Sticker Shock: GASB-ing over the high cost of retiree health benefits
By:
Carol Brydolf
The language describing its potential impacts on schools may sometimes verge on the apocalyptic, but technically the new GASB 45 standard is just an accounting rule change — albeit a dramatic one.
By changing the way public employers list unfunded liabilities on their financial reports, Standard 45 from the Governmental Accounting Standards Board — GASB 45 for short — will soon require districts to calculate and publicly report the potential future costs of retirement benefits already promised to employees now on the payroll.
Why is that scary? Because, say experts, once the actuarial estimates of these future costs are in, many public agencies — including schools — will discover that the present “pay-as-you-go” system for handling non-pension retirement costs has landed them in a world of future debt. GASB 45 requires that they publicly report these future costs as unfunded liabilities or debt and come up with a plan for paying them off.
Driven by a perfect storm of double-digit increases in health care costs, an aging workforce with a glut of boomer retirees who are living longer and costing more, some districts may find themselves in serious financial trouble — at least on paper.
Under pay-as-you-go, public employers pay only what they owe in a given year and are not required to calculate costs that may be coming down the road. Critics say the system is collapsing.
“It’s like running up your credit cards to the max and making minimum payments every month on your account forever,” says Joel Montero, Chief Executive Officer of the Fiscal Crisis and Management Assistance Team, or FCMAT. “Districts that are giving uncapped benefits to retirees are going to find that expenses will soon exceed revenues.”
GASB is an accounting standard, not a law, and districts, county offices and other public employers can continue to use the old pay-as-you-go method of paying for retirees.
But by requiring districts to tally up their future retiree benefit tabs, the new rules shine a public light on what for some districts will be a shocking and rapidly growing future debt — one for which many districts are unprepared.
In a recent report the California Legislative Analyst estimated, not counting K-12 obligations, that the state faces potential future liabilities for its employees that “are likely in the range of $40 billion to $70 billion — and perhaps more.” The LAO defines this “unfunded liability” as “the amount which, if invested today, would be sufficient (with future investment returns) to cover the future costs of all retiree health benefits already earned by current and past employees.”
Part of the problem, the LAO concluded, is that health costs are out of control, rising three times faster than the rate of inflation since 1999. Employer health care premiums are rising even faster, increasing by double digits in some years, according to the report.
Act now
“It’s a national problem that’s not unique to schools,” says Tom Henry, a special trustee for Compton Community College and former CEO of FCMAT. “It’s huge, but at this time, no one from a state or local perspective has a feel for just how big it is.”
Fiscal watchdogs from the state LAO and FCMAT are urging public agencies to take action now to avoid future disaster. Districts like Fresno and San Jose have already begun negotiating benefit cuts, working with providers, hospitals and insurers to get better rates and figuring out how much money they need to put aside now so they’ll be able to pay later.
GASB 45 requires that the country’s largest districts and county offices calculate and begin reporting their unfunded liabilities beginning in fiscal year 2007, with medium and small districts following in fiscal 2008 and 2009 respectively. At the very least, districts and county offices will be forced to confront the issue publicly.
But many districts and county offices have no idea yet whether they have a problem. “The bills for many districts are growing exponentially, because they are not stopping the hemorrhaging,” says Henry. “It’s a huge problem that continues to grow. It’s already impacting the general fund in many districts on a day-to-day basis. It sounds bleak because it is.”
A looming crisis
Veteran education writer and Sacramento Bee columnist Peter Schrag says the looming problem of unfunded liability for future retirees is a major cloud on the public education horizon. “It won’t be a problem for every district, but it will be for districts in declining enrollment and that’s about half the districts in the state,” he says. “It’s the Pacman in this picture. If the system is not fixed, districts are going to get bitten.”
The LAO and other pay-as-you-go critics say the present system defers the real costs of retiree benefits to future generations, while racking up enormous long-term debt. This has ominous implications for everything from district bond ratings, which affect the cost of borrowing, to civic engagement.
The number of retirees covered by state health plans has increased by an average of 3.6 percent a year since 1998, and the LAO estimates that between 35 and 45 percent of the state’s active workforce will retire over the next decade.
The coming glut of baby boomer retirees and their expensive retirement benefits threaten to alienate younger Californians still in the workforce and contribute to what Schrag sees as a growing civic disengagement among citizens who may find their own benefits cut to subsidize workers who have long since retired. “They are going to be paying for services rendered years ago, while at the same time receiving fewer government services themselves because of budgetary constraints,” worries Schrag. “They’ll expect less from government and care less about participating.”
