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entitled 'State And Local Government Retiree Benefits: Current Status
of Benefit Structures, Protections, and Fiscal Outlook for Funding
Future Costs' which was released on October 24, 2007.
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United States Government Accountability Office:
GAO:
Report to the Committee on Finance, U.S. Senate:
September 2007:
State And Local Government Retiree Benefits:
Current Status of Benefit Structures, Protections, