City’s next fiscal gap? Retirees’ health care

Agency hired to help officials shore up books

With their approval of a billion-dollar bond referendum this month, Houston voters secured Mayor Sylvester Turner’s landmark pension reform plan and erased $2.9 billion in liabilities from the city’s books, beginning to fill an ever-deepening hole that threatened to undermine services.

Pensions, however, are not the only expensive long-term promise Houston has made to its workers.

Taxpayers also face a $2.1 billion liability for retiree health care costs in

the coming decades, and Houston — like many state and local governments — has not set aside a penny to pay for those promises.

This burden is the city’s “next major long-term fiscal challenge,” according to PFM, a financial analysis firm Houston has hired to recommend ways to shore up its long-shaky books.

Turner said any financial hurdle concerns him, but the far-larger pension problem took precedence, as the city’s recovery from Hurricane Harvey will do now.

“That’s one of many issues that we have to address, but I am very much aware of it,” Turner said. “Let’s just say we tackled the biggest item and then we’ll tackle the other ones as we go. One step at a time.”

These costs for what are known as “Other Post-Employment Benefits” — OPEB for short — have become a growing issue for local governments, thanks to rising health care expenses and an aging population and public workforce. In Houston, retirees comprised a third of all the city’s health care beneficiaries in 2012, up from 18 percent in 1994.

A shift in accounting rules also has played a key role. In 2008, the Governmental Accounting Standards Board began requiring governments to report their retiree health care costs, not as an annual operating expense, but in the same manner as pensions: Trust funds fed by payments from the city and workers on which investment earnings accumulate to pay for benefits over the next few decades.

More flexibility

Houston and many of its peers have never stopped treating the expense as simply an annual bill to be paid, however.

Turner’s predecessor Annise Parker took a bite out of the problem in 2010 by hiking the monthly insurance premiums for thousands of retirees younger than 65 by nearly 50 percent and then, the next year, requiring all beneficiaries to enter Medicare upon eligibility at age 65. The city’s share of premiums has fallen from 56 percent in 2010 to 37 percent this year, as those costs have been shifted to retirees.

These changes helped cut the city’s unfunded OPEB liability from more than $3 billion to less than $2 billion; annual costs fell from more than $58 million to about $30 million within two years.

Still, the cost of care continues to rise, prompting the city to adjust copays, deductibles and drug benefits in recent years. Houston paid an estimated $308 million for employee and retiree medical care in the budget year that ended in June, and another $26 million to supplement retirees’ Medicare coverage.

The $53 million the city reported spending on OPEB last fiscal year is barely a quarter of the payment that would be needed to begin setting aside sufficient funds to cover the projected cost.

“In the long term, this is not a sustainable approach,” the PFM analysts state in a recent report.

The Government Finance Officers Association and the Pew Charitable Trusts recommend that governments begin setting aside funds for future benefit payments because promises being made today should not be left to future taxpayers to pay, and because failing to set funds aside leaves retirees at risk of having a cash-strapped City Council cut their benefits to balance a tight budget.

Josh McGee, an expert in retirement policy at the Houston-based Arnold Foundation, echoed those points.

However, he said, retiree health care costs are far easier to shrink through benefit changes than pension costs; in Houston, mayoral action alone can change health benefits.

“Anything that is pay-as-yougo that’s been earned in the past has the potential to increase unexpectedly, so we’ve got to watch it,” McGee said. “However, it’s a little more flexible than pension promises, so there are more tools at our disposal to get benefit levels and costs back in line.”

Consider the context

Still, senior Moody’s analyst Tom Aaron said politicians’ freedom to adjust benefits does not mean retiree health care liabilities can be ignored.

“While typically there is more flexibility there, it’s not as if those are not promises that have been made,” Aaron said. “Especially if you put it in the context of Houston’s recent reforms, the political appetite to cut retiree medical benefits, given that there were just substantial changes to pensions, at the moment may not be all that high.”

City Controller Chris Brown, Houston’s elected financial watchdog, agreed, but said leaders cannot allow the liability to grow unchecked.

“There’s a moral issue when you’re specifically talking about retirees and their health care, which is so vitally important for peoples’ well-being, especially in the later years of their life, but overall it’s something we need to address,” he said. “If we keep going another 10 years, this thing could easily be $5 billion, $6 billion, and again we find ourselves in a big problem of ‘How do we get out of it?’”

Regardless, Aaron and McGee said, concerns about OPEB must be placed in context.

Houston’s retiree health care liability is about $2 billion, whereas Aaron noted that Moody’s viewed Houston’s pre-reform pension liability as topping $14 billion. Health premiums cover only one category of benefits and largely last only until workers turn 65, McGee added, whereas pensions replace at least a portion of the worker’s salary until death.

“At some point it just boils down to mathematics,” Aaron said.