For retirees who have attained age 65, this zero-premium actuarial alchemy is the result of a decade of negotiations between Medicare officials and national health-care systems that offer discounted in-network pricing in exchange for a massive captive patient base. It’s essentially the HMO-like model that enables Medicare trustees to suppress costs for covered services by granting semi-exclusive franchises to the participating networks, which in turn guarantee a billable patient flow to their in-network health-care providers.
The good news from this evolution is that the Medicare system is now in slightly better financial shape than previously feared, in part because of efficiencies that resulted from the 2010 Affordable Care Act and these cost-containing Medicare Advantage networks. And therein lies an opportunity for state and local retirement systems to move toward more sustainable retiree medical benefits.
For background, let’s step back to the turn-of-the-21st-century era, when the hidden costs of governmental retirement health-care promises first caught the national attention of the public finance community. The accounting buzzword then was OPEB — “Other Post-Employment Benefits” (i.e., not pensions).
Back then, basic Medicare coverage was available to public employees, of course, but today’s supplemental insurance deals for Medicare beneficiaries were not so prevalent. Today, these individual policies offer a legitimate alternative to group insurance for retirees. Yet over the two ensuing decades, many public employers have failed to adjust their retirement benefits programs to sync their promises with modern insurance industry practices and — importantly, at the same time— increased life expectancy.
Given that the Medicare trust funds are still expected to be depleted in just eight years under current funding schemes, I certainly don’t think it wise to erect a future benefits program on quicksand. But some kind of integration with the modern Medicare benefits schema is worth exploring, at least for starters. Certainly it’s now time to “rethink” OPEB, to borrow the latest buzzword now fashionable in government finance circles. Alternative strategies and plan designs are right there in front of us. Some public employers began migrating to this idea about five years ago, and the economics of private insurance workarounds have since become even more favorable.
The original idea of medical care benefits for public-sector retirees essentially had two parts: (1) a supplement to their Medicare benefits for age-qualified retirees so they could afford to make co-payments and cover deductibles from their then-frugal pensions, and (2) the far more costly promise to continue health insurance benefits to public servants who retire before age 65. The former concept is almost trivial nowadays in light of the in-network pricing that’s available to practically everybody over age 65, so that doesn’t need to be a budget-buster. But the costs of covering ever-escalating health insurance premiums for employees who retire before age 65 definitely need rethinking.
The Early Retirement Conundrum
The design of public employee pension plans is partly the problem. Most of them were formulated and then redesigned over the last century to offer full retirement benefits to civilian workers after 30 years of service regardless of age. For police and firefighters, and sometimes highway maintenance workers and others performing hard manual labor, a lower age and service requirement was hard-wired into pension eligibility. Putting aside union pressures and politics, the rationale for earlier full retirement benefits for these “outdoor workers” was that nobody wants to have a frail 60-year-old firefighter show up to climb tall ladders up to a blazing apartment, nor feeble cops chasing down menacing thugs. Likewise, we all remember the dithering elderly schoolteacher we had in junior high who was totally out of touch with teenagers.
Social Security allows early retirement with reduced benefits at age 62 for a similar reason, but many public pension funds took that compassionate idea to an unaffordable extreme, without reducing the benefits for early retirees. These became an entitlement, especially in union shops.
I knew trouble lay ahead when I was a city finance director in the late 1970s and the police locker rooms were plastered with union stickers pitching “20 and out” as collective-bargaining demands. With police and fire rookies starting their careers in their early 20s, it didn’t take a genius to realize that such math was going to be an actuarial disaster, as it has proven to be.
But it only got worse when the expectation later developed that full pension retirement benefits in one’s 50s, commonly enhanced with cost-of-living adjustments, should be accompanied by a generous health insurance benefit as an extra entitlement. Never mind that those retiree medical benefits were never funded actuarially; back then it was just a handful of public safety retirees and teachers, after all. Nobody would notice the budget impact — which later proved to be just the tip of the iceberg.
Let’s flash forward to today. We’re all told that “60 is the new 50,” and most baby boomers will agree that they expect to live much longer than their parents on average and are in better shape. Walk into a firehouse nowadays, and odds are you’ll see a nice gym, and the kitchen menu is not beef chili and burgers but healthier foods than civilians eat at Mickey D’s. This doesn’t mean that taxpayers and elected officials should expect our entire public safety workforce to continue serving beyond age 60, but we shouldn’t be giving them incentives to leave early, at the expense of younger workers whose paychecks are now crimped by the budgetary pressures caused by runaway unfunded OPEB benefits.
