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BENEFITS BEAT
Girding for Benefits Battles
Get ready for tougher labor negotiations ahead.
Questions, success stories or anecdotes about benefit issues in government? Girard Miller wants to hear from you.
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As I traverse the country working with public officials responsible for managing public employee benefits, a common theme emerges: They need to prepare for some tough negotiating sessions with their labor groups.
Most state and local governments were hit by a perfect storm this year: Their property tax revenues are down and are expected to decline even further in the coming year as the nation's housing market continues its downward spiral. Sales tax revenues have held up a little better (for those who receive such), but they're stagnant at best in many locations. Meanwhile, the costs of fuel for police cars and buses, heating oil for buildings, and other commodities have jumped in the past year, even with oil prices "back down" to $100 a barrel. "Rainy-day" funds have dried up. Then came the real budget buster: OPEB ("other post-employment benefits"). Whatever free money states might have had for pay raises was already committed by prior governing bodies and labor unions to providing retiree health benefits that in many cases cannot be sustained indefinitely.
The typical union reaction is "That's your problem. You promised us this benefit already. Now you have to pay for it. Don't move my cheese!"
That kind of thinking is obsolete in today's world of public finance. The fact of life today is that retiree health care was a wonderful benefit and a great idea when private companies like General Motors dominated the world markets, America's state and local governments had virtually unlimited taxing powers, and local economies were growing fast enough to pay the bills with next year's taxes. But those days are over, and the sooner everybody wakes up to that harsh reality, the better. What worked in the past simply won't work in the future.
Yet I find that most municipal officials, especially the elected officials who have to stare down the unions at election time, are walking on eggshells over the OPEB conundrum and benefits issues generally. Politicians in particular just wish it would all go away, at least until their term expires and they move on to a higher office. That's the kind of pass-the-buck thinking that got us into this mess in the first place.
Here are some actionable thoughts for responsible state and local government managers, human resources directors, financial officials and benefits administrators to take to heart:
Delaying action on OPEB reform is simply digging a deeper hole.
The first rule of getting out of holes is to stop digging. By continuing the past practice of "pay-as-you-go," the ultimate liability for future retiree health benefits continues to mount.
Procrastinators will say that it's all just an accounting thing, so what harm is there if we skip this year's actuarially required annual contribution? After all, we have 30 more years to pay this off, right?
Well, I'm here to tell you that for each year you defer action in making your ARC (annual required contribution) payment, you will increase the unfunded liability — it won't just stand still while you sit around doing nothing. Historically, pension funds went through a similar stage of learning, in which states like Massachusetts declined to make actuarial contributions for decades and others took selective "contribution holidays" to balance their budgets — always with dismal results. They all learned that the hole just got deeper each time they resorted to gimmicks.
The one difference in these modern times is that the Governmental Accounting Standards Board now requires the deficiency from actuarial funding to be displayed in the government's financial statements, so there is nowhere for the politicians to hide when they try to cook the books or blink an eye.
Ultimately, bond ratings will suffer for those who fail to fix their OPEB.
My companion column this month addresses the "state of benign neglect" now prevailing in the nation's municipal bond rating agencies. That state of grace will not last much longer. Municipal bond investors will soon see through the fog of official excuses and begin demanding action. And those who keep "moving the pea from one walnut shell to another" will eventually be found out. With $1.5 trillion of OPEB liabilities in a municipal bond market with about $2.7 billion of bonded debt outstanding, there will come a day when investors see that the emperor has no clothes.
Could you get a mortgage if you have credit-card or home-equity debt equal to half your house's value? What would be your credit rating?
The time to negotiate unavoidable benefits reductions is during a recession.
If you ever hope to start reforming your retiree medical benefits plan design to achieve lower long-term costs, now is the time. Governmental balance sheets and budgets in 2009 are likely to be the worst of this business cycle. Employees know that times are hard — they are reminded every day by the presidential candidates, TV reporters and newspapers. Many already know in their hearts that compensation reforms are necessary and inevitable. Waiting until the next business cycle recovery to make sustainable changes in an OPEB plan is a doomed strategy. By then there will be demands for yet more money and bigger benefits. Asking then for cost mitigation measures will be a fool's errand.
