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Paving a Way Out: California’s Rising Retirement Healthcare Costs

ret2 Credit: American Advisors Group Flickr

Executive Summary and Introduction

Rising retiree healthcare costs is one of the emerging problems that state and local governments face nationwide. The true costs of providing promised healthcare and other non-pension benefits to retirees became clear when the Governmental Accounting Standards Board (GASB) mandated public disclosure of these costs and liabilities in fiscal year 2008. Since then, policy makers have gradually shifted their attention toward limiting this cost growth. Still, growing liabilities and annual out-of-pocket costs now exert increasing strain on government budgets.

Collectively, non-pension retirement benefits are called other post-employment benefits (OPEB), and they are comprised mainly of healthcare benefits. The State of California currently has an OPEB liability of $63.9 billion, which represents today’s cost of providing benefits that employees have already earned based on the time they have already worked. However, the state does not utilize a prefunding plan, under which it would set aside funds today for benefits due later. Consequently, virtually all of this debt remains unfunded and the state’s promise to its employees far from secure. Additionally, the state leaves the other areas of its future operating budgets and tomorrow’s taxpayers open to absorbing costs for benefits that are currently being earned today.

The state currently pays for its annual OPEB costs out-of-pocket. In 2012-2013, the state is expected to pay $1.8 billion for the health benefits of current state retirees. Since 2008, these pay-as-you-go OPEB costs have grown at an average annual rate of nearly 8%, a level of growth that has outpaced overall state spending and revenue growth. Due to rapidly rising health costs, longer life expectancies, and a growing number of retirees, these annual pay-as-you-go payments will continue to grow. Simply put, more retirees will be receiving benefits at much higher costs for longer periods of time. Absent significant reform, OPEB costs will consume increasing portions of government spending, thereby crowding out other areas of the budget.

Rising OPEB costs contributed to the bankruptcies of Stockton and Vallejo because the cities budgets were unable to accommodate the rapid growth in pay-as-you-go costs. Following its bankruptcy declaration, Stockton eliminated retiree health benefits for its employees entirely. For the state, OPEB costs are rising but still manageable. However, delaying the implementation of OPEB reform will ultimately enable the costs to reach unsustainable levels.

This report serves as a follow-up to our 2012 report titled California’s Neglected Promise: How California Has Failed to Prepare for its Accumulating Retiree Health Care Obligations.1 Here, we present updated OPEB financial data, reexamine the state’s OPEB problem, and consider potential reforms (refer to the Appendix for methodology). Our findings are as follows:

  • As of June 30, 2012, California has an OPEB liability of $63.9 billion. Currently, the state has just $8.3 million in assets (for California Highway Patrol employees), meaning that the liability is almost entirely unfunded.
  • The state pays for OPEB costs on a pay-as-you-go basis. Since 1985, state spending on retiree health and dental benefits has risen by 1415%, doubling nearly four times.
  • More recently, in 2008, the state spent $1.3 billion on OPEBs, and in 2013 the state will spend an estimated $1.8 billion, amounting to average annual growth of 7.7%. This 45% growth in OPEB spending has come even at a time when total state spending grew by only 3%. Comparatively, total state spending on Health and Human Services grew by 18%, and state spending on K-12 Education and Higher Education (UC and CSU) declined by 12% and 37%, respectively.
  • From 2008 to 2012, the number of retirees receiving benefits grew from 134,703 to 158,740, an 18% increase. During that time, the OPEB cost per retiree rose from $9,280 to $10,835, a 17% increase.
  • The state’s officially reported unfunded liability for both pension and non-pension benefits is a staggering $181.2 billion. Of this total, non-pension benefits account for more than a third.
  • Even though his proposal stated it would do so, Governor Jerry Brown’s retirement benefit reform failed to address OPEBs.

The state now has the opportunity to manage the cost growth of retiree healthcare before they become unmanageable. The state has a number of options to consider, including capping benefit levels, increasing qualifying retirement ages and service years, prefunding, buy-outs, and/or switching to defined contribution plans. But ultimately, any reforms need to be feasible to implement, affordable, competitive, and sustainable in the long term.

Other Post-Employment Benefits (OPEBs)

Other Post-Employment Benefits (OPEBs), meaning non-pension retirement benefits, are primarily composed of retiree healthcare (as such, we will use the terms OPEB and retiree healthcare interchangeably throughout this report). In particular, the state pays for medical, prescription drug, and dental benefits for its retired statewide employees (see Table 1).2 Eligible members enroll in a health plan through the California Public Employees Retirement System (CalPERS).

