ElderBranch recently published a study describing the major unfunded healthcare liabilities in America’s largest cities. These promises to current and future retired city employees played a large part in Detroit’s decision to file for bankruptcy; nonetheless, the large and growing unfunded healthcare liabilities in cities nationwide continue to command little attention from local legislators.
The longer cities choose to underfund their healthcare plans, the more likely it is that city leaders will be forced to take drastic actions to deal with these large and growing liabilities in the future. In fact, as our analysis below shows, over half of America’s largest cities will very likely be unable to close their funding gaps through revenue increases and general spending cuts alone. As a result, many city employees are likely to see their retirement health benefits significantly reduced.
Cities Continue to Fall Short of their “Annual Required Contribution”
Each year, actuaries estimate cities’ “annual required contribution (A.R.C.)” to properly fund healthcare plans for retired city employees. The A.R.C. is the amount that, if paid on an ongoing basis, is projected to cover the normal cost of care in a given year, as well as to properly fund benefits already accrued and unpaid (the unfunded actuarial liability) over a period of less than 30 years.
Put simply, if cities pay their A.R.C. each year, over the course of 30 years, they will have saved enough money to pay for the healthcare costs of all current and future retired city employees. If cities do not pay their A.R.C., on the other hand, the underfunded healthcare liability will continue to grow, making future attempts at closing the deficit even more difficult.
Despite this mathematical reality, many cities across the country have continually failed to meet the A.R.C. for city employees’ future healthcare benefits. As seen in Graph 1 below, in Fiscal Year 2012, only five cities (Washington D.C., Los Angeles, Phoenix, Boston, and Charlotte) paid over 95 percent of their respective annual required contributions. Fourteen of the 25 largest cities paid less than 50 percent of their A.R.C.
How Can Cities Close their A.R.C. Gaps?
The underfunding of benefits that have been promised to retired city employees cannot continue indefinitely. Whether it is driven by pressure from rating agencies or concerned employees, eventually city leaders will be forced to find a way to close underfunded liability gaps. When they do, three options are available to city leaders: increase taxes, cut spending elsewhere and redirect funds to healthcare benefits, or reduce healthcare benefits for city employees.
Option 1: Raise Taxes
No politician wants to raise taxes. Nonetheless, faced with difficult budget realities, city leaders at times must turn to their citizens to ensure that desired spending levels can be maintained. For example, in November 2009, citizens of Springfield, Missouri approved a 0.75 percent increase in the sales tax over five years to help close its underfunded pension liability for city employees.
Are increased taxes an option to close the unfunded healthcare liability gap in America’s largest cities? To answer that question, ElderBranch looked at the difference between the A.R.C. in Fiscal Year 2012 and what cities contributed towards that amount (called the “A.R.C. Gap”). The A.R.C. Gap per household is presented in Graph 2.
We then compared the A.R.C. Gap to the current level of General Fund Revenues collected in Fiscal Year 2012. The resulting percentage (seen in Graph 3) illustrates the amount each city would need to increase taxes (or other forms of revenue) such that they could pay 100 percent of the A.R.C. on a go-forward basis.
If Springfield, Missouri is a case study for the political feasibility of raising taxes to close public employee benefit liabilities, raising taxes alone does not appear to be an option for most of America’s largest cities. In fact, Springfield was only able to obtain public support for its sales tax increase after residents voted down an earlier 1.0 percent tax increase proposal. Indeed, only Boston, Charlotte, Denver, and Jacksonville would be able to close their A.R.C. Gaps by raising taxes less than 0.75 percent.
Option 2: Cut Spending
Not only is raising taxes difficult politically, but the above analysis shows that it would not be sufficient to close the gap in most cities. As a result, cities may find themselves looking at other areas in the budget where they can cut spending and redirect those funds towards closing the A.R.C. Gap.
San Jose is an example of a city that has begun to do just that to close its $1.5 billion unfunded pension liability and $2.0 billion unfunded healthcare liability (together representing over $11,400 per household). Over the last few years, San Jose has laid off firefighters and police officers, closed libraries and community centers, and cut salaries and hours for those city employees who have not been fired. Unfortunately cuts alone have not been able to fully close the benefit gaps in San Jose – but what about in other cities?
To answer that question, ElderBranch compared each city’s A.R.C. Gap to its expenditures. The resulting percentages (see Graph 4) illustrate the amount of General Fund Expenditures, funding items like law enforcement, prisons, libraries, highway and street maintenance, public health and hospitals, and other general government expenditures that must be cut to fully close the A.R.C. Gap for healthcare benefits.
The level of public spending varies widely by city – Washington D.C., for example, spends over $23,000 per household, while El Paso spends only $1,512 per household – and each city’s ability to cut spending without sacrificing other vital public interests can only be known at a local level. Nonetheless, the analysis above demonstrates that closing the healthcare benefit A.R.C. Gap through spending cuts alone would require significant sacrifice in most major American cities.
Option 3: Reduce Healthcare Benefits to Current and Former Employees
Given the significant underfunded healthcare liabilities and large A.R.C. Gaps in most large American cities, ElderBranch’s analysis shows that most cities will be unable to rely on raising taxes and spending cuts alone. As a result, in the coming years, public employees nationwide are likely to see local legislators implement reductions in the healthcare benefits that had previously been promised to them.
