How to solve the OPEB problem (Part II)

In yesterday’s post, we suggested that, if City Council truly is interested in solving Alameda’s “OPEB problem,” it ought to break the issue of “unfunded liabilities” into its two components.  Yesterday, we discussed “liabilities” – i.e., what the City owes for medical benefits for retired employees (aka Other Post-Employment Benefits or “OPEB”)  – and what it can do about them.  Today, we’ll talk about funding – i.e., how the liabilities are going to get paid – and what can be done about that part of the problem.

According to the actuaries, the City’s “unfunded liabilities” for OPEB were $86.4 million as of January 1, 2011.  The “liabilities” represent today’s cost of providing health insurance – for life – to current employees upon their retirement as well as to employees who are already retired.  As more workers are hired, people live longer, and health care costs rise, the debt gets larger.  And since the City has set aside nothing – absolutely nothing – to pay its future health insurance tab, the liabilities are referred to as “unfunded.”

This is an extraordinary state of affairs.  No prudent person would choose not to save money to pay bills he or she knows will come due in the future.  No responsible government should choose not to put away money to pay retirement benefits, either.  In fact, CalPERS requires municipal employers offering pension plans to make annual contributions to fund their future pension obligations.  Historically, the required contribution hasn’t been enough to cover all of the future cost – which is why we have “unfunded liabilities” for pensions, too – but CalPERS recently increased the contribution rate in an effort to close the gap between total assets and total liabilities.  But for some reason cities – and Alameda is not alone – have allowed their OPEB debt just to grow and grow.

As the staff report prepared for Council recognizes, it isn’t as if no one has called upon cities to mend their ways.  Back in 2008, the very first recommendation made by the Public Employee Post-Employment Benefits Commission appointed by the Governor was that, ”Public agencies providing OPEB benefits should adopt prefunding as their policy.”  (“Pre-funding” is pension-speak for setting aside money now to pay for benefits due in the future).  The same year, Alameda City Manager Debra Kurita (prompted by Interim Finance Director Ann Marie Gallant) not only endorsed pre-funding but presented Council with four ways to do it.  (Council ignored them).  Since then, the chorus has grown even louder.  As one recent article by a nonpartisan research group stated the case,

Pre-funding accumulates assets towards paying future costs and supplements them with investment profits. It is also dictated by the simple idea that the costs of benefits (such as pensions) should be realized as they are earned, not de­ferred into the future. In addition to any normative argu­ments, pre-funding discourages irresponsible political be­havior that saddles future generations with costs they may not be able to bear.

The pre-funding approach usually focuses on the municipal employer setting aside money to pay for OPEB.  But there is another potential source of funds: the employees who will get the benefits when they retire.  At present, Alameda’s public employees – current and retired — pay nothing toward the cost of their retiree medical benefits.  To some, it seems only fair that the beneficiaries shoulder at least part of the burden.  The new pension law passed by the State Legislature and signed by the Governor last year establishes the “standard” that current employees pay 50% of the “normal cost” of their pensions.  (In pension-speak, “normal cost” refers to the value of the benefits “earned” during the current year).  But if that’s the standard for pensions, why shouldn’t it be the standard for OPEB, too?

According to Bartel and Associates, the City’s actuarial consultant, the “normal cost” of the OPEB “earned” by Alameda public employees in fiscal year 2012-13 was $3.343 million.  If current employees ponied up half of that amount and the funds were invested in a trust, the accumulated assets would reduce the amount the City itself would have to pay – i.e., its unfunded liabilities – for retiree medical benefits in the future.

Requiring current employees to contribute toward OPEB costs – whether by paying half the “normal cost” or in some other amount – is one of the options identified in the staff report prepared for Council.  But it would take consent by the unions to make it happen.  Last year, when the public safety unions agreed that current employees would pick up a part of the increase in health insurance premiums, union leaders – and City staff – hailed the move as a huge concession.  But it will cost union members collectively only $629,000 over four years.  Being required to contribute toward OPEB costs as well would produce a payroll deduction those members might actually feel.  They may well ask, Haven’t we done enough already?