Each employee earns these benefits during his or her career and receives them after retirement. How much the state contributes toward each retiree’s health coverage depends on the extent to which the employee’s benefits are vested, which refers to the level of benefits the retiree has earned. Benefit vesting is dependent upon each employee’s type, date of hire, and years of service (see Appendix).

Table 1: OPEBs Sponsored by State of California3 44 (paving)

For example, most state employees receive 5% of the full benefit for each year that they work if they work a minimum of 10 years. Thus after 20 years of work, the employee is eligible to receive the state’s full contribution to his healthcare premium upon retirement. Full state coverage of retiree healthcare benefits is based on a 100/90 formula, meaning the contribution is 100% of the weighted average of health premiums for retirees and 90% for eligible dependents, until the retiree qualifies for Medicare benefits (the pre-Medicare benefit). When an employee becomes Medicare eligible, typically at age 65, Medicare becomes the primary funder for health benefits. Beyond that point, the state will pay health costs not paid for by Medicare (the post-Medicare benefit).4

What Does the Unfunded Liability Mean

The future costs of providing retiree healthcare to plan participants are unknown. Participants include retirees who are currently receiving benefits and active employees who have not yet begun drawing benefits. Currently, there are 159,740 retirees receiving healthcare benefits and 256,949 employees earning them.

Future costs depend on each participant’s years of service, years of life after retirement, future healthcare prices, investment returns of the plan, and many other factors. The state works with actuaries who study the OPEB plan’s membership data and make assumptions about these factors for each plan participant. By doing this for each plan member and adjusting these assumptions based on what actually happens, the actuary predicts the total cost of providing retiree healthcare to current plan participants. State actuaries then discount this total to a present day value that represents the amount of money that would need to be invested now to have sufficient assets to pay for future benefits when they are due.

As of June 30, 2012, the State of California has an officially reported OPEB liability of $63.9 billion, which represents today’s cost of providing benefits that employees have already earned but not yet received.5 However, this sum grows with interest each year it remains unfunded and grows each time employees earn additional benefits.

Rather than set aside funds as an employee actually works, the state currently makes retiree healthcare payments when a retiree comes to collect the benefit each year. Setting aside funds during the employee’s career called is called prefunding the future obligation. State actuaries design a payment plan that would both pay for benefits as employees earn them and pay off the existing OPEB debt. The calculated payment is called the Annual Required Contribution (ARC).

Prefunding or not, the state will eventually have to pay back its OPEB debt. This debt has grown from $47.9 billion to $63.9 billion in just five years. At its core, the growing unfunded OPEB liability represents the costs accumulating today but due in the future.6 In fact, the state’s OPEB costs are back-loaded, meaning that the majority of payments will be made for benefits that are still being earned by current employees (see Appendix for the distribution of the OPEB liability). Thus, the full cost impact of providing these promised benefits will not be felt until years down the road and at higher costs. Additionally, as new and current employees continue to earn additional benefits, the OPEB debt will continue to grow and increase future costs even further. 

Now if the state had enough assets to cover the OPEB debt today, it would theoretically have enough funds (plus investment earnings) to pay for future costs entirely. However, as stated before, the state has not participated in a prefunding plan, and has thus left all of this OPEB debt unfunded.7 The state’s current benefit and funding structure will allow this debt to increase indefinitely, meaning that OPEB costs will continue to rise without an end in sight.

Growing OPEB Costs

The core question is how will future OPEB costs impact the state’s future budgets Since 1985, state spending on retiree health and dental benefits has skyrocketed by 1415%, doubling nearly four times.8 More recently, in 2008, the state spent $1.3 billion on OPEBs, and in 2013 the state will spend an estimated $1.8 billion, an average annual growth rate of 7.7%. This 45% increase in OPEB spending has come even at a time when state spending rose by only 3%. Comparatively, state spending on Health and Human Services grew 18%, and state spending on K-12 Education and Higher Education (UC and CSU) declined by 12% and 37%, respectively (see Figure 1).