Plan, don’t panic
Union leaders are urging districts not to panic, contending that it would be premature for districts and county offices to begin cutting programs or trying to negotiate cuts in employee benefits.
Fresno Teachers Association President Larry Moore urges school boards not to listen to FCMAT and other “bean counters,” who he says have consistently overstated districts’ potential future liability for non-pension benefits.
“This is a red herring being used to panic districts,” he says. “I hate to see school boards get sucked in. There’s nothing in GASB 45 that requires districts to set aside huge amounts of money for future bills. Districts can’t afford to do that; we are not private businesses.”
Better, he says, to work on systemic reform, attacking the root cause of sky-rocketing health care costs and helping retirees and employees stay healthy so they use fewer services.
The California School Boards Association is among the management associations working with employee groups like the California Teachers Association and the California School Employees Association as part of the Education Coalition for Health Care Reform to explore long-term reforms. These reformers are devising strategies for negotiating cheaper group rates, encouraging wellness or working to build political support for a single-payer system that would provide universal coverage for state residents like the one proposed by Los Angeles Democratic Sen. Sheila Kuehl in Senate Bill 840.
Sally Covington, Director of the California Health Care Coalition, an umbrella group with which the Education Coalition health care reformers are working, is leading the campaign to help labor and management work together to get better care, reasonable prices and accountability from doctors, hospitals and insurers. She faults both labor and management for focusing on “cost-shifting” rather than organizing to demand better care and fairer pricing.
In the short term, however, more and more districts are cutting benefits and asking employees to pay higher premiums to keep plans afloat.
Although Moore insists that there is no need for school boards to set aside money for future retiree payments, his union has agreed to significant concessions in order to help the district stem spiraling health care costs. The most important, the district says, is a cap on the district’s per-member contribution toward health care premiums. For fiscal 2005-06, the district’s contribution is capped at $12,805 per member, for an annual cost of $97 million.
To qualify for lifetime health care retirement benefits Fresno’s newer teachers must be older and work longer than their colleagues hired in previous years. Teachers hired before July 1, 2005 can retire with benefits at age 60 after 25 years of service; compared with colleagues hired before that date who qualify for retirement at age 57 after 16 years of service. All Fresno teachers are paying slightly higher health care premiums and a $10 monthly “assessment.” The district also negotiated nominal but new fees for retirees, including those over 65, a move retirees may challenge in court on grounds that they were not represented at the bargaining table.
The district also established a Joint Management Health Board that gives management and labor equal decision-making authority on “health benefit management and delivery.”
Something’s got to give
Los Angeles school board member Mark Lansing says both labor and management need to be ready “to give up something.” At the very least, school boards need to start crunching the numbers and figuring out whether they have a problem.
“People have been arguing about whether GASB 45 is just a reporting issue or a reality issue,” says Lansing, who has been sounding the alarm about the costs of LAUSD’s lifetime health care benefits for retirees. “I don’t care what it is. We’ve got a problem. We can make all the rationalizations we want, but it won’t do any good unless we stop digging this hole.”
In September 2004, LAUSD board member Lansing compiled a “budget score sheet” to alert his colleagues to the coming crisis. Using information provided by the superintendent, district budget consultants and top administrative budget officials, Lansing concluded that the district would need to contribute $93 million every year for the next three decades to accumulate the $2.79 billion needed to cover future retirement benefits for current employees. In addition, the district would need to set aside $79 million a year for the next 30 years to reach an aggregate total of $2.37 billion to cover future benefits of employees who have already retired.
“If we do not act swiftly and responsibly, there is a real potential for the district to become insolvent within the next two years, forcing us into receivership,” Lansing warns.
At a two-day retreat on the topic in March, Lansing says the board took a hard look at serious challenges ahead.
“I think there’s a growing realization that something has got to give,” Lansing says. “There are lots of options to consider, including wellness initiatives that keep employees healthy. But we have to ask why everyone has to get Cadillac coverage. Obviously, the union doesn’t want to give anything away. But when you look at the extent of the problems, you realize that everyone has to come to the table willing to give up something.”
Preliminary GASB 45 estimates of these future unfunded retiree benefit costs are already sending shockwaves throughout the education community.
In its assessment of the state’s growing health care benefit problems, the LAO did not calculate potential liabilities of many public employers, including the University of California, cities, counties and K-12 districts.
But the report did profile two large California school districts that provide lifetime benefits for retirees and their dependents as examples of the potential costs facing schools. The LAO reported that the Fresno Unified School District had a retiree health liability of $1.1 billion in the summer of 2005 and put LAUSD’s liability at nearly $5 billion; a recent district study doubled that estimate. District costs will vary widely, depending on what health care benefits these employers offer, the age of their workforce and future premium costs.
