Cities and the Fiscal Challenge of Retiree Health Care

A few big cities are adequately funding health care for their current and future retirees. The rest face distasteful choices.

As state and local governments focus on how to fix their pension problems, a recent report demonstrates the dramatic measures large American cities will have to take to address another issue: huge retiree health-care liabilities. The overarching lesson of the study from ElderBranch, an online information portal that helps people find and evaluate long-term-care providers, is to address the retiree health-care issue before it gets out of hand.

For many cities, it's already too late. In fiscal 2012, only five of the nation's 25 largest cities had set aside 95 percent of their annual required contribution (ARC) -- the amount that would put them on track to pay for the health-care costs of all current and future retirees over 30 years. More than half the cities contributed less than half of ARC.

That leaves most large cities with three distasteful options: Raise taxes, cut spending and/or reduce health benefits.

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Springfield, Mo., is one city that is trying the tax-hike approach. In 2009, Springfield's voters approved a 0.75 percent sales tax increase. While that tax increase was to address the city's unfunded pension liability, not retiree health care, the way things played out politically is instructive: The tax increase passed only after a proposed 1 percent hike had been voted down. Of the 25 largest American cities, only Boston, Charlotte, Denver and Jacksonville could close their retiree health-care funding gaps with tax increases of 0.75 percent or less. Austin, Detroit and Nashville would need to raise taxes by more than 15 percent.

Spending cuts are no silver bullet either. The same three cities that would have to raise taxes by more than 15 percent to solve their retiree health-care problems would have to cut spending by over 16 percent to achieve that goal.

That leaves the third unpleasant option: reducing health benefits. One approach is to shift more of the health-care cost burden onto employees. But solving the problem that way would require seven of the 25 cities to increase the amount deducted from workers' paychecks by more than 15 percent. Detroit would have to deduct one-third more than it already does from employee salaries to close its retiree health-care funding gap.

Of course, cities could simply offer less-generous benefits. In 2011, Atlantic City switched to a plan that caps payments to medical providers for retirees. But that's not very appealing for talented individuals who are attracted to the reliable benefits that have traditionally accompanied public employment.

Two other options are somewhat more promising. One is to increase the service time required for retirees to earn health benefits. In 2008, San Francisco voters approved a ballot measure raising the service time needed to qualify for lifetime subsidized health care from a paltry five years to 20 years. Changing the law, whether by elected lawmakers or by the voters at the ballot box, is the right way to approach this issue: The service time needed to earn health benefits should not be subject to collective bargaining.

Perhaps the most promising approach would be to discontinue the practice of allowing new and recent hires to collect retiree health benefits before they qualify for Medicare at age 65. (Exceptions should be made for police officers, firefighters and other public-safety positions for which earlier retirement is the norm.) There is plenty of precedent in the private sector for this approach. Of the private firms that offer health-insurance benefits to their employees, just 28 percent also offer retiree health benefits. Taxpayers shouldn't be expected to fund packages that are far more generous than what private employers provide.

The few cities that have consistently funded their retiree health-care liabilities are in a position to thoughtfully consider various cost-cutting options. But most big cities, for which the problem has become enormous, will have to settle for trying to put out the fire any way they can.

Principal of Chieppo Strategies and former policy director for Massachusetts’s Executive Office for Administration and Finance