Figure 1: Growth in Total State Spending, by Area (2007-08 to 2012-13) 45 (paving)
Table 2: OPEB Claim Costs10 45 (paving)

Currently, OPEB costs amount to 2% of the General Fund budget, but paying out of pocket both delays higher costs to the state and increases the magnitude of cost growth later.11 For proof of this, look no further than the Annual Required Contribution, what the state would pay if it recognized the actual cost of these benefits while they were being earned. Instead of $1.8 billion, it would pay $4.9 billion, or 5.4% of General Fund spending.12 Instead it delays those costs, allowing the deferred costs to increase by 4.5% per year.

OPEB cost growth is the product of two main factors at work, growth in the number of retirees collecting their benefits and the rise in the cost per retiree. Their growth is due to health cost inflation, an aging population, more retirees, and longer life expectancies.

Figure 2: Why OPEB Costs Will Continue to Rise 47 (paving)

In just a five-year span, the number of retirees receiving benefits has risen 18%, from 134,703 to 158,740. The retiree population will continue to expand given that there are currently 256,949 employees still earning benefits. As of June 2012, approximately half of these individuals are both at least 40 years old and have at least 10 years of service, meaning they are nearing retirement age and will retire with vested benefits.13 Once these employees retiree, they will be replaced by new employees who will also earn benefits and repeat the cycle. Furthermore, these new retirees will typically live longer. In 1990 the remaining life expectancy of someone of age 65 was 17.9 years. In 2009, this rose to 21.1 years.14

The annual cost per retiree increased from $9,280 in 2008 to $10,835 in 2012, a 17% increase. The cost per retiree will also continue to increase, mainly due to health cost inflation. Overall, CalPERS health premiums negotiated for employee benefits have grown at an 8.4% average annual rate from 2004-2012.15 This growth rate has significantly outpaced state inflation and wage increases. National projections indicate that this trend will not subside.16And as retirees age, actuaries also anticipate that the cost of benefits will also increase.17

This means that more retirees will be receiving OPEB benefits at much higher costs for longer periods of time. The OPEB costs will continue to increase greatly without meaningful reform.

Call for Concern: Security & Credit Ratings

The state’s officially reported unfunded liability for pension and non-pension benefits is a staggering $181.2 billion.18 Of this, retiree healthcare accounts for more than a third. Yet, no substantial effort has been made to either restructure these benefits or reform the way they are funded.

The cost of retiree healthcare benefits greatly depends on future healthcare prices, which are out of the state’s control. Those costs are subject to external policy changes such as the federal Affordable Care Act, which will implement numerous changes throughout the nation’s healthcare system.19 Another source of uncertainty is the plan’s relationship with Medicare.

Should the federal government alter Medicare, which provides health benefits to seniors, those changes may have direct impact on the state’s retiree health costs. For example, a commonly discussed change to Medicare is to increase the eligibility age from 65 to 67.20 Under that change, California’s OPEB plans would have to pay the full costs of each retiree’s healthcare for two additional years, years during which Medicare would have normally been the primary payer.

By having such a large unfunded OPEB liability, the state leaves its OPEB plans and its future budgets in great uncertainty. Given the rapid growth of these costs, there is no guarantee that future budgets will be able to pay for them. And if future budgets cannot pay for them, the benefits promised to employees are in jeopardy. In that case, to still provide the benefits, future taxpayers would have to make up the budget gap with increased taxes and/or cuts to other public services. For these reasons, having an unfunded liability this large should be concerning to all parties involved: the employer (the State of California), employees, and taxpayers.

Figure 3: Who Should Be Concerned 45 (paving)

Within the state budget, OPEB costs may very well be manageable now and in the near future. However, the negative consequences of leaving the issue unaddressed have already emerged in a few California cities. Stockton, for example, became the largest city in U.S history to file for bankruptcy in June 2012. Several factors led to this outcome, including the housing market crash, an ill-timed bond offering, and unsustainable employee compensation promises.21 As of 2011, Stockton had approximately $544 million in OPEB liabilities. Just as the state does, the city paid for these benefits on a pay-as-you-go basis entirely out of its operating budget, so the liability was completely unfunded. 

Stockton’s OPEB costs increased 12% per year between 2004 and 2011, with pay-as-you-go costs equaling approximately 8% of its General Fund budget in 2009-10. The year before declaring bankruptcy, the city reduced these benefits in 2011 to limit their growth to about 7% per year. Ultimately, its OPEB obligations still proved unsustainable, and in its bankruptcy plan, the city chose to eliminate retiree healthcare benefits altogether.22 While the consequences of retiree healthcare costs were severe in Stockton, the risk these rising costs pose to financial security are very real for other governments as well.

