatives to the Board, but rejected by the Massachusetts Municipal Association. The MMA issued a statement on the recommendations:

Cities and towns are committed to providing quality health care benefits for their retired employees, and it is important to recognize that the current system must be reformed to make it sustainable and affordable for taxpayers, municipal workers, and present and future retirees. Without effective reform that provides meaningful savings now, the cost of the system will soon spiral out of control and consume a larger and larger share of local budgets, forcing cutbacks in essential services and increasing a property tax burden that is already too high.

The Massachusetts Municipal Association appreciates the initial steps toward reform that have been offered by the OPEB Commission and endorsed by Gov. Deval Patrick and others. There are many elements of the proposal that we strongly support, and we look forward to working with the administration, Legislature and all stakeholders to achieve reform this year.

We cannot endorse the full package offered by the commission for two reasons.

First, although the proponents are predicting that cities and towns could save between $9 billion and $12 billion over the next 30 years, almost all of this savings would be delayed by more than a decade. Only 5 percent of the savings would be achieved in the next 10 years, and 95 percent of the savings would not be realized until 2024 and beyond. Cities and towns cannot wait 10 years for meaningful savings – especially since municipal retiree health costs are expected to grow by at least 50 percent over the next decade. Retiree health reform must offer immediate relief, otherwise OPEB costs will expand and squeeze out education, public safety and other vital services from local budgets.

Second, the legislation would impose a three-year moratorium on any changes to the percentage contribution paid by retirees, and after that, it would permanently strip cities and towns of their existing ability to adjust the premium percentage for anyone who has already retired, even for those who receive generous pensions. This proposal would effectively eliminate the most important tool that cities and towns can use to carefully manage the cost of retiree health benefits.

Again, we applaud Gov. Patrick and the members of the commission for recognizing that Massachusetts must take steps to reform the retiree health insurance system. We look forward to working with all parties to build on the commission’s recommendations so that the final product provides communities and taxpayers with immediate and meaningful savings and provides employees and retirees with an affordable and sustainable system that provides excellent benefits.

It is likely that we will see some legislative action on the Commission recommendations this year. I anticipate more weight will be given to the Committee recommendations than to the MMA position, but it will be very interesting, especially in light of all the other heavy lifting that the Legislature is facing this session. As far as municipal finance goes there is not a more important issue.

Link to the OPEB Commission report here.

Link to the Massachusetts Taxpayers Foundation Report here.

Link to the MMA Presentation to the OPEB Commission here.

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