Strategies to consider as OPEB costs escalate.

• Author: Miller, Girard

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"If I could figure out how to portray OPEB in a costume, I would go as unfunded OPEB to my next Halloween party. I can't think of anything scarier."

--Phil Moore, city manager, Alma, Michigan

Six years have passed since the Governmental Accounting Standards Board (GASB) issued its Statement No. 45, Accounting and Financial Reporting by Employers for Postemployment Benefits Other Than Pensions. During that period, many state and local governments have done little to address their retiree medical liabilities and cost structures. Their escalating unfunded liabilities are shown in the footnotes to their financial statements, but their management teams, and elected officials, have generally not mitigated costs or proactively managed the liabilities downward. As a result, the national total of unfunded liabilities for these benefits alone is approaching $2 trillion in 2011, dwarfing the "public pension problem" that captured national media headlines last year.

Not every governmental employer has a problem with other postemployment benefits (OPEB), but many do. Ironically, the only generalizations that can honestly be made about OPEB plans nationwide is that they are not homogeneous and they defy generalization. Anecdotally, only about a half of all state and municipal employees receive significant lifetime retiree medical benefits before reaching Medicare age. A substantial number of this subset receives generous benefits, while at the other end of the spectrum, many public-sector employers provide little or no financial assistance to help their retirees defray medical expenses, beyond the implicit subsidy of providing access to their group insurance plans at the same premiums paid by active employees.

MISTAKES OF THE PAST

In retrospect, the most common managerial and leadership error of "complacently generous" governmental employers was their failure to begin fully funding their OPEB benefits immediately after GASB issued Statement No. 45. Instead of reining in their benefits when the numbers arrived at their doorstep, most made no changes and continued expanding their payrolls with additional employees. Headcounts increased all the way into the first nine months of the Great Recession that began in December 2007. As revenues thereafter plummeted, governments laid off employees, declared furloughs, cut services, and further deferred funding of retiree medical benefits. In addition, the unfunded liabilities of the nation's public pension funds doubled during the 2007-10 period, making matters more complicated as financial markets tumbled and recovered only two-thirds of their market losses in the ensuing economic recovery.

As a previous Government Finance Review article explained, (1) governments that are experiencing OPEB (and pension) funding problems should not expect those problems to be solved by economic growth alone in this decade. The Great Recession brought the worst percentage decreases in economic activity, production, employment, and equity (stock and real estate) market levels since the Great Depression of the 1930s, which lingered for more than a decade. With real property values in many states down significantly, markets suffering a long pipeline of underwater home mortgages that are heading toward foreclosure, and unemployment stubbornly high, given corporate reluctance to expand production in the face of excessive capacity, there is no reason to expect rapid revenue growth any time soon. Tax revenues will eventually recover from depressed levels, but nobody expects a nationwide return to 2007 levels, adjusted for inflation, for another three or four years. Meanwhile, retiree medical costs continue to escalate far faster than general inflation, governmental revenues, and the investment returns on general fund assets. The hole keeps getting deeper for jurisdictions that have procrastinated.

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In this context, many public managers and elected officials need to confront the realization that their governments cannot afford the benefits promises made to public employees in the past. OPEB costs under pay-as-you-go financing will automatically double in this decade--and ultimately quadruple, or worse. Actuarially, most unfunded employer contributions for OPEB plans should be doubled immediately just to put plans on a track toward eventually achieving a proper financial footing. For employers with high retiree medical insurance cost structures, extremely underfunded pension plans, and tax limitations (either because of law, natural economic limits, or taxpayer rebellion), the most likely scenario for this decade will be multi-year hiring freezes and virtually no salary increases.

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The answer for most private-sector CFOs was to jettison their OPEB plans quickly after the...