Having large unfunded OPEB liabilities may also result in lower credit ratings and increased borrowing costs to the state down the road. Credit rating agencies Fitch Ratings, Standard and Poor’s, and Moody’s have stated that they will consider OPEB funding status in their evaluations of a government’s current financial status. A municipality’s OPEB funding policy and progress are becoming increasingly important among the factors these agencies use to determine credit ratings.23 Fitch, for example, has stated that it does not expect OPEB plan funding ratios to reach the generally high levels of pension systems for many years, but steady progress toward reaching the actuarially determined annual contribution level will be critical to sound credit quality.24 Standard and Poor’s has stated that while the funding schedule for these long-term liabilities can be more flexible than a fixed debt repayment schedule, in our opinion these liabilities can also be more volatile and could lead to fiscal stress if not managed.25 

The Way Out

Providing generous benefits helps public sector employers be competitive and attract highly-skilled workers. The private sector’s OPEB plans have been under similar cost pressures. As the state considers OPEB reform, it should examine private sector experiences. When the Financial Accounting Standards Board required corporations to report these post retirement liabilities on their financial statements, several private sector companies began to immediately reform these benefits to reduce costs, with some choosing to eliminate them all together. 

From 1997 to 2008, the share of private sector workers offered pre-Medicare retirement health benefits fell from 31% to 22%.26 Over the same period, the percentage of private sector workers offered post-Medicare benefits decreased from 28% to 17%. Compared to most private sector plans, the state offers more generous healthcare benefits. In California, a state employee can work 20 years, retire at any age, and receive full pre-Medicare and post-Medicare healthcare benefits for the rest of his life without making contributions to the plan. With regard to competitiveness, the state has the flexibility to alter its benefit structure while still providing more generous than private sector companies. 

In September 2012, Governor Jerry Brown and the Legislature passed retirement benefit legislation, which altered the pension benefit structure for new employees with the intent of reducing future pension costs.27 In scope, the legislation failed to match Governor Brown’s initial October 2011 proposal (the Twelve Point Pension Reform Plan). One key difference was that the legislation failed to address retiree healthcare at all, though the Governor’s proposal offered changes to new employees retiree health benefits. In the proposal, Governor Brown stated, The state’s retiree health care premium costs have increased by more than 60 percent in the last five years and will almost double over ten years. This approach has to change.28 He proposed that new employees work longer before qualifying for OPEBs and required that they contribute towards their healthcare premiums. However, the final legislation included no such reforms. 

Potential Reforms

There are many reforms the state can adopt to lower its retiree healthcare costs. Though varied, the benefits reforms are usually aimed at reducing the cost or risk to provide them. Even beginning incremental reforms early, while the costs are still relatively low, would afford the state time to implement a long-term and more sustainable solution. On the other hand, continuing to delay reform would limit the state’s options, making it more likely to resort to revoking promised benefits, possibly even those already earned. A number of these strategies, already undertaken in municipalities nationwide, are outlined below: 

Prefunding

Prefunding is one of the most intuitive ways to begin tackling the state’s OPEB debt. The strategy relies on paying off the debt sooner rather than later and investing assets in the meantime. Contrary to some claims, prefunding is ultimately cheaper than paying for OPEBs on a pay-as-you-go basis out of the government’s operating budget. It does require higher annual contributions upfront however. The state realizes savings when assets invested now grow significantly with investment return earnings, helping build the fund even further.

If the state paid the full actuarially recommended contribution and deposit it into an OPEB trust (similar to the way it does with pensions), it could reduce its officially reported unfunded liability by up to $21.8 billion (approximately a third). However, this approach would now require not only paying the $1.8 billion for benefit payments due now, but also depositing at least an additional $1.7 billion into an irrevocable OPEB trust fund for future payments. 29 This additional $1.7 billion could come from a combination of employer and employee contributions. Last year, the state implemented a similar cost-sharing plan to fund pensions: new employees now split pension costs with the state.30

Prefunding does not eliminate the key question all retirement plans must answer: Can the plan truly afford to continue paying for these promised benefits indefinitely If it cannot, then the plan must be restructured. Prefunding does not lower the monetary costs of OPEBs; it provides plans with additional assistance in building up assets to cover those costs, making them more affordable and secure. Prefunding would reduce the burden on the state budget, but requiring employee contributions would also result in a net loss in benefits.

