Retiree Health

Introduction | Consumer-Driven Health | HSAs & HRAs | Retiree Health

What are retiree health or OPEB benefits for public employees?

When they retire, public employees in California typically receive monthly pension payments, as well as health, dental, or other benefits that are funded in part by their former employer. These health, dental, and other benefits are called "other post-employment benefits" (OPEBs) by financial experts. There is no standard pension or OPEB benefit package for retired public employees. Employees of different governmental entities (the state, universities, cities, counties, school districts, and other public entities) receive different levels of benefits. In some cases, governments offer no OPEB benefits to their retirees.

On this Web site, we refer to OPEBs as retiree health benefits. Retiree health benefits are the most expensive OPEBs.

Why are retiree health costs an issue now?

Nearly all governments pay for health benefits for their retired employees on a pay-as-you-go basis each year. Generally, no funds have been set aside to address future benefit obligations.

In California and across the country—in both the public and private sectors--employers' costs for these retiree health benefits have been rising rapidly. There are two main reasons for these cost increases. First, health care premiums have been rising faster than inflation for many years. Second, the aging of the "baby boom" generation, as well as lengthening life expectancy, have increased the number of retirees receiving these benefits. In California, recent changes in public pension systems also have increased incentives for public employees to retire earlier, and this has contributed to an increase in the number of retirees receiving health benefits.

For governments, when retiree health costs rise faster than the rate of growth of tax revenues, a larger and larger percentage of governmental revenues must be devoted to providing retiree health benefits. This means that a smaller percentage of revenues is available to provide services to the general public and to pay current governmental employees.

What is GASB 45?

The Governmental Accounting Standards Board (GASB) is a nonprofit entity that sets accounting standards for state and local governments in the United States. The GASB is similar to the professional boards that set accounting standards for private sector entities and the federal government.

Beginning in 2007, the provisions of GASB Statement 45 (GASB 45) will begin to take effect for state and local governments. Under GASB 45, over the next several years, state and local governments will—for the first time—compile data about their retiree health and similar benefits and have an actuary calculate the unfunded liabilities that have been accrued to provide those benefits to retirees in future years. Governments already collect such information for their pension systems.

The GASB 45 is an accounting standard—not a legal requirement for governments to change anything about current public retiree health benefits or their funding. Nevertheless, under state and local laws, as well as bond agreements, most governments must release financial statements that comply with GASB rules, such as GASB 45, each year. Therefore, most governmental entities will release financial statements that include a valuation of unfunded retiree health liabilities at some point during the next few years.

What is an unfunded liability?

An unfunded liability exists when a governmental or corporate entity has an obligation to provide payments or benefits to groups of individuals, but has set aside no money to fund all or a part of that obligation.

Unfunded liabilities for retirement systems are estimated by actuaries. Actuaries make assumptions about a pension system's investment returns, the life expectancy of public employees, and future public employee salary increases to estimate the future costs of benefits that have been earned by current and past public employees. In very simplified terms, the unfunded liability is the amount of extra money that would need to be set aside today and invested by the pension system to cover the future costs of all promised benefits earned to date by members of that pension system.

Under Governmental Accounting Standards Board Statement 45 (GASB 45), governments will calculate unfunded retiree health liabilities for the first time. Because most governments have never had to set aside any funds to address future retiree health obligations, unfunded retiree health liabilities generally will be massive—often much larger than governments' unfunded pension liabilities.

What can governments do about retiree health costs?

Under Governmental Accounting Standards Board Statement 45 (GASB 45), most governments will report very large unfunded retiree health liabilities. Left unfunded, these liabilities may continue to result in rapidly growing costs each year for the foreseeable future. Over time, addressing the costs of these liabilities will tend to consume a larger and larger percentage of governmental revenues.

There are two basic ways for governments to address unfunded retiree health liabilities. Governments can either (1) set aside money and invest it in order to address part or all of the future costs of retiree health benefits (sometimes called "prefunding") or (2) change retiree health benefits in some way so as to reduce future costs. Because unfunded retiree health liabilities often will be very large, neither of these options represents an easy choice for many public entities. Eliminating retiree health liabilities, for example, may require setting aside large amounts of money or implementing large cuts in benefits for some or all retirees.

What about issuing bonds to address retiree health liabilities?

Some governments have adopted a strategy that involves issuing bonds and depositing the proceeds of those bonds into an investment account to reduce unfunded retiree health liabilities. In some cases, this may be a viable option, but the approach carries some risks. If, for example, investment returns are weak in some years and reduce the value of this investment account, the government generally will still be obligated to pay for benefits, as well as the debt service on the bonds (including interest).