If Alameda’s public employees can’t be convinced to chip in toward the cost of their retiree medical benefits, it will be up to the City to figure out a way to fund the OPEB liabilities itself.  There are only a few possibilities.  In theory, the City could use revenues from current operations – e.g., taxes — to set up a fund to be used to pay for retiree medical benefits in the future.  Indeed, this was the recommendation made by the Fiscal Sustainability Committee (“FSC”) back in 2008: in addition to paying this year’s health insurance premiums for retirees – which is all the City did then, or does now – it also should contribute money to an OPEB trust.  The staff report prepared for Council floats a similar idea.

But the 2008 Council took no action on the FSC recommendation, and it is unlikely that this Council will be any more inclined to go this route.  Under the two-year budget approved last month, the City will need to draw down general fund reserves next year just to cover the projected shortfall between revenues and operating expenses.  And the drawdowns are expected to get bigger every year thereafter, to the point where the reserve balance falls to $7.2 million – well below the talismanic 20% threshold — by the end of Fiscal Year 2017-18.  Under these circumstances, funding an OPEB trust from current revenues seems highly problematic.

The alternative to setting aside current revenues is to sell City-owned assets and use the proceeds to fund the OPEB trust.  According to its report, the Pension/OPEB Task Force considered this approach, but some of the proposals seem a little fanciful.  One of them was to sell Alameda Point.  Three members of the Task Force, which included the current and former presidents of the firefighters union and the current police union president, actually ranked this idea first or second on their list of potential solutions.  Unfortunately, as an unsuccessful Council candidate known to the Merry-Go-Round pointed out on her campaign blog, and City Manager John Russo confirmed, this proposal was, well, illegal, since the conveyance agreement between the City and the Navy requires that any proceeds from the sale of land at the former Naval Air Station must be used exclusively for the development of Alameda Point.  Of course, the City still has the power company available to put on the auction block.

Then there’s the Beverly Hills buyout.  To attack its own problem with unfunded OPEB liabilities, the city of Beverly Hills came up with a plan to offer cash to its current employees in exchange for their retiree medical benefits.  Workers who took the deal got cash equal to the actuarial value of their accrued retiree medical benefits.  Of this amount, they had to contribute 20% to a new health savings plan; the rest they could keep.  Beverly Hills raised the money to make the buy-out by issuing municipal bonds at a 4.5% interest rate.  By trading a soft liability with escalating, uncontrollable costs for a hard liability with lower, fixed costs, the city not only slowed the growth of its unfunded OPEB liabilities but actually decreased them.  According to the city’s estimate, the strategy will reduce Beverly Hills’s unfunded OPEB liabilities by $157 million over 40 years.

One of the exhibits to the staff report prepared for Council is a PowerPoint presentation about the Beverly Hills buy-out.  It makes clear that the strategy raises a host of legal issues relating, in particular, to taxes.  Fortunately, the law firm that prepared the part of the PowerPoint addressing these issues, Hanson Bridgett LLP, is well-known to at least one Councilmember:  Vice Mayor Marilyn Ezzy Ashcraft, whose husband is a partner in the firm.  No word about whether she can arrange a discount.

In the end, funding the City’s OPEB liabilities may pose as difficult a challenge as changing the system that created those liabilities.  One can only hope, however, that Council will choose to do more than rely on proposed solution no. 3 in the Pension/OPEB Task Force report: “Use any ‘windfall’ moneys the City may receive to help” pay for OPEB.  The prospect of seeing Mayor Gilmore and City Manager Russo sitting on the steps of City Hall waiting for Ed McMahon to appear with a check is just too hard to bear.

Sources:

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

Exhibit to July 23, 2013 staff report (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

October 30, 2012 staff memo on Pension/OPEB Task Force: 2012-10-30 staff memo re pension task force report

Pension/OPEB Task Force report: 2012-10-30 task force report

Public Employee Post-Employment Benefits Commission, “Funding Pensions and Retiree Health Care for Public Employees (2008): Funding Pensions & Retiree Health Care for Public Employees

California Common Sense, “Paving a Way Out: Options for Managing California’s Rising Retirement Healthcare Costs” (April 18, 2013): CACS OPEB paper (2013)

California Common Sense, “California’s Neglected Promise: How California Has Failed to Prepare for its Accumulating Retiree Health Care Obligations” (2012): CACS OPEB paper (2012)

Girard Miller, “Strategies to Consider as OPEB Costs Escalate” (Government Finance Review, February 2011): Government Finance Review OPEB article

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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