Restrict the Benefit

Right now, the state promises fully vested state employees that it will pay 100% of the average healthcare premium, which amounts to full coverage for many retirees. Instead, the state could lower the maximum percentage contribution. Alternatively, it could cap the benefit to at a set dollar amount, as opposed to promising to pay a set percentage of a benefit with no defined future cost. This would allow the state to exert more control over its benefit spending. 

The state could also offer only a post-Medicare benefit, meaning that it would no longer cover healthcare costs for those not yet old enough to qualify for Medicare. Under such a change, the state would only serve as the secondary health provider for retirees, significantly reducing its costs. For example, the monthly health cost for a male of age 60 is only a third of the cost for a male of age 65.31 But regardless of the change, restricting the benefit does reduce its value to retirees. 

Restrict Benefit Eligibility

Restricting benefit eligibility refers to either increasing the number of service years or the retirement age required to qualify for healthcare. Right now, most employees can qualify for retiree healthcare benefits after 10 years of service and receive the full benefit after 20 years of service, regardless of age.32 Governor Brown’s October 2011 pension reform proposal called for new state employees to work for 15 years to qualify and work 25 years to receive the full benefit.

Restricting eligibility will encourage employees to work for longer periods of time, thereby reducing the number of retirement years for which they receive healthcare and reducing the number of total plan participants. Those who choose to not work longer will most likely retire with benefits of relatively lesser value because the benefit thresholds have shifted upward. Both scenarios reduce OPEB costs, though having employees work longer may result in higher overall employment costs due to salary increases and larger pension payouts.33

Defined Contribution Plans

The state could restrict costs and reduce risk by switching to defined contribution plans (as opposed to defined benefit plans). A defined contribution plan does not guarantee to pay any set future benefit (such as 100% of one’s future health premium), but rather, only contributes a defined amount into a trust fund during each employee’s career. Thus, the plan focuses on inputs rather than outputs. The employer (the state) and/or employees make contributions. The accumulated assets in the trust will fund the retirees benefits. The employee takes on the risk that the accumulated assets may prove insufficient to sustain the level of benefits desired. Given that they require contributions that cannot be deferred to future years, defined contribution plans may raise cash flow concerns for the state. Furthermore, defined contribution plans are likely to result in reduced benefits for retirees because health cost inflation generally outpaces investment returns on retirement trust funds.

Buy-Out

The state could offer employees upfront cash in exchange for their vested rights to retiree healthcare benefits. Actuaries would calculate the amount used to buy out each employee’s benefit. This means that in determining how much to offer employees, the state would consider how much is needed to incentivize employee participation while also reducing the cost of each employee’s benefit plan. 

Beverly Hills took this approach. To tackle its $58 million unfunded OPEB liability, Beverly Hills offered to pay its employees in exchange for their retiree healthcare benefits.34 Workers had to contribute a portion of the pay-out to a defined contribution account. The participating employees agreed to receive less money from the city than they would have received in the form of health benefits during retirement under the original defined benefit plan. Exceeding expectations by a wide margin, 58% of active employees agreed to participate in the buy-out option. Going forward, new employees were only eligible for defined contribution plans. Overall, the plan not only slowed the growth of the city’s unfunded OPEB liability, but it decreased it by $13 million for fiscal year 2010-11. The city’s total reduction in its unfunded OPEB liability over 40 years is projected to be $91 million.

Like other options, buy-outs raise cash flow concerns. Beverly Hills borrowed money with a bond issued at a 4.5% interest rate. While this borrowing transformed a soft liability into a hard liability, the city was able to transform an uncertain and rapidly rising cost into a lower fixed cost. 

It is important to note that none of these options must be ‘stand alone reforms. There are numerous ways to mix and match reforms into hybrid plans. The key is creating a plan that is feasible to implement, affordable, competitive, and sustainable in the long run. Ideally, OPEB plans should maintain benefit levels that the state can afford to prefund, so that the benefit would be both affordable and secure over the long term.

To Whom Should Reforms Apply

The policy impact of OPEB reforms depends on how soon the costs will become unmanageable. Future OPEB costs will depend on employee retirement patterns and future health prices. The state needs to consult with its actuaries to generate projections of OPEB spending under different funding and benefit options to assess the required urgency and magnitude of reforms. As a primary foundation behind well informed decisions, it is imperative that the parties involved have access to essential plan data and cost projections. Negotiations among the state, its employees, and its taxpayers will require the most accurate cost projections that clearly illustrate the impact that OPEBs will have on future budgets.

