August 17, 2013
City retirement costs mount
An estimated $54.7 million disparity between retirement benefits earned by employees and the funding set aside to cover them over the next 30 years has the city investigating methods to close the gap and protect the city’s bond rating.
As health care costs rise and more employees reach retirement age, the problem will only increase for municipalities.
The city paid $1.7 million to cover retirement benefit payments for around 140 retirees in 2012, which included full payment of current retiree health care premiums.
While the projected costs of unfunded retirement benefits will be $55 million in 30 years, the city has put aside no assets to mitigate the future expense.
The problem with the pay-as-you-go model for health care has little to do with meeting annual insurance costs for retirees, though they will continue to rise at around 8 percent each year. It is more about the city’s long-term financial health and ability to make investments.
Dominic Mazza, of the Bonadio Group, highlighted the retirement benefits problem as a potential pitfall for the city at the Aug. 6 Common Council meeting when discussing an audit of the city’s finances.
“OPEB is a significant challenge, one that needs to be addressed by the council, by management, by everyone involved,” Mazza said. OPEB is an acronym for other post-employment benefits. “No one can turn their back and say it’s someone else’s problem.”
It’s a sentiment that is shared by Mayor Brian Tobin, who believes that change is important, it’s necessary.
“For the short term there isn’t much we can do on a year basis,” Tobin said. “Based on projections, we can’t handle the costs. If we don’t have a plan, it’ll cause bigger problems later on.”
While Cortland is facing a considerable challenge with retirement benefits, it’s certainly not alone.
According to recent information, the city of Ithaca has an unfunded retirement benefit liability of over $270 million as of December 2011.
Cortland County is looking at $65.7 million in unfunded liabilities for its retirement program. Both figures span the same 30-year period to which the city’s projections are tied.
Some municipalities, like Marathon, have no liability because they don’t offer health care benefits to their employees.
The Governmental Accounting Standards Board, or GASB, passed Provision 45 in July 2004, which requires the reporting of retirement benefit liabilities. Prior to GASB 45 passing, municipalities were not required to report the retirement benefits earned by their employees in financial reports.
The provision does not require that cities fully fund their retirement benefits obligations.
The intention of the provision is to ensure that benefits are properly funded each year, so that the money for future costs is already set aside. The city would have had to pay $5.1 million to fully fund its future retirement benefits in 2012, an amount $3.4 million greater than the cost of the annual expenses.
While the figures are daunting, the numbers in the audit are inflated, city Finance and Administration Director Mack Cook said.
The projection makes a number of assumptions, including stable increases in the costs of health care and the length of a city employee’s career and life expectancy. It’s possible the city could owe more or less than the projected $55 million.
Regardless of the final figure, the city’s sizable unfunded liability can turn away future bond investors.
“It takes away from the net worth of the city,” Cook said.
Municipalities use bonds to fund expensive, long-term projects. The municipal bond market was considered to be one of the most stable, but rising interest rates have resulted as financial difficulties mount for cities.
This comes at a time when the city has one of its most robust bond ratings in recent years: AA-. The rating reflects a quality investment, according to Standard and Poor’s rating system.
While the rating is healthy now, as the unfunded retirement benefit liability increases, it will have a negative effect going ahead.
“If the city has a growing OPEB liability, it’s regressing,” said Cook. “They (rating services) recognize it is a problem.”
The unfunded liability for retirement benefits has grown from $7.5 million in 2010 to $13.8 million in 2012.
The good news is that the costs of not funding OPEB will never be realized all at once. If the cost of the gap was divided up by the city’s population, it would work out to $2,847 per person.
To combat the gap between the earned benefits and future funding, one solution could be adjusting the benefits for Medicare-eligible recipients for future retirees, Cook said.
As Medicare acts as the primary insurance for eligible recipients, full health care coverage is not necessary. If the city moved to a Medicare supplement plan, it could result in considerable savings.
Medicare supplement plans, known as Medigap, cover any additional costs Medicare does not such as copayments and deductibles.
The total savings for the city could be as much as 60 percent of the projected unfunded $55 million gap, Cook said. The city will have to work with unions to effect this change, something that it intends to pursue. Some union contracts call for full benefits for those receiving Medicare.
The city has already taken the first steps in mitigating the future impact of unfunded retirement benefits by renegotiating with the wastewater union. Under the new arrangement with the union, the city has no obligation once retirees are Medicare eligible.
Other municipalities have tried cost-saving tactics as well. These included changing the requirement for retirement health care benefits to a minimum of 20 years service and limiting paid benefits to the employee only, not their spouse or dependents.
Health care benefits were at one time viewed as an affordable way to make municipal jobs more attractive but rising costs and stagnant city revenue has exacerbated the problem.
“The cost of health care 30 years ago was significantly lower,” said Tobin. “We’re trying to balance the costs between the taxpayer and retiree.”
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