Observers interested in Detroit’s recent filing for bankruptcy may be surprised to find that it still owes $6.4 billion in other post-employment benefits (OPEB) like health care, Bob Pozen wrote for The Brookings Institute on Thursday, more than twice what it owes in pension obligations.
Pozen acknowledged that unfunded health care obligations tend to get less attention than unfunded pension benefits, but said that a gap like the one seen in Detroit is not uncommon. “Detroit is not unique in this respect. The unfunded health care obligations of most cities are much larger than their unfunded pension obligations,” he wrote.
As an example, he pointed to other large cities with pension and health care shortfalls similar to those in Detroit, according to a study released earlier this year by the Pew Charitable Trust. In New York, the pension shortfall is $14,302 per household, while the OPEB shortfall is $22,857. In San Francisco, the pension shortfall was $1,677, but the OPEB shortfall approached $13,500.
“Unfunded retiree health care benefits are generally larger than unfunded pension deficits for regulatory reasons,” Pozen (left) wrote. “Only in 2006 did the government accounting board begin to require that local governments report their unfunded retiree health care obligations in their public financial statements. Until then, these unfunded obligations were below the radar screen and allowed to increase rapidly.”
As a result, even cities with the worst-funded pension plans can boast funding levels of 50% or 60%, while the average city only has a 5% funding level for health care obligations, according to Pozen.
Unlike pension obligations, cities can usually modify their health care obligations, Pozen said. He offered six strategies that cities have used to ease the burden of healthcare obligations they couldn’t meet.
- First, many states have reduced the benefits they offer new municipal employees. Unfortunately, it may take several years to see the results of this strategy, Pozen said.
- Some have required employees to join Medicare when they reach age 65, although some are still paying a “significant portion of Medicare premiums for their retirees,” Pozen wrote.
- Under the Affordable Care Act, cities could require retirees under age 65 to get health insurance through exchanges. Some could be eligible for partial federal subsidies for their premiums.
- Cities could amend their policies by increasing deductibles and co-payments, or cut back on what they cover like dental or vision benefits.
- Cities could raise the number of years an employee has to work before earning retirement benefits.
- Finally, they could fund health care obligations in advance, similar to how pension obligations are funded. Funding from general municipal revenues and employees could be invested in a separate trust.
Ultimately, reducing the health care obligations cities owe their public retirees is critical, Pozen wrote. “Although such reductions will be politically controversial, they are necessary for most cities—in the short term to avoid a spike in the interest rates paid on their municipal bonds, and in the long term to avoid a fiscal crisis like the current one in Detroit.”