That said, it is easiest to alter benefits for new employees because they have not yet entered into employment contracts, nor have they earned benefits. However, the impact of changing the benefit structure for new employees will be delayed decades into the future. For example, consider a new employee, age 30. If he retires at 60, he will not begin collecting his retiree health benefit for another 30 years. Thus, reforms targeting him would not take effect until after the existing liability has already taken its toll on the state’s budget during the interim years. The state can only realize more immediate impact on its short-term OPEB costs by adjusting benefits for current plan participants.

While the most immediately effective reforms modify the benefits payable to current plan participants, they are often the most difficult to implement. Because these benefits have been promised and some already earned by plan participants, there are legal, moral, and morale concerns to recognize. For example, state and CSU employees hired after January 1, 1989 earn 5% of the total benefit for each year that they work (with minimum of 10 years of service). Thus, an employee with 12 years of service will have already earned 60% of his total benefit contribution. However, the extent to which the law protects earned retiree healthcare benefits remains unsettled.35 Still, to mitigate costs while still maintaining benefits current employees have already earned, the state could only alter benefits employees have yet to earn. Such alterations include reducing the vesting percentage for an employee’s remaining work years (reducing from 5% each year). 

Bottom Line

The State of California currently has an OPEB liability of $63.9 billion, which represents the accumulated cost of providing benefits current employees and retirees have already earned. Instead of setting aside funds beforehand, the State of California pays for retiree health benefits on a pay-as-you-go basis out of its operating budget when retirees come to collect them. Because it has no assets designated for these promised benefits, the state has failed to secure this promise to its employees and left future taxpayers to pay for benefits being earned today. 

Between 2008 and 2013, those out-of-pocket costs increased 45%. Without sustainable reform, there is no indication that this growth will slow in the foreseeable future. And if this growth persists, OPEB costs will consume increasing portions of future state budgets, which would require additional revenue increases and/or cuts to other budget areas to compensate.

OPEB plans costs and structures are still manageable for the state. It therefore has both a window of opportunity and the hindsight provided by damaging experiences in places like Stockton. In shaping its strategy, the state must consult with its actuaries to generate OPEB cost projections under various benefit structures and funding options. The state has a number of reform options to consider, including prefunding, benefit restrictions, buy-out plans, and switching to defined contribution plans. A reform plan can include a combination of those options, but the key to success will rest in the plan being feasible to implement, affordable, competitive, and sustainable in the long term.

Finally, the structure of the state’s OPEB plan and its true costs should be clearly disclosed to all parties involved. The mandates set by the Government Accounting Standards Board were a decent starting point, but yearly out-of-pocket costs for retiree healthcare remain veiled behind actuarial technicalities that fail to clearly show the impact these benefits will have on future budgets. Careful management of post-retirement benefits has proven to be a key step in securing more stable financial conditions for local and state governments. Decisive action by the state legislature will help California avoid the retiree healthcare elephant from taking up more space in an already crowded room.

Appendix

Data for the state’s OPEB plan was found in the State of California OPEB Valuations performed as of June 30, 2008 through June 30, 2012. These valuations were performed by Gabriel Roeder Smith & Company (GRS). These valuations do not exist prior to 2008, which was the year the state implemented the GASB statements No. 43 and No. 45. Links to these reports can be found on the state Controller’s Office website (see endnote for a URL link).36 Other sources used throughout the report are otherwise noted in the endnotes. Historical OPEB data on a number of key variables is shown below. 

Table 3: California OPEB Data (dollar amounts are in billions) 49 (paving)

OPEB vesting schedules vary by employee type and higher date. Details on the vesting schedule for the state’s contribution can be found in the Summary of the Current Substantive Plan Provisions for the Other Postemployment Benefit Sponsored by the State of California contained in the 2012 Actuarial Valuation. 