There are a number of ways in which cities nationwide have started to do just that:
1. Increase Employees’ Contribution
As healthcare costs continue to grow, employers nationwide have begun to ask their employees to chip in more for healthcare costs. This has come in the form of paying a higher percentage of total premiums, increasing deductibles, and requiring higher co-pays.
Cities have started to follow suit. For example, in March 2011, Los Angeles reached a collective bargaining agreement with its 19,000 existing employees to increase their contributions towards their pension plans from 6 percent of salary, to 11 percent of salary. That same month, L.A. voters approved a new ballot measure requiring that newly hired police and firefighters begin contributing 2 percent of their salaries toward their retiree healthcare.
ElderBranch examined what percentage of city employees’ current pay (“Covered Payroll”) would be needed to be automatically deducted by the city to close the A.R.C. Gap. The results are illustrated in Graph 5.
Cities’ ability to completely close the A.R.C. Gap through increased employee/retiree contributions will vary depending on the current level of employer/beneficiary cost-sharing as well as the willingness of public-sector unions to negotiate on this item. Regardless, in cities where the A.R.C. Gap is greater than 10 percent of employee pay such as in San Francisco, Austin, and New York City, other benefit cuts will need to be made to close the A.R.C. Gap.
2. Offer Less Generous Health Benefits
Another option for cities to bring down their health costs is to offer less generous health benefits. This could come in a variety of forms, including switching to a narrower provider network, which would allow the city’s health plan to negotiate better payment rates in return for higher volumes, eliminating certain higher-cost benefits, such as dental or vision, or capping payments to providers.
In August 2011, Jersey City, NJ implemented this strategy when they decided to switch the health plan they offered employees to a new plan that capped payments to medical providers. Retirees were given the option to pay the difference in premium costs if they wanted to stay with their current plan. City officials estimated this switch would save over $1,700 per retiree.
3. Increase Required Service Time Before Employees Receive Retiree Health Benefits
Every collective bargaining agreement is different, but in many cases, public sector employees see their pension and healthcare benefits vest after a certain number of years of service or at a certain age. By increasing the required number of years worked or the age at which benefits go into effect, cities can meaningfully reduce the number of retirees eligible to receive benefits.
For example, in June 2008, voters in San Francisco approved Proposition B which eliminated lifetime subsidized healthcare for retirees with only five years of experience, and increased the threshold for full vesting to 20 years of employment.
4. Move Retirees Under the Age of 65 onto New Insurance Exchanges
With the creation of the new insurance exchanges which went into effect on October 1st as part of the implementation of the Affordable Care Act, some city leaders are considering ending city-provided retirement plans altogether. One scenario for this involves cities giving a stipend to employees who do not qualify for Medicare to purchase their own insurance on the newly-created exchanges. In some cases, these employees may also qualify for subsidies from the federal government, in effect, shifting part of the burden for retiree healthcare from local governments to the federal government.
Detroit is attempting to do just this, offering a stipend of approximately $125 a month to retirees under the age of 65 to purchase insurance on exchanges. If they can successfully negotiate with their public-sector unions, under the guidance of bankruptcy court, Detroit’s emergency manager believes shifting young retirees onto the exchanges will save the city over $120 million. Detroit’s efforts are being watched closely by other cities nationwide. If Detroit is successful, this tactic is likely to be employed by other cities.
5. Move Retirees Over the Age of 65 onto Medicare
For those retirees over the age of 65, cities can again shift costs from local governments to the federal government by moving retirees onto Medicare.
In April 2013, Providence, RI, after a lengthy legal process, received approval from the Rhode Island Superior Court to move retired police and fire employees over the age of 65 to Medicare. Under the terms of the settlement, Providence promised to continue providing funding for Medicare’s Part B supplement and any penalties retirees might be required to pay. Additionally, Providence also agreed to provide funding to cover the Medicare Part D prescription drug coverage. These changes alone were projected to save Providence $4 million in Fiscal Year 2013 and $40 million over a ten year period.
6. Drop Retiree Health Benefits Altogether
A last resort for cities is to stop providing health benefits to retirees altogether. While public-sector unions have historically fought hard for this valuable benefit, it is a benefit that most private-sector unions do not receive from their employers. In fact, according to the Kaiser Family Foundation’s 2013 Employer Health Benefits Survey, only 28 percent of private firms that offer health benefits also offer retiree health benefits.
This tactic has also been employed in cities across the country, including in San Diego and Charlotte. San Diego stopped offering retiree health benefits to employees hired after July 1, 2005, and in April 2011, the California Supreme Court ruled that San Diego had no obligation to provide healthcare to current employees once they retire, despite any promises made in the past. In June 2009, the city of Charlotte also decided to stop providing retiree health insurance for newly-hired fire fighters.
Option 4: Bankruptcy as a Last Resort
Absent a significant uptick in revenue from a surging economy, ElderBranch’s analysis suggests that many of America’s largest cities will be faced with very difficult choices to close their large and growing underfunded healthcare liabilities. While raising taxes, cutting spending, and reducing benefits will not be popular with constituents or city employees, Detroit’s historic bankruptcy filing demonstrates that it is in cities’ best interest to start making these difficult decisions sooner rather than later.
Appendix – Summary Table
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