Looming Retiree Health-Care Costs? Let the Feds Help.

As retiree health-care costs soar, maybe state and local governments would be wise to shift some of the burden to Uncle Sam, according to a new report.
by | March 12, 2014 AT 8:00 AM

As retiree health care costs soar, state and local governments would be wise to shift more of the burden to the federal government as they try to get a handle on their growing liabilities.

An analysis by Moody’s Investors Service notes that growing health care liabilities pose an increasing credit risk for many municipal governments. States alone listed a total of more than $530 billion in unfunded “other post-retirement benefits” (OPEB) liabilities in 2012, Moody’s reports.

A big chunk of these liabilities occur because roughly two-thirds of states and large local governments offer supplemental health insurance to retirees who are at least 65 years old and eligible for Medicare. Governments that shift more of the cost burden for supplemental health care to Medicare-eligible retirees, and force them to enroll in federal programs available to them (like Medicare Part D) would save big in the long run. The report notes that even small reductions "can have a considerable impact on future costs because savings compound over retirees’ increasingly long lifetimes."

“A lot of the liabilities are concentrated in a handful of states,” said Marcia Van Wagner, the author of the report, which advises that investors pay attention to which states are seeking to reduce their liabilities through Medicare.

Case in point: Maryland in 2011 reduced its $16.1 billion OPEB liability by 40 percent, largely by requiring retirees to enroll in Medicare Part D (prescription drug coverage) in 2020 when the Part D federal coverage is scheduled to improve. The move also increased prescription drug copayments, retiree premium payments and out-of-pocket maximums. In a single year the state cut its liability down to $9.4 billion.

The savings could increase in the coming years as Medicare-eligible retirees will comprise a growing portion of state and local government retirees. This shift is thanks to two policy factors: one, fewer retirees are those who entered government service before 1986, when Medicare participation for state and local government employees became mandatory. And two, pension reforms that have raised retirement ages will eventually reduce the number of retirees younger than 65, said Van Wagner.

Local governments will not benefit as much as states in this cost shift because they have a greater portion of public safety retirees who retiree younger and are not Medicare-eligible.

A big reason governments have such looming unfunded health care liabilities is because they are not prefunded as pension benefits are for retirees. Most governments fund retiree health care on an annual basis without setting aside money to invest and earn returns to help reduce future liabilities. (OPEB generally does not have the same legal protections that pensions have against altering benefits, however.)

Van Wagner noted that states like California, New York, Texas and Illinois are among the states with the largest liabilities. Last week, California’s Controller John Chiang released a report showing the state’s unfunded retiree health care liability to be $64.6 billion, an increase of $730 million from the prior year.

“While most [states] are focused on unfunded pension obligations, this is a sleeper problem that can become the next big fiscal threat if we continue to do nothing,” Chiang said in a statement.

California is among the states that provide supplemental insurance coverage for Medicare-eligible retirees. But Chiang is proposing a five-year plan to phase in lower OPEB contributions and reduce the state’s liabilities by roughly $18 billion, or 27 percent.