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Chiang Unveils Costs for State Retiree Health Benefits, Offers Solutions

Contact: Hallye Jordan

SACRAMENTO – State Controller John Chiang today unveiled a new actuarial report that shows California faces a $59.9 billion bill to pay for health and dental benefits for state retirees over the next 30 years.

“As the State’s obligation to pay health and dental benefits for its current and retired workforce continues to grow, it is critical that we begin making down payments on this tab and adopt strategies to reduce health care costs,” Chiang said. “Because this bill is not immediately due, California has the time and the opportunity to reduce the impact on future generations by putting additional dollars into the annual payments so that we can invest those funds, grow that money and tackle our obligation in a responsible manner.”

The unfunded obligation as of June 30, 2010, grew $8.1 billion from the $51.8 billion obligation identified in the prior year. Less than half of the increase was simply due to another year of costs, payments and interest. The bulk of the increase was due to a change in the California Public Employees’ Retirement System’s (CalPERS) pension-benefit assumptions based on their latest 10-year study. That study found employees are retiring earlier, retirees are living longer, and actual premiums increased more than previously projected by the actuary. The increase appears larger because in 2008 and 2009, CalPERS decided to use surplus funds from its health care plans to reduce increases in health care premium rates. The 2011 rates were not subsidized, causing the premiums to jump back closer to what the level would have been without the surplus.

Unlike state pensions, which are pre-funded and allow investment returns to reduce liabilities, California retiree health benefits are covered on a “pay-as-you-go” basis, meaning as the costs come due each year. The latest actuarial report estimates 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 actuarial unfunded obligation of $59.9 billion, which represents the total present value of future retiree health benefits earned as of June 30, 2010, by current and future state retirees. Based on this unfunded obligation, California has an annual OPEB cost of $4.2 billion for 2010-11 – or the amount the State would need to pay to cover these benefits. In the 2010-11 Budget Act, the State only provided $1.4 billion for retirees’ health and dental benefits.

• If the State shifted to fully pre-funding the costs of future benefits, the actuarial unfunded obligation would be cut by more than $21 billion to $38.5 billion. Under a full pre-funding approach, the State would set aside money in a separate trust solely for future
retirement health care benefits. The investment income generated by that trust would be used to reduce the costs of paying for future benefits. The State would need to contribute $2.9 billion in 2010-11 to fully fund its obligation for this year.

A separate analysis performed at the request of the Controller shows that even incremental steps toward pre-funding the obligation would significantly reduce the State’s liability (see attached chart). For example, if the State pre-funded just 10 percent of its obligation, it would only need to pay $130.3 million more than its current pay-as-you-go contribution. But that additional payment would shave $2.7 billion off of the State’s unfunded liability.

In 2004, the Governmental Accounting Standards Board Statement 45 (GASB 45) required states and local governments to publicly disclose the future costs of paying for post-employment benefits other than pensions for current state retirees and employees. Chiang commissioned California’s first report shortly after taking office in 2007. This report is the fourth to be issued under his administration.

While GASB 45 does not require states to fully fund its obligations, all three credit rating agencies have urged states to at least have a funding plan in place to avoid any future downgrades.

Chiang urged the State to follow the lead of several bargaining units that are starting to pre-fund their obligations. In August 2009, the California Association of Highway Patrolmen established a trust with the California Employers’ Retiree Benefit Trust (CERBT) to prefund its health and dental benefits for retired CHP officers under Bargaining Unit 5. Recently, other bargaining units, such as the International Union of Operating Engineers (Bargaining Unit 12) and the Union of American Physicians and Dentists (Bargaining Unit 16) have contacted the CERBT to begin the process of entering into contracts to begin in 2012 to prefund their post-retirement health and dental benefits obligations.

In addition to cutting costs by prefunding the obligation, Chiang said the State should take steps to contain health care costs by promoting prevention and wellness, and innovations in health care delivery. He also recommends switching from the traditional fees-for-services payment model to one that pays providers based on performance and outcomes.

“If we can reduce the assumed rate of health care inflation by 1 percent, that could cut our unfunded liability by $7.4 billion,” Chiang said. “I continue to call on CalPERS to make prevention and chronic disease management a priority to reduce the demand for health care.”

The actuarial report and a chart showing how much pre-funding would cut future costs can be found on the Controller’s Web site at