Next fiscal challenge looming at City Hall
Less than a year removed from achieving landmark pension reform — and avoiding an uncertain fiscal future — the city of Houston’s next financial challenge looms.
This time, it’s the city’s $2.153 billion unfunded Other Post-Employment Benefits (OPEB) liability that threatens the city’s balance sheet. The OPEB plan deals with the health care benefits the city provides to retirees and their beneficiaries. Almost all city employees become eligible for these benefits after they reach normal retirement age.
This unfunded liability is the byproduct of deferring annually required contributions and the rising costs of health care. Historically, the city has paid OPEB obligations on a pay-as-you-go basis, which meets its financial obligations but does not structurally reduce the already-accrued liability. Paying only the “PAYGO” amount is like making a minimum payment on a credit card balance. While it satisfies the short-term obligation to the debt, it makes very little tangible progress on paying off the outstanding balance.
And that outstanding balance is only getting larger. Based on the five-year average, the city is adding more than $160 million per year to the unfunded OPEB liability.
Couple that with the practice of making minimum payments, and it’s clear that the city’s approach to funding its OPEB obligation is unsustainable.
The long-term impact of this unfunded OPEB liability on the city’s bottom line could be significant.
The Controller’s Office views the city’s statement of net position — or its net worth — as an indicator of overall fiscal health. In fiscal year 2016, the city showed a net worth of -$95 million. For the first time in its modern history, the city ended a fiscal year with more liabilities than assets, due almost exclusively to its pension liability.
Thanks to landmark pension reform put forward by Mayor Sylvester Turner, the city’s financial position drastically improved, as evidenced by its net worth of $1.855 billion at the end of fiscal year 2017.
The nearly $2 billion positive swing not only buoyed the city’s bottom line, it was also welcome news for the city’s credit ratings agencies that affirmed the benefits of pension reform by improving the city’s credit outlook.
Now the city’s $2.153 billion unfunded OPEB liability threatens to erase those gains over the long-term and will weigh down the city’s net worth in the upcoming annual financial report.
The good news is that a potential solution exists that will address the unfunded liability, keep promises made to employees, and help the city avoid the long-term negative effects of a ballooning unfunded OPEB liability. That solution is establishing an OPEB trust to address the unfunded liability.
There are several benefits to establishing a trust to fund OPEB liabilities.
First, an OPEB trust will allow the city to curtail the practice of deferring current benefit payments. An OPEB trust will also allow the city to structurally reduce the net OPEB liability, a benefit that does not exist in the “PAYGO” model. Lastly, an OPEB trust will allow the city to pool and invest assets, and earn an investment rate of return on that money.
In addition to the amount it pays annually, the city will also have to find additional dollars to fund an OPEB Trust. During these lean financial times, the challenge of finding additional resources to put into the trust should not be understated. But, put simply, this liability presents the city with just two options: Pay a little bit now to fund the trust, or pay a lot later as the unfunded liability continues to balloon.
Finally — and maybe most importantly — unlike changes made to the city’s pension systems, which had to go through the Texas Legislature for implementation, any necessary changes to OPEB benefits can be done locally.
In other words, establishing the trust, taking the necessary administrative steps and making changes to funding mechanisms can be done at City Hall with a vote from the mayor and City Council.
And it’s clear that something must be done. With the ink still drying on Houston’s pension reform, the time to address the city’s next fiscal challenge is now.