Table 4: California OPEB plan Vesting Schedule 50 (paving)

View Senate Hearing Testimony as PDF

Works Cited [+ Expand]

1 California Common Sense, California’s Neglected Promise: How California has Failed to prepare for its Accumulating Retire Health Care Obligations, July 2012

URL: http://cacs.org/images/dynamic/articleAttachments/14.pdf 

2 The state also pays an implied subsidy (also called the implicit rate subsidy) for retiree healthcare since retirees not eligible for Medicare are grouped with active employees. These members will be receiving a subsidy because the average healthcare costs of retired members is generally higher than the blended average costs of a group comprised of both active and retired members. 

3 Information can be found in the Summary of the Current Substantive Plan Provisions in the state of California OPEB Valuation as of June 30, 2012. Additionally, one should consult California’s 2012 Comprehensive Annual Financial Report, which contains information about the OPEB plan provisions.

4 CalPERS retired members who qualify for premium-free Part A, either on their own or through a spouse (current, former, or deceased), must sign up for Part B as soon as they qualify for Part A. A member must then enroll in a CalPERS sponsored Medicare plan. The CalPERS sponsored Medicare plan will pay for costs not paid by Medicare, by coordinating benefits.

5 Note that earned here technically applies to the actuarial allocation of normal costs (along with interest and actuarial adjustments). California uses the entry age normal cost method.

6 The liability is also impacted by deviations and changes in the actuarial assumptions, which are reviewed and updated with each actuarial valuation.

California Highway Patrol (CHP) employees have saved up $8.3 million in assets. So technically, the liability is 0.01% funded.

8 In 1984-1985 the state spent $100 million on retiree health and dental. In 2012-2013, it is estimated the state will spend $1.6 billion. These numbers come from the Legislative Analyst’s Office. Note that these totals are not complete OPEB contributions. In 2012-2013, as indicated throughout the report, estimated OPEB spending is $1.81 billion.

9 State spending totals include everything but federal funds as calculated by the Legislative Analyst Office. This spreadsheet, titled ‘state of California Expenditures, 1984-85 to 2012-13 can be found at the following:

URL:  http://www.lao.ca.gov/laoapp/LAOMenus/lao_menu_economics.aspx

10OPEB costs were obtained from the Annual OPEB Cost Summary in the state of California OPEB Valuation as of June 30, 2012. Data on the number of retirees and complete OPEB spending is not available before 2008.

11State General Fund spending is estimated to be $91.3 billion in fiscal year 2012-13. General Fund spending totals can be obtained from the website of the state Controller.

URL: http://www.sco.ca.gov/state_finances_101_state_spending.html

12This amount is the Annual Required Contribution (ARC), which is the sum of the normal cost for 2013 and an amortization payment on the already accrued, but unfunded, liability. This ARC is calculated using a discount rate of 4.5%. If the State prefunds regularly into an OPEB trust fund, the discount rate changes to 7.61%, reducing the ARC to $3.5 billion. But because the state does not prefund at all, using the higher ARC is a more appropriate representation of accruing costs.

13More specifically, 124,430, or 48%. This information can be found in the Summary of Participant Data from the state of California OPEB Valuation as of June 30, 2012. The 40 years, 10 years of service is somewhat arbitrary, but it shows that a significant number of active employees will be retiring with earned benefits in the coming years.

14The life expectancy for those at age 65 grew at an average of .17 years each calendar year. These numbers can be found from the California Department of Public Health from their Life Expectancy Data. URL:http://www.cdph.ca.gov/data/statistics/Documents/VSC-2009-0114.pdf

15This information regarding CalPERS can be found the CalPERS website. All information regarding CalPERS found in this section was found from the following Fact Sheet.

URL: http://www.calpers.ca.gov/eip-docs/about/facts/health.pdf 

16For example, CMS Actuaries project that per capita employer sponsored health insurance costs will increase by an average of 4.6% from 2011 to 2021. National projections of future health spending can be found from the Center for Medicare and Medicaid Services in their National Health Expenditure Projections 2011-2021.

URL: http://www.cms.gov/Research-Statistics-Data-and-Systems/Statistics-Trends-and-Reports/NationalHealthExpendData/Downloads/Proj2011PDF.pdf

17In the Actuarial Valuation it is noted, As the ages of employees and retires in the covered population increase, so does the cost of benefits. For example, the monthly per capita cost for a male of age 60 in an HMO plan is expected to be $254.07, while for a male of age 80 it is expected to be $366.13. The exception comes when someone goes from a pre-Medicare benefit to a post-Medicare benefit. This changes the level of spending, but a similar correlation remains thereafter.

