Healthcare Debt is Strangling Cities
The local debt crisis often centers around unfunded pension liabilities, and rightfully so. These are the debts owed to retiring public employees, and cities and states rack them up by deferring, or in some instances, altogether not making payments. But, the sleeping giant and next big budgetary issue for cities and states is retiree healthcare debt or Other Post-Employment Benefits (OPEB).
OPEB liabilities come from contractual agreements between governments and retired employees. Often, as a part of their employment contract, they are promised healthcare and dental coverage as well as coverage for family members after retirement.
Since the 2008 downturn, pension and retiree healthcare debt for public employees has skyrocketed. This is from a combination of the previously mentioned failure to pay require contributions into these employee funds, but also from overinflated investment returns and increasing healthcare costs. With costs growing in every other area of government, healthcare and pension payments are often the first to be ignored by local entities because the payout for employees is in the distant future, in other words, cities and states kick the can down the road.
The OPEB burden has gotten so big that at the end of the most recent fiscal year, when Annual Financial Reports are published by public entities, the City of Houston’s net position was in the negatives.
The city’s Office of Controller wrote that new reporting requirements making cities acknowledge the true amount of their unfunded healthcare liabilities, “had a significant effect on the statement of net position for the city’s governmental funds, which decreased to negative $914.84 million at the end of FY 18.” He blamed the net position “almost exclusively” on OPEB debt. The country’s 4thlargest city’s financial position fell into the negatives for the first time in modern history from simply, accurately reporting on their healthcare debt, imagine what these liabilities will do to cities with smaller tax bases.
Of the five largest U.S. cities, New York City is the outlier, with $96 billion in OPEB liabilities, it tops the list. Los Angeles, Houston, and Philadelphia, on the other hand, all have liabilities hovering around $2.5 billion, which for cities with their populations, land size, and tax base, is a massive burden.
It’s not only taxpayers who should be concerned, public employees should be paying attention, too.
Benefits are often structured under collective bargaining agreements between a city, or state, and an employee group. Employees within these are can be prohibited from participating in Social Security or Medicare, so they rely on these benefits.
When municipalities file for Chapter 9 bankruptcy, often driven by unfunded liabilities, pensions and OPEB are always some of the most difficult issues, from both an accounting and political perspective, to sort out. While it’s wholly a fiscal matter, there’s a very tangible human element to restructuring municipal finances because cities employ thousands and their livelihood, retirement and healthcare security hangs in the balance.
The cost burden of OPEB liabilities is increasing and at a faster rate than pension obligations making it only a matter of time before entities begin to acknowledge it as the crisis that it is.
Truth in Accounting, a nonprofit that monitors municipal finances, noted that for Fiscal Year 2017, OPEB obligations increased 7.8 percent while pension obligation costs were relatively flat, they only increased .6 percent. Houston, for instance, adds about $160 million per year to its overall unfunded liabilities for healthcare.
Most cities operate on a PAYGO (pay-as-you-go) scheme today. They meet their minimum annual financial obligations but never really make a dent in the already-accrued liability. Essentially the same thing as making the minimum monthly payment on a credit card or loan. But, too often they don’t even meet their minimum payment obligations because they have to pay other, non-deferrable governmental expenditures.
Experts differ on the solution. Some call for an OPEB trust, an outside entity with the flexibility to manage assets and get higher returns, something that cities can’t do because of restrictions on general fund spending.
Others call for a phase out of OPEB, saying that it wouldn’t impact employee retention or recruitment. There’s also a growing chorus to shift the burden away from the taxpayers by asking employees to contribute more to their benefit plans.
As different as the solutions are, what they have in common is that, unlike pension changes, in most instances these changes can be made locally. In Texas, substantive changes to pension agreements of employees in any of the major cities is required to go through the legislature, the same doesn’t apply to healthcare liabilities. The problem rests with local government and the resolutions can be found there as well.