Counting the cost
Districts that list large retirement debts on their financial reports may find that their ratings suffer, making it more expensive to borrow money and issue bonds.
At the very least, a district budget that shows huge unfunded liabilities for future health care costs for retirees is likely to affect a district’s bond rating and make it harder to borrow money or issue bonds.
“In the past, if districts didn’t have to pay it yet, it wasn’t put on the books,” says Pearl Iizuka, Palos Verdes Peninsula Unified School District Deputy Superintendent for Business Services and President of the California Association of School Business Officials. “But if you have a huge unfunded liability on the books, it begs the question: ‘Why aren’t you setting aside money for this?’ I think boards will increasingly feel pressure from the public to explain.”
Although there are no comprehensive data about the extent of potential school district liability, a number of organizations – including CSBA and FCMAT – have gathered some information.
While designing its GASB 45 Solutions program to help districts plan for the coming changes, CSBA surveyed 1,037 districts and county offices and found that 445 of 607 respondents provide some sort of non-pension retirement benefits. The survey also indicated that very few of the respondents had begun setting aside money for these future costs; 326 had never commissioned an actuarial valuation.
The LAO reported that most public employers offer some type of health care benefits to retirees, but that only 7 percent of California districts offer lifetime benefits for retired employees and their dependents. Some districts provide limited benefits until employees reach age 65 and qualify for Medicare; others require employees to contribute varying amounts toward their health care premiums or cap the amount of money the district is required to pay into the system.
At the high end of the benefit scale are districts like L.A., Fresno and West Contra Costa County. Compton trustee and former FCMAT CEO Henry says districts simply can no longer afford these benefits.
In a cover story on skyrocketing health care costs in the fall 2005 issue of California Educator, the California Teachers Association reported that generous health care benefits were once considered a “bargain,” a way to fatten compensation packages without giving teachers big raises. Now those decisions are coming back to haunt many.
In West Contra Costa, for example, Henry says, a school administrator or teacher like himself who is already vested in the State Teachers Retirement System or Public Employees Retirement System can easily qualify for lifetime health care benefits. “I would only have to work there for a year to get full health care for myself and my wife,” he says. In fact, he adds, one of his former colleagues did just that, earning generous retirement health care benefits for herself and her spouse after a single year of service in the district.
Forced to confront GASB early
But the problem is not confined to districts that provide lifetime benefits. Consider the case of Corning Union Elementary, a district that had no choice but to confront its GASB 45 liabilities years ahead of schedule after fiscal watchdogs at the Tehama County Office of Education rejected its budget in September 2003.
The district had provided uncapped health care benefits to certificated employees and retirees until age 65, at which time they qualify for Medicare. But health care costs for Corning’s 215-member workforce and 15 retirees helped contribute to the district being on the verge of bankruptcy.
According to the actuarial study that was required as part of Corning’s fiscal recovery plan, the district would need to set aside $4.1 million immediately to cover retirement benefits for the district’s 15 retirees and future costs for the 215 now on the Corning payroll. “They told us, ‘You won’t be able to fully fund it, because you don’t have enough money,’ ” says Corning Business Manager Wes Grossman.
Instead, district actuaries developed a number of scenarios for establishing a special trust to cover future benefits. The district opted for a 22-year plan that called for an initial deposit of $335,000 into an irrevocable trust and annual deposits of between one-half to 2 percent of payroll over the next two decades.
The district also negotiated significant concessions from employees, who received no pay raises (except for step and column increases) between 2003 and 2005. Employees also agreed to a district cap on benefits of $10,671 per employee in fiscal 2003-2004 and $9,800 per employee in fiscal 2004-2005, which cut further into earnings. Employees must now pay the difference between the district’s contributions and the actual costs of the benefits, which in 2003 had already reached $13,000 a year.
“It was very tough,” says Grossman, “but we got it.”
Suzi Rader, CSBA’s Director for District and Financial Services, says Corning’s situation is hardly unique. “The numbers are almost always bigger than districts think,” she says.
Rader should know. She’s been working closely with Corning and a number of other districts as part of the GASB 45 Solutions program, a CSBA service that helps education agencies comply with the new standards and plan for how to finance future non-pension retiree costs.
“Because districts don’t have to do anything right away, I’d say it’s premature to say districts are in denial,” she says. “But the sooner they determine whether they have a problem, the sooner they can start planning for the future.”
Carol Brydolf (cbrydolf@csba.org) is a staff writer for California Schools.
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