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State, Local Officials Face Looming Health-Care Tab
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Author, Source (14, unbold)
November 23, 2005
A looming accounting change is forcing state and local governments to fess up to something that's been lurking on their books for years: Many have made costly retirement health-care promises without planning how to pay for them.
Under a new accounting rule, governments soon must start recognizing their long-term obligations to pay for retirees' health benefits -- and, for the first time, publicly disclose what it would cost each year to fund that liability.
For many governments, the promised amount is likely to be sizeable enough to prompt big changes such as cutting retiree benefits, borrowing money and diverting tax dollars from other spending priorities -- or risk a credit-rating downgrade that could significantly boost borrowing costs. Estimates of obligations for some states range from $500 million to as much as $40 billion.
"This is going to be a big jolt to many state budgets, and this problem is one that is not immediately resolved," said Cecilia Januszkiewicz, secretary of Maryland's department of budget and management.
In many ways, the problem facing state and local governments mirrors that which has faced some companies, especially in labor-intensive, unionized industries such as autos and steel, which made big promises on pensions and health care that they ultimately couldn't afford to fund. Many governments are expected to respond in much the same way as corporations, which have slashed benefits since being forced in 1990 to recognize their retiree health-care obligations in financial statements.
But the dilemma for governments may be even thornier. Most states are legally required to provide some form of employee and retiree benefits for government workers, and changing or doing away with those benefits usually requires legislative action. While some local municipalities have more flexibility to change benefits, others must work through their state legislatures. In contrast, most public companies can easily trim benefits, especially those with weak or no union representation.
Cutting benefits for government workers is especially tough given that many employees are protected by strong unions that will challenge any such efforts.
While unions representing workers in the private sector have lost significant clout, the municipal and state unions remain quite strong. Additionally, while public companies can fall back on the Pension Benefit Guaranty Corp., which insures corporate pension funds, for some of the burden, governments have no such option.
So far, no state or local government has actually defaulted on any of its benefit plans. And the new rule doesn't require governments to set aside any money to fund the long-term obligations -- only to report what those obligations are.
But the change will shed new light on their long-term liabilities. And credit-ratings companies have told governments they expect the retiree health-care liability to be dealt with in some fashion. "We're looking to see that governments don't ignore it and look to control the growth of the obligation," said Richard Raphael, an analyst with Fitch Ratings.
How the ratings agencies respond will have big consequences for local and state governments, which borrow heavily from the public markets and need to maintain good ratings to keep borrowing rates low.
The accounting change will affect most big governments starting in fiscal 2008, which generally begins on July 1, 2007. It stems from a rule passed last year by the Government Accounting Standards Board, the independent advisory board that sets accounting standards for state and local governments.
With less than two years until the rule takes effect, governments already are scrambling to determine what they've promised to pay for retiree health care over the next 30 years -- and how to fund that liability. Until now, health-care benefits have been recorded on a pay-as-you-go basis, with budgets reflecting only the actual expense of benefits paid to employees and retirees each year.
Some already have gotten a taste of the bad news. Last month, Maryland disclosed a retiree-health-care liability of $20 billion, and said it must put aside $1.6 billion annually to fund the obligation. That's about 13% of the state's $12 billion general fund and comes on top of the $770 million Maryland shells out each year to pay for employee and retiree health-care benefits.
Ms. Januszkiewicz said the $20 billion obligation was much higher than the $3 billion to $5 billion officials had been anticipating, and will force the state to make some hard choices.
"When I got the number I was in shock," said Ms. Januszkiewicz, adding that "there are a limited number of things we can do." A task force created by the state General Assembly earlier this year is examining the obligation and will make recommendations on how to deal with it.
The change comes at a time when many state and local governments already are struggling with other costs, such as fully funding their employee pension plans, which face shortfalls of as much as $300 billion nationwide. Some are still recovering from the recession early this decade, which dented capital-gains and income taxes and caused a shortfall in revenue. In fiscal 2002, states suffered their steepest revenue drop since the Depression, said Mr. Raphael.
"States are coming off their worst fiscal crisis in decades," said Sujit CanagaRetna, a senior fiscal analyst with the Council of State Governments. "They're not really flush with funds and it's still a dire revenue picture as far as expenditures needed down the road."
Indeed, the situation is similar to the problems facing government-employee pension plans. Officials often promised big benefits but failed to set aside enough money to fund them, preferring during the 1990s to focus on outsized investment gains which eventually disappeared. The city of San Diego, for instance, is facing a $1.1 billion pension shortfall in part because of agreements it made to sweeten benefits in exchange for reduced payments into the pension fund.
The problem has been years in the making. State and local governments began heavily expanding in the 1960s for a number of reasons, including the need for more schools as the Baby Boomers grew up and a heavier load of federal mandates, such as the 1965 Medicare law. As the number of employees grew, so did the cost of providing them benefits.
At the same time, the strength of public employees grew in tandem with the power of the American Federation of State, County and Municipal Employees, which represents public workers. By the end of 1965, AFSCME had won collective-bargaining rights in several states, which translated into better and more generous benefits. And even with some recent cutbacks, costs are expected to swell over the next few years as the Baby Boomers begin to retire and collect both pension and health-care benefits.
For local officials, the latest dilemma could mean taking some politically unpopular stands. In Nevada, a proposal by Republican Gov. Kenny Guinn to discontinue retiree health-care benefits for any state government employee hired after July 1, 2006, ignited a firestorm.
The proposal was estimated to save the state $500 million per year, but the state's employee union lobbied aggressively to scotch the legislation, and it failed in the Democratic-controlled state assembly. Nevada has estimated its retiree-health-care obligation to be as high as $4.4 billion and says it will need to put aside about $200 million annually to fund the liability.
Scott Mackenzie, executive director for the State of Nevada Employees Association, said unions understand that governments need to cut costs, but that ending benefits will turn people away from civil service, where robust benefits often make up for lower salaries.
"Government attracts people because they have a bit of a cushion there when they retire," said Mr. Mackenzie.
Other states have been unable to reach consensus on how to address the liability. A committee established earlier this year by Delaware Gov. Ruth Ann Minner, a Democrat, explored various ways to address the state's estimated $3 billion obligation and the $185 million it needs to set aside annually. The committee looked at a range of options, including reducing the state's agreement to pay 100% of health insurance for retirees, but was unable to agree on a plan. "Without exception, the options presented to the Committee included difficult and unavoidable policy trade-offs," the report concluded.
"There are no straightforward 'win-win' solutions."
Some governments are opting to sell debt to finance their health-care obligation. For instance, Gainesville, Fla., issued bonds earlier this year to help finance its $30.6 million liability.
Others are trimming benefits, despite the political ramifications. The city of Arlington, Texas, recently did away with retiree health benefits for any employee hired after 2006 and trimmed the percentage of health-care costs that the city covers. Arlington Chief Financial Officer Donna Swarb said the moves cut the city's health-care obligation to $150 million from $196 million.
However, a more controversial plan to charge premiums based on age wasn't
adopted and the city is still facing costs that Ms. Swarb called "unmanageable."
Alabama, Utah and Ohio also have taken steps to scale back benefits, including raising health-care premiums for retirees and increasing the length of time employees must work before being eligible for retiree health care.
Other states, such as California and New York, have yet to officially determine their liabilities but policy watchers and credit-ratings analysts expect those numbers will be significant. Some have predicted that California's obligation could be $40 billion or more. The state controller's office has requested money from the governor and Legislature to perform an assessment of the liability.
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