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Chiang Urges Action on State's $72 Billion Unfunded Retiree Healthcare Liability

Contact: Jacob Roper

Unveils pre-funding plan that uses investment returns to lower costs

SACRAMENTO – State Controller John Chiang today released a new report showing the unfunded liability of providing health and dental benefits for state retirees under the current funding policy is $71.8 billion. The amount represents the present-day cost to provide benefits earned as of June 30, 2014, which is expected to be paid over the lifetime of current and future retirees.

The total unfunded obligation grew $7.2 billion from the $64.6 billion obligation identified as of June 30, 2013. Healthcare claims did not grow as rapidly as expected, and design changes in health systems also helped to lower costs, but those positive events were outweighed by new mortality assumptions that alone added $7.1 billion to the liability. Specifically, men are assumed to live approximately 2 years longer than previously expected. For women, the new mortality assumptions increase life expectancy by up to 1.8 years.

"The price tag associated with providing healthcare to retired state workers has quietly grown to rival or even eclipse the funding gap associated with public pensions," said Chiang. "While important steps have recently been taken to properly fund the State's pension obligations, we remain dangerously complacent about a liability that has grown by a stunning $24 billion in just the past eight years. If we continue to do nothing, we will be sowing the seeds of a future crisis."

Today's annual report is the eighth time Chiang has sounded the alarm on unfunded retiree healthcare costs. His first report, in 2007, identified the long-term liability at $47.8 billion. Today's unfunded liability is 33 percent higher.

While state pensions are pre-funded, allowing investment returns to significantly reduce liabilities, California only pays for retiree health benefits on a "pay-as-you-go" basis, or only covering the minimum amount needed to fund the costs as they are due. The latest actuarial report provides estimates of California's obligation for retiree health and dental benefits, also referred to as Other Postemployment Benefits (OPEB), based on two different funding scenarios:

  • The current pay-as-you-go policy results in an unfunded liability of $71.8 billion, which represents the present-day cost of providing retiree health benefits earned by current and future state retirees. Based on this funding policy, California should pay more than $5 billion in 2014-15 to fund the costs as they are due as well as the future costs of paying retiree healthcare benefits.  However, that year’s Budget Act only provides $1.9 billion to cover just the actual costs of current retirees' health and dental benefits.
  • If the State shifted to fully pre-funding the costs of benefits earned in the future, the unfunded liability for FY 2014-15 could be cut by $25 billion (or 35 percent) to $46.8 billion because, under current governmental accounting rules, a higher discount rate can be supported. Under a full pre-funding approach, money would be set-aside in a separate trust solely for future retiree healthcare benefits. The investment income generated by the trust would be used to reduce future costs to the State and its employees of paying for retiree healthcare benefits. To take advantage of the tremendous reduction in liability from fully-prefunding, the State would need to contribute $3.7 billion in 2014-15, or $1.8 billion more than the State currently has budgeted.

Recognizing that fully pre-funding this obligation cannot be accomplished overnight, Controller Chiang proposes that the initial objective be to annually put away enough money to cover the full costs of retiree health benefits earned that year by active employees.

"This is a liability that has grown over decades of poor fiscal planning and a callous willingness to pass along debt to our children's generation," said Chiang. "While it can't be erased overnight, we have to resolve ourselves to meaningful progress. Let that first step be a commitment that liabilities created by one generation of Californians be fully paid by that generation and not passed off to the next.

"With pre-funded pensions, investment returns cover roughly two-thirds of all payouts. By pre-funding healthcare in a similar manner, we can allow interest returns to significantly reduce the burden on workers and the taxpayers they serve."

The Controller proposes a five-year implementation plan, at the end of which retiree medical and dental costs earned annually in the future by its active workforce (often referred to as "normal costs") will be fully pre-funded, reducing the unfunded, long-term liability by $19.5 billion because a higher discount rate can be supported under the funding policy.

The following table details the level of pre-funding of normal costs that would be achieved during each of the five years, the amount in annual contributions that would be needed above and beyond the $1.8 billion pay-as-you-go amount, and by how much the $71.8 billion liability would be reduced.

Fiscal Year Cumulative Amount of Annual Payments above Current Contribution Level of Pre-funding of Costs Associated with Current Workforce Reduction in Unfunded Liability Due to Additional Payment
2015-16 $250m 10% $3.2b
2016-17 $670m 30% $8.7b
2017-18 $1.0b 50% $12.8b
2018-19 $1.3b 70% $16.1b
2019-20 $1.7b 100% $19.5b

In addition to cutting costs by prefunding the obligation, Chiang said the State should continue to be aggressive in its efforts to contain healthcare costs by promoting prevention and wellness and innovations in health care delivery.

Read the actuarial report.

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