It's very hard to strip away a benefit from somebody who’s already retired, so let’s not even open that door. But a freeze on accumulated in-service benefits for workers under, say, age 57 — using a pro rata formula or an equitable actuarial value that takes into account each employee’s years of service and the employer’s fiscal condition — could be coupled with a modest and affordable pre-Medicare health cost stipend or tax-advantaged health-care savings account that requires a matching employee contribution based on salary, to reflect ability to pay. Those unwilling to pay a matching contribution could opt out.
Collective Bargaining Issues
Employees and their unions may gripe about “takeaways” that require a quid pro quo offset somewhere else. So let’s talk about the “quo”: The entitlement advocates need to be reminded that what they hold right now is the governmental equivalent of what in the corporate world would be called a subordinated bond — a claim that becomes worthless when other debts must be paid off first from a nearly empty barrel. Municipal bankruptcy courts have quite consistently held that an unfunded OPEB promise does not rise to the level of pensions and municipal bonds when it comes to prioritizing the obligations of an underwater employer. In fact, these benefits are dubbed “first loss” in the pecking order of some cases, and were settled for pennies on the dollar in several bankruptcies.
That principle should apply to the discount factor applying to accrued future OPEB promises of financially strapped employers. I’m not arguing for pennies, but something more like a few quarters, calibrated by each employer’s actual financial condition and the fiscal burden of these unfunded liabilities on the operating budget and the younger workforce. Another approach is to cap the duration of customary pre-Medicare retiree health insurance payments to something like one month for each year of active service, but add a retention incentive of perhaps four additional months of paid retirement health insurance for each year worked beyond age 57, to encourage early retirees to think twice about when they exit. Such a formula would bridge the coverage gap after age 62 until Medicare kicks in at age 65.
Such reforms have a secondary benefit in pension funding, as the incentives to retire later with longer career spans can only help the actuarial math for most pension systems. In some cases, those retention incentives can pay for themselves, certainly more effectively than many of the infamously overgenerous “DROP” plans concocted years ago.
Collective bargaining is usually the only feasible and fair way to solve this riddle, with a realistically negotiated exchange of fiscally viable compensation in trade for unfunded promises that once were well intended but became misguided and unaffordable. In cases where budgets are so strapped by payouts to retirees that incumbent workers are taking a haircut on their pay increases, the handwriting on the wall should be sobering enough that some employers’ obsolete age and service requirements need revision and the unaffordable monetary benefits now awarded before age 65 need to be reined in.
Realistically, in most cases collective bargaining is now the employers’ only real remedy for OPEB reform. Even where unions lack explicit powers under state law, employers who make unilateral cutbacks run the risk of lawsuits from disgruntled individuals whose lawyers can argue in a group action that they were sold down the river. Age and service differences make it very difficult for one size to fit all and for one formula to make everybody happy — or at least not angry enough to sue.
Union leaders naturally hate making such deals, because they inevitably pit the interests of their members against each other intergenerationally, but kicking the can only delays the inevitable. The perfect cannot be the enemy of the good when making a plan conversion. Finance officers may cringe, but they need to open their books and be honest about employers’ ability to pay and not get cute about any hidden financial reserves that only insiders know about.
Ever since the Governmental Accounting Standards Board opened everybody’s eyes to the shaky economics of OPEB benefits, there have been dozens of alternative benefits plans implemented, so nobody needs to invent a sensible plan out of thin air. Where unions must inherently become involved, specialized benefit plan experts and sometimes even bankruptcy attorneys must be engaged because such disputes often require court or quasi-legal proceedings under prevailing labor laws.
Just as Congress will ultimately need to raise the eligibility age for Social Security and Medicare for those born after 1962, today’s longevity math requires similar adjustments for public employees. Unfunded early retirement schemes have become unaffordable far too often. The point here is that doing nothing won’t be an option as the walls keep closing in on public employers with unsustainable OPEB plans.
Governing's opinion columns reflect the views of their authors and not necessarily those of Governing's editors or management.
Related Articles