18These values come from the 2013-2014 proposed budget in Figure INT-4. Note that these liabilities are the officially reported amounts. Their reported OPEB liability is a year old. Now it is slightly higher, but this does not result in a substantial difference. URL: http://www.ebudget.ca.gov/pdf/BudgetSummary/FullBudgetSummary.pdf

It is not clear how the ACA will impact health costs for state retirees. Many concerns have been raised that the ACA will increase health premiums for young individuals purchasing individual plans. But this does not necessary have any implications for retiree 

health insurance. However, the ACA imposes a 40% excise tax on healthcare plans beginning in 2018. State actuaries estimate that this will increase the ultimate growth rate by 0.14% after 2025.

20The idea of changing the Medicare age to 65 to 67 is not arbitrary on our part, but rather, has been discussed quite often in health policy. For more information on Medicare change proposals, please consult the following: 

URL:  http://www.aarp.org/content/dam/aarp/health/medicare_insurance/2012-05/five-medicare-options-aarp.pdf 

21Sydney Evans, Bohdan Kosenko, and Mike Polyakov. How Stockton Went Bust: A California City’s Decade of Policies and the Financial Crisis That Followed. CACS: Los Altos, CA. 2012.

URL: http://www.cacs.org/images/dynamic/articleAttachments/12.pdf

22Jim Christie and Peter Henderson, ‘stockton, California, Cuts Retiree Health Care Benefits Amid Bankruptcy Proceedings, Reuters, July 27, 2012.

URL:  http://www.huffingtonpost.com/2012/07/27/stockton-bankruptcy-retiree-health-care_n_1712260.html

23Moody’s Investors Service. Other Post-Employment Benefits (OPEB). 2005, p. 4

URL: http://www.csac.counties.org/ images/public/Services/OPEBS_moodys.pdf

24Fitch Ratings. The Not So Golden Years: Credit Implications of GASB 45. 2005, p.2.

25  Standard & Poor’s. U.S states OPEB Liabilities and Funding Strategies Vary Widely. National Association of Insurance

Commissioners. 2009. 

URL: <http://www.naic.org/documents/ committees_e_rating_agency_101118_hearing_doc4.pdf>.

26These Statistics, and those in the following sentence, were obtained from the American Legislative Exchange Council (ALEC) in their report titled Public Employee Other Post Employment Benefit Plans: A Case for Shifting to a Defined-Contribution Approach.

This is also a good resource for information regarding defined contribution plans. URL: http://www.alec.org/wp-content/uploads/alec_opeb.pdf

27Information regarding the Public Employee Pension Reform Act of 2012 can be found on the Governor’s website.

URL: http://gov.ca.gov/news.phpid=17694

28The Governor’s Twelve Point Pension Reform proposal was publicly released in October 2011. The 12th point is where he addressed retiree healthcare costs.

URL: http://gov.ca.gov/docs/Twelve_Point_Pension_Reform_10.27.11.pdf

29These values were obtained from the OPEB Prefunding Analysis performed for the State Controller’s Office (SCO).

URL: http://www.sco.ca.gov/Files-EO/CalSCO_OPEB_PreFunding_2012_Rounded_2_21_13.pdf.

30Note that the cost split applies only to the normal costs, and not the costs associated with the amortization of the unfunded liability.

31This is the per capita medical/Rx cost estimated by the state actuary. This assumes enrollment in an HMO plan.

32  See the Appendix for OPEB vesting details

33Increases in service years are generally correlated with increases in salary. State actuaries assume an annual payroll growth of 3.5%. 

34For more information regarding the city’s buy-out plan, please consult the Alternative Retiree Medical Program (ARMP) Presentation located on the Beverly Hills city website. 

URL: http://www.beverlyhills.org/citygovernment/departments/administrativeservices/humanresources/alternativeretireemedicalprogra

 marmp/print.jsp

35For more information on the uncertainly of OPEBs being vested under law, please see our side box Are OPEBs Obligations Revocable from our 2012 city OPEB report titled Our Cities Need Preventive Care Too How Pre-Funding and Policy Changes Can Help California’s 20 Largest Cities Manage Growing Retiree Benefit Costs.

URL: http://www.cacs.org/images/dynamic/articleAttachments/16.pdf

36The state of California OPEB Valuation as of June 30, 2012 can be found at the following:

URL: http://www.sco.ca.gov/Files-EO/OPEB_Report_02212013_Final.pdf

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