Unfunded Cost of Retiree Health Plans

I was at a meeting the other weekend with my state representative, and one of his (other) constituents referred to a report from the Pew Center on the States this winter about the unfunded pension and retiree health care obligations of the states.   I hadn’t seen this report – so I read through the executive summary today.

It’s a scary picture indeed.  Some states have funded their pensions as they go.  Florida, Idaho, New York, North Carolina and Wisconsin all had fully funded pension plans as of mid 2008.  On the other hand, most states are a mess, and a few probably make Greece look fiscally prudent.  Illinois, for instance, has funded just a bit over half of its future post-retiree liability.

What does it mean for a state to have an unfunded retiree obligation?  It means the state has spent too much and/or not collected enough taxes in the past. Sooner or later, the state will have to either agree to collect more tax revenue (which can chase away business and lose elections for incumbents) or will have to spend less (which means laying off workers, who then pay less in taxes and require more services – which creates a terrible vicious cycle – just what we’re likely to see in Greece)

The graphic above demonstrates a problem that hasn’t reached the public consciousness.  There is widespread dismay that public employees have generous conventional defined benefit pensions, where those in the private sector are lucky if they have defined contribution pensions – which means great uncertainty about lifestyle in retirement.  But it turns out that while 17% of total pension obligations are unfunded, a whopping 95% of all post-retiree health care costs are unfunded.  Of course, a shortfall is a shortfall – and money can be moved from account to account  - but still – states have put away only 5% of the dollars they need to pay for the health care costs of their current and future retirees.
Click on image to enlarge

Why does it appear so many states are being so fiscally imprudent?

States have to balance their budgets, but “OPEB” (other post employment benefits) costs are notoriously hard to project, and many governments simply project unrealistically low future costs. Frankly, politicians don’t want to raise taxes OR to spend less – so it’s not surprising to find this underfunding.

Could it get worse?

Sure.  The Pew Center analysis is based on data collected before stock market losses led to further shrinkage of pension funds. Further, this only counts the states.   Municipalities, quasigovernmental agencies and other government entities also have unfunded retiree obligations! The Government Accounting Standards Board  (pronounced “Gas-bee”) has announced new rules that will force all government agencies to be more transparent about their future obligations, so we’ll be reading a lot more about this in the future.

Could it get better?

Yes.  This huge unfunded liability assumes that health care costs will continue to increase rapidly over the coming years. If health care costs do not increase at such a rapid rate, we’ll likely escape the worst of this reckoning.  That means fewer teachers, policemen and firefighters laid off – and a future of fewer unpaved potholes.

The unfunded governmental post-retirement health care liability  is another powerful reason why we have to rein in health care cost inflation.