A benefits negotiations plan is the first step.
I would be the first to acknowledge the financial stress in America's cities, counties, school districts and state capitals. I realize full well that most governmental agencies today are simply unable to pay their full OPEB ARC costs when the consequences of doing so are layoffs. But that is no excuse for inaction. Instead, this is the time when responsible leadership should be advancing strategies to overcome this problem, including these basic negotiating tactics:
• Conduct a local labor market benefits survey to see what real-world employers in the area are actually providing in employee benefits including retiree medical. If new employees cannot get this benefit elsewhere, then taxpayers should ask their elected leaders why they are defending the status quo?
• Educate employees and unions about the real costs of OPEB and other benefits. This includes providing annual benefits statements showing the full cost of the benefits employees now receive. And a reminder that there actually isn't any money going into the retiree health fund even though it is a real cost.
• Establish a policy to eventually fund the OPEB plan. If revenues are not there now, it is essential for the financial team and the chief administrator to present a plan for getting from zero to full actuarial funding in a reasonable time period. That may involve token payment in the first year, with a three-year ramp-up to get to full ARC funding. The policy should also provide that when revenues exceed the budget and a surplus is achieved at the end of the budget year, the OPEB trust fund gets first claim on those moneys, since it should have been paid in the first place. Likewise, when future revenues eventually return after the next business-cycle recovery in the economy, the five-year financial plan needs to earmark the future revenue increases for OPEB solvency before the politicians are allowed to grab it for new programs and more employees.
• Make clear the trade-off between pay increases and health insurance/OPEB benefits. This is the choice unions don't want to hear about. Taxpayers should not be asked to fork over more money to cover skyrocketing benefits costs at the same time active employees receive inflation-based pay increases. Labor negotiators should introduce a little reality to the bargaining table and explain that municipal revenues haven't kept up with inflation and population growth. Here's the opening line: "The last labor contract promised employees the right to receive these health insurance and OPEB benefits, and thus the first obligation of management and the taxpayers is to pay for what has already been bargained for. In fact, those benefits costs are going up by more than the normal inflation rate. And unfortunately after that, there is just no money left for pay increases." Maybe some concessions on the retiree health care plan and the active employees' share of the insurance premium won't look so bad if salary increases are what's at stake.
• There are two sides to the inflation game now. If CPI inflation is the benchmark we are looking to use in making salary adjustments, then taxpayers should not be asked to pay for benefits that go up faster than CPI inflation, such as retiree medical expenses. Unions that expect a CPI increase in salaries should accept a CPI cap on future OPEB benefits paid by taxpayers, which would at least bring some symmetry into the bargaining process and the financial structures. The long-term cost consequences are significant because a CPI cap on OPEB costs can materially reduce the ARC and the unfunded liability. It is one of the first cost-mitigation measures worth fighting for.
• Employees will appreciate having tools to manage a problem that makes them nervous. In a future column I will explain how a defined-contribution retirement health savings account (whatever name it may be given by different organizations) can empower employees to make the right choices in funding their fair share of future retiree medical costs. Alternatively, some governments have required their employees to begin paying a portion of the OPEB expense into their newly formed OPEB trusts. I'll explain how that works in a future column also.
I know this isn't easy. Nobody wants to be the Grinch Who Stole Christmas. But today's fiscal reality is that difficult trade-offs must be made during difficult times. Those who start the process with a clear focus and a commitment to change can make the difference. If you need some help in the process, e-mail me.
Girard Miller, an analyst of benefits and investments with 30 years of experience in the public, private and nonprofit sectors, can be reached at Girardinmalibu@charter.net. His general market observations and institutional investment strategies are his own and should not be construed as investment advice or recommendations concerning specific securities.
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