How to solve the OPEB problem (Part I)

If City Council truly is interested in solving Alameda’s “OPEB problem,” the first thing it needs to do is to define exactly what problem it wants to solve.

The actuaries tell us that, as of January 1, 2011, the City had incurred $86.4 million in “unfunded liabilities” for medical benefits to be provided to retired employees in the future (aka Other Post-Employment Benefits or “OPEB”)  The phrase “unfunded liabilities” encompasses two distinct aspects.  One is “liabilities” – i.e., how much the City owes.  The other is “funding” – i.e., how the liabilities are going to get paid.

The various strategies proposed to solve the “OPEB problem” focus on one or the other of these two aspects of the issue.  For that reason, it makes sense to analyze each of them separately.  Today, we’ll discuss OPEB “liabilities” and what the City can do about them. Tomorrow, we’ll turn to funding.

Let’s start with how the OPEB liabilities arose in the first place.  No federal or state law requires a city to provide medical benefits for retired employees.  But the City of Alameda has negotiated contracts with the public employee unions in which it has agreed to pay for health insurance for retirees – for life.  The contract terms governing such things as eligibility, coverage, and benefit levels determine how much the City owes for OPEB. Accordingly, the most straightforward way to reduce OPEB liabilities is to change those terms to make it less expensive to provide retiree medical benefits.

Take a look at a couple of the key contract provisions:

  • Public safety employees hired before June 7, 2011 need to work for the City for only five years in order to become eligible for lifetime retiree medical benefits.  For public safety employees hired after that date, it’s 10 years.
  • Similarly, the City pays for health insurance coverage for the spouses of retired public safety employees hired before June 7, 2011, which includes all current retirees.  Public safety employees hired after that date get coverage upon retirement only for themselves.
  • For public safety employees who were hired and retired before June 7, 2011, the City pays the premiums for the health plan chosen by the retiree from those offered by CalPERS.  This costs $2,166 per month.  For public safety employees who were hired before and retired after June 7, 2011, the City pays the premiums for a Kaiser or Blue Shield Bay Area health plan – whichever the retiree picks.  This runs $1,569.26 per month.  But for all other retired public employees, the City pays only the minimum required by CalPERS – all of $115 per month — toward health insurance; it’s up to the retiree to make up the difference.

Now suppose the City made the eligibility period for public safety employees 10 (or even 20) years across the board and eliminated spousal coverage altogether.  Then suppose the City standardized the amount paid for health insurance for all retired employees at the CalPERS minimum.  By taking one – or all – of these three steps, the City would make its retiree benefit plan less expensive and thereby reduce the amount of its OPEB liabilities.

Savings would result even if the City didn’t go all the way in any of these areas.  For example, the staff report prepared for Council describes a staggered eligibility structure in which employees who work 10 years qualify for 50% of the full benefit and it takes 20 years to become eligible to get it all.  Such a structure, the staff report says, “is consistent with the PERS pension benefit design and would encourage employees to work longer.”  Similarly, rather than putting public safety retirees on the same footing as other retired City employees by paying only the CalPERS minimum, the City could pick a figure somewhere between the minimum and the current benefit level.  This approach resembles the federal government’s design for Obamacare, which subsidizes only basic health insurance coverage.

More dramatic action also is possible.  Instead of reducing its OPEB liabilities by changing the existing contract terms, the City could offer a different deal entirely.  The current retiree medical benefit plan – like the current pension plan – is a “defined benefit” plan in which the benefits to retirees are fixed, and the City is obligated to pay whatever it takes to provide them.  The alternative is to go to a “defined contribution” plan in which the annual payments by the employer are fixed, the funds are deposited into a trust and invested, and benefits are paid out of the accumulated trust assets.

The trend in the private sector is to move from defined benefit to defined contribution plans because the latter shift the risk of inflation in health care costs from the employer to the employee.  Generally speaking, they’re also less expensive.  And the idea seems to be catching on in the public sector as well.  The most prominent example is the city of Beverly Hills, whose plan is described in the staff report prepared for Council.

At this juncture, you might well be saying, Hey, wait a minute.  These are contracts we’re talking about.  As the proverbial first-year law student knows, you can’t change the terms of a contract – much less tear up one contract and put another in its place – without the consent of both parties.  So unless the firefighters and police unions go along, forget about all these ways of reducing the City’s OPEB liabilities.  The City may pay the piper – but it’s the unions who call the tune.  What else is new?

