Retiree health costs await city fix
After pension reform, unfunded liability bill climbs to $2.4 billion
Four years ago, the main source of Houston’s deteriorating financial health — billions of dollars in unfunded pension obligations — loomed over the race for mayor, promising a massive test for the winner.
Now, Mayor Sylvester Turner, having overhauled the city’s troubled pension systems, is running for re-election and touting the reforms as his signature policy accomplishment. He faces several challengers, including Bill King, the businessman he defeated four years ago, millionaire lawyer and self-funder Tony Buzbee, City Councilman Dwight Boykins who has clashed with the mayor over firefighter pay and former Councilwoman Sue Lovell, as well as a handful of lesser known candidates.
Whoever wins will be forced to confront another simmering financial problem: Houston’s $2.4 billion unfunded liability for retiree health care costs, the result of years of deferred contributions, an aging city workforce and, experts say, growing medical costs that outpace the city’s revenue.
The total has grown in recent years by an average of $160 million a year, or more than $400,000 a day. That is less than the $8.2 billion unfunded pension liability’s $1 million-per-day growth rate, but enough to require swift and sweeping changes, experts and local officials say.
“We’re in the earlier stages in this. It’s not a crisis by any means, but it would be better to address it now,” Controller Chris Brown said. “We don’t want to let this thing grow to another $8 billion unfunded liability . ... Let’s pay a little now instead of paying a lot later.”
The unfunded liability refers to the city’s obligations in the coming decades for retired employees’ medical, life and prescription drug insurance, commonly called other post-employment benefits, or OPEB. Houston has covered its OPEB expenses through a pay-as-yougo system, akin to making a minimum credit card payment while the balance grows.
After pension reform, Turner acknowledged the issue, though
he did not take significant action until June 2018, when the city hired Segal Consulting to study its growing OPEB liability. In January, the firm presented City Council’s budget committee with a handful of options to cut into the unfunded future costs. Among them:
• limit how much the city subsidizes retirees’ supplemental Medicare policy premiums, by capping the subsidy at the amount paid to the less expensive privately administered Medicare Advantage plans.
The city has subsidized 20 to 30 percent of employees’ premiums under both plans, Segal Vice President David Berger said, but the average premium for supplementary Medicare plans is more than double that of Medicare Advantage.
Limiting support for supplementary Medicare premiums would have a sharp impact on the city’s liability, because about twothirds of OPEB payments go to retirees over the age of 65 — when Medicare kicks in — or their spouses, Berger said.
• stop covering spouses or dependents of employees who are under 40 or who have less than 15 years of service, and make employees hired after 2020 ineligible for Medicare coverage subsidies.
• limit Houston’s total OPEB subsidies to a 4 percent annual increase, a move aimed at protecting the city from future large increases in medical costs, which would be passed on to retirees instead.
In a statement, Turner said he has reviewed the options and formed a working group from the city’s human resources, finance and legal departments to study them.
“We have also been in discussions with the employee groups working toward consensus, while keeping in mind the sacrifices employees have made to help us achieve the city’s historic pension reform,” Turner said.
The proposals align with recommendations from a separate firm, Philadelphiabased PFM, which said in its 10-year Houston financial plan the city should eliminate OPEB coverage altogether for retirees or dependents who have access to other coverage.
Other cities have taken a similar approach, limiting cuts for retirees and older employees who were promised certain benefits, while requiring bigger sacrifices from younger and future employees with more time to prepare.
As with the pension problem, many cities and states have kicked the OPEB can down the road for years. Though difficult to tally, the national total of unfunded liabilities approached $2 trillion in 2011, according to the Government Finance Officers Association.
States alone took on a combined $63 billion in OPEB liability during fiscal 2017, a S&P Global Ratings report found, bringing the total unfunded liability at the state level to $678 billion.
Though a change in accounting standards likely drove part of the increase by forcing more conservative liability estimates, the report still found many governments “continue to severely underfund their OPEB liabilities,” producing higher costs in the future.
“(Houston’s) current practice of making OPEB contributions, or paying down OPEB liability on a pay-as-you-go basis, is typically what we see in a lot of states across the nation,” said Adebola Kushimo, a senior analyst at Moody’s Investor Service.
In fiscal 2018, Houston paid about $40 million, or 24 percent, of its $166 million annual OPEB costs, as part of a $4.9 billion budget.
For now, Houston’s $2.4 billion liability does not appear to threaten its credit rating, in part because rating agencies evaluate OPEB alongside other “fixed costs,” such as debt service and the recently reformed pension systems.
“What we’re trying to do as part of that analysis is understand how many resources do you have to spend on things that the city is mandated to do, whether it’s public safety or whatever the case may be,” said Kushimo, Moody’s lead analyst on Houston.
Unlike pension reform, the city can enact OPEB reforms without going through the Legislature, where complications can arise. During pension reform, for instance, Turner opposed state Sen. Joan Huffman’s move to require a public referendum on $1 billion in pension obligation bonds, which she said was necessary to pass the bill.
Turner said he anticipates submitting an OPEB plan to City Council by the end of the year.
Aside from the benefit cuts, Segal Consulting recommended Houston pay for its OPEB liabilities through a trust fund, allowing the city to invest its assets and assume higher investment returns, generating a lower OPEB liability.
Even after reigning in the city’s OPEB liability, Brown said, the city faces numerous looming financial problems, including annual deferred maintenance and, in the recent city budget, recurring spending that outstrips recurring revenue. In addition, Houston has been operating under a voter-imposed cap on property tax revenue since 2004 and has trimmed its tax rate to avoid collecting more money than allowed.
“This is another piece of the larger problem that’s looming for the city of Houston, which is the structurally imbalanced budget,” Brown said. “Essentially, we want to be paying for all of our current expenses in the fiscal year in full. And we don’t want to defer anything out, i.e. kick the can down the road.”