Underlying problems facing post-retirement medical plans in the public sector.

• Author: Kalman, Robert W.
• Position: Spotlighting Small Governments

Many public- and private-sector employers provide medical benefits for their retirees. These plans, in combination with Medicare for retirees aged 65 and older, offer important financial protection to retirees. The rate of increase in the cost and accrued liabilities of these plans has accelerated in recent years, forcing many public and private employers to begin redesigning the scope of medical benefits provided to retirees.

Economic and demographic factors that have contributed to rising retiree medical plan costs include:

* medical price inflation;

* marketplace cost shifting from Medicare, Medicaid and managed care plans;

* aging of the workforce; and

* increased life expectancy.

In response to these economic and demographic forces, many private employers have implemented managed care features in their post-retirement medical plans in an effort to slow down the rate of increase in plan costs from year to year. In addition, many private employers have reduced their future financial commitment to these plans in response to the requirements of the Financial Accounting Standards Board's (FASB) Statement of Financial Accounting Standards No. 106, Employers' Accounting for Postretirement Benefits Other Than Pensions. FASB Statement No. 106 requires private employers to report the actuarially determined annual contribution to retiree medical plans for active as well as retired employees as an expense on their financial statements. This requirement is having a substantial adverse impact on the annual net income of many private employers since these costs, usually funded on a pay-as-you-go basis, previously were recognized only during the year that benefits were paid.

Many private employers have reduced their future obligation to post-retirement medical plans by implementing a defined-dollar benefit (DDB) plan design approach, in which the employer sets a tolerable dollar-cost limit on its contributions to the retiree medical plan. Retirees and dependents must pay the balance of plan costs. In many cases, the actual employer contribution is linked to a retiree's length of service so that only a career employee with, for example, 25 or 30 years of service would receive maximum employer contributions. Using this approach, an employer's retiree medical plan obligation is fixed from year to year; future increases in employer contributions are within the employer's control.

State and local government employers also offer post-retirement medical benefits to their retirees as part of the medical plan covering active employees, as a separate plan or, as in Ohio, as part of a statewide retirement system. Public-sector post-retirement medical plans are experiencing the same dramatic increases in plan costs each year as their private-sector counterparts because they are experiencing the same adverse effects from medical price inflation and other economic and demographic forces that are driving up private-sector retiree medical plan costs.

Public employers, just like their private-sector counterparts, do not have control over outside economic and demographic forces that drive up plan costs. They do, however, have control over the design of their medical plans (i.e., the level of benefits being offered and the share of retiree contributions) and how these benefits are delivered (i.e., through a traditional indemnity program, which reimburses retirees for services rendered, or through a managed...