You’d be right – up to a point.  The politicians and the unions have shown willingness to rein in retirement benefits – as long as the burden falls solely on future employees.  The new pension law passed by the State Legislature and signed by the Governor last year is one example: Virtually all of the changes the law makes to required or permitted pension terms apply only to new hires.  The same is true in Alameda.  The much-ballyhooed “concession” made by the public safety unions last year – removing spousal benefits for retirees — affects only cops and firefighters hired after June 7, 2011.  The best we can tell from the City and union Websites, only three firefighters fit into this category.  Neither the current public safety union members participating in the retiree medical benefit plan – 182 people as of January 1, 2011 – nor the retired public safety union members already receiving benefits under the plan – 209 people – feel the pinch.

Eliminating retiree health insurance coverage for the spouses of three guys who won’t be retiring for many years won’t make much of a dent in the City’s OPEB liabilities.  Changing the terms of the arrangement for already retired public safety employees is another matter.

Take a look at those numbers again:  As of January 1, 2011, 209 public safety retirees are participating in the retiree medical benefit plan.  Dig a little deeper and you’ll find that, of that group, 34 retirees are getting full family health insurance coverage and another 107 are getting coverage for themselves and their spouses.  You’ll also find that 28% of the retirees under age 65 and 31% of the retirees over age 65 are enrolled in health plans other than Kaiser and Blue Shield – presumably, these are the infamous “Cadillac plans.”  Getting rid of spousal coverage and putting a lid on premium payments for already retired public safety employees might actually save the City a ton of dough.  (The City’s actuarial consultants, Bartel and Associates, could give us a pretty good estimate of the amount).

One could argue that scaling back medical benefits for retired employees amounts to reneging on a promise the City made to them when they were working.  That would be so  – if the promise is viewed as binding on the City for all time.  If not, cost-cutting measures like these may be perfectly legal.

Recently, California public employers – including Contra Costa and Sonoma counties – have responded to the crisis of unfunded liabilities by placing caps on the amounts paid for retiree medical benefits.  Then, when the lawsuit invariably follows, the employers have defended their decisions by asserting that they have no contractual duty to abide by the prior benefit formula forever.

Both the California Supreme Court and the federal Ninth Circuit Court of Appeals have weighed in on the legal issue.  These courts have placed the burden on the retirees to prove that their employer promised to keep the same benefit plan in perpetuity.  If the contract itself doesn’t contain an express promise to that effect, the retirees have to find other evidence to show that was the employer’s intent.  The cases involving the Bay Area counties haven’t gone to trial, but one federal judge in southern California threw the retirees out of the court because, he held, they hadn’t shown the requisite intent.  (The retirees have appealed).

But let’s not kid ourselves.  The odds of City Manager John Russo recommending that Council unilaterally cut medical benefits for retired employees are about as high as those of seeing John Knox White cruising down Park Street in a Cadillac Escalade.   Should Mr. Russo be seized with a fit of masochism, the odds of anyone on this Council voting for such a recommendation – and thereby kissing their political careers goodbye – are no higher.  We’ll even bet that Mr. Russo has City Attorney Janet Kern primed to deliver a memo stating that, in her opinion, any effort to slice medical benefits for retired employees would be unconstitutional.

But who knows?  Maybe the unions will agree after all to reductions in the medical benefits their members will get when they retire.  This may seem far-fetched.  But when the four-year public safety contracts were presented to Council last December, IAFF Local 689 president Dom Weaver stood up and solemnly declared, “We want to be part of Team Alameda.”  Having just gotten a deal that added $2.6 million to the general fund deficit, perhaps the public safety unions now will be willing to take one for the team.

Sources:

July 23, 2013 staff report: 2013-07-23 staff report re OPEB

Powerpoint presentation on Beverly Hills buy-out: 2013-07-23 Ex. 5 to staff report (BH plan)

Bartel and Associates OPEB report: 2011-10-04 Bartels report on OPEB

2013-17 IAFF MOU: 2013-17 MOU

Harris v County of Orange, 682 F.3d 1126 (9th Cir. 2012): Harris v. County of Orange

Sonoma County Association of Retired Employees v. Sonoma County, 708 F.3d 1109 (9th Cir. 2013): Sonoma County Association of Retired Employees v. Sonoma County

Retiree Support Group of Contra Costa County v. Contra Costa County, — F.Supp.2d –, 2013 WL 1915661 (N. D. Cal. 2013):Retiree Support Group of Contra Costa County v. Contra Costa County

Retired Employees Association of Orange County, Inc. v. County of Orange, slip op.: Retired Employees Association of Orange County v. County of Orange

About Robert Sullwold

Partner, Sullwold & Hughes Specializes in investment litigation
This entry was posted in Budget, City Council, Firefighters, Pensions and tagged , , , , , , , , , , , , . Bookmark the permalink.

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