Public Sector Retiree Health Care Benefits: A View from the American States

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Introduction

Public sector benefits, especially those offered by state governments, are widely regarded as being more generous than those available from private sector employers. In a 2007 national survey, for example, almost 60 percent of respondents reported this belief. (1) The same survey found that health care and retirement plans were among the most important job characteristics for respondents. The Pew Center on the States (2) recently reported on empirical studies showing not only that state government benefits are more generous than the private sectors', but also that the gap between the two may be widening. Not surprisingly, governments have successfully used their relatively lucrative benefits--in lieu of large salaries, bonuses, or stock grants--for competitive advantage in the market for human capital. (3)

Such emphasis has led to benefits constituting a higher proportion of total compensation (i.e., pay plus benefits) in the public sector than in the private sector. (4) A major component of government's total compensation and overall human resources strategy (5) is retiree benefits, including pensions and retiree health care. The latter of these is the primary form of other post-employment (non-pension) benefits, or OPEB, offered by government. OPEB represents "payments made directly to former employees or their beneficiaries, or to third parties on their behalf, as compensation for services rendered while they were still active employees." (6)

Public employers have opted to enhance pensions and OPEB over large salary increases for a variety of reasons. Primary among these is the fact that benefit enhancements are less immediate and visible, hence less politically controversial, than salary increases. (7) Also important to these enhancements has been the political and electoral clout of unions and other public employee groups. (8)

In contrast to pensions, which are now largely prefunded (at least partially), governments historically have funded OPEB on a pay-as-you-go (PAYGO) basis, that is, as an annual operating expense. As a result, little attention has been paid to the long-term cost implications of retiree health care commitments. As Peterson (9) notes, this approach once seemed reasonable: 'A few decades ago, when the country was younger and governments were growing, paying a little extra each year to relatively few retirees for health care was no big deal." In recent years, however, this picture has changed dramatically. Specifically, factors like the expected wave of baby boomer retirements, longer life expectancies, increased demands for earlier retirement, and rapid growth in health care costs suggest that OPEB costs can be expected to increase substantially. (10) Despite these concerns, governments' OPEB liabilities have generally gone unreported and unnoticed, that is until fairly recently.

The Government Accounting Standards Board's (GASB) issuance of two new accounting and financial reporting standards, GASB 43 and 45, has effectively removed the cloak from OPEB liabilities. These standards, announced in 2004, require state (and local) governments to report annually on their OPEB liabilities. The goal of these requirements is to improve the transparency of government financial reporting, disclose governments' true total compensation costs, and better align government practices with the private sector. (11)

Early estimates of these liabilities have been substantial. For example, the U.S. General Accountability Office (12) cites estimates of the combined present value of state and local government OPEB liabilities that range from as low as $600 billion to as much as $1.6 trillion. Looking just at the states, Standard & Poor's (13) estimated total OPEB liabilities at about $400 billion (from a low of $52 million in North Dakota to a high of $58 billion in New Jersey), though this figure was based on only 40 states that had completed OPEB valuations at the time. …