Adjusting for Age
A new accounting rule could seriously undermine the health insurance that states and localities provide to their retirees.
There's something scary lurking out there, and it's known by the acronym OPEB. It's no Nightmare on Elm Street, but for retiring state and local employees, it could bring on a full-fledged anxiety attack.
OPEB stands for Other Post-employment Benefits. It sounds bureaucratic and lots of boring items fall into the category, but the key ingredient and the driving force of OPEB is health care--more specifically, the health benefits state and local governments pay their retired employees. While OPEB has been around for a while, the acronym is becoming more widely known thanks to another acronym: GASB. The Governmental Accounting Standards Board is concerned with the way governments disclose their long-term obligations--obligations such as retiree health care that tend to look very large when the fullness of two or three decades of promised payments are taken into account. The concern is such that the GASB has come up with a new accounting standard for retiree health costs.
Those who aren't financial officials or investment managers may not be familiar with GASB, but make no mistake: It is a very influential body. A state or local government that goes against GASB accounting rules imperils its credit rating. So what GASB wants, it tends to get, and now it wants accountability on retiree health care obligations.
The rule is similar to one that the Financial Accounting Standards Board (FASB), wrote for private businesses a decade ago. That rule forced companies to report the value of health insurance they had promised to their retirees. Now, governments have to do the same. With the implementation of GASB 43 and GASB 45, which are scheduled to go into effect December 2005 and December 2006, respectively, state and local governments will have to treat OPEB the way they do defined- benefit pension plans. That is, they will have to put aside money for future liabilities--only in this case, for liabilities that have not been recognized as such in the past.
Accounting for the actual costs of health care is a right and proper thing to do. Sound accounting practices should reflect the real world and keep governments running with, well, accountability. After all, although governments don't have shareholders to answer to, they do have bondholders--and taxpayers.
So what's worrisome about OPEB? In a word: size. Some governments that have begun to report their accrued OPEB data ahead of the December 2005 deadline have generated what David Hitchcock, a director at Standard & Poor's Corp., the credit-rating agency, calls "eye- popping numbers." The figures suggest that for governments providing retiree health care benefits, the financial impact of the GASB rules on OPEB is likely to be significant.
One reason is that while health care costs are rising for everyone, they are growing at an even faster pace for retirees. Age may have its privileges, but it also has its illnesses and increasingly complex medical needs--a fact that's reflected in age-adjusted health care premiums. Many state and local employers however, use a single common premium for both their active and retired employees, in which case the premium paid for active employees tends to be higher than it otherwise would be. GASB considers the higher premiums for active employees an implicit rate subsidy of retirees and requires that such amounts be included as part of the actuarially projected cash flows for OPEB-- helping to create that "eye-popping" effect.
Clearly, the change in OPEB accounting could result in policy changes, possibly pressuring state or local officials to cut back on retiree health care benefits--now or in the near future. There is precedent for such a revision. In the 1990s, in the wake of the FASB rule, a substantial number of companies reduced their retiree health coverage or ended coverage entirely. That trend--toward reductions or termination--has continued as health care costs continue their inflationary spiral, leading to an ever-bigger OPEB and a drag on the picture of corporate health that a company hopes to project.
Since the public sector is not the private sector, the profit motive is not an issue. And yet, a report on local governments and employee health care costs, issued in December by Fitch, the credit-rating agency, found that half of the local governments surveyed provide retiree health care benefits, and some of these say they have cut or are considering cutting back on these benefits for employees starting after a certain date. This would be done in an effort to mitigate the impact of GASB's OPEB rule.
The accounting rule comes at an unfortunate time. State and local revenues are still in recovery from the recent recession, and pension fund liabilities--the 800-pound gorilla of post-employment benefits-- are a constant budgetary concern. And now, on top of that comes the OPEB rule in an atmosphere in which the private sector has already-- for a host of fiscal as well as accounting reasons--downsized its obligations to retirees and their health care. No wonder that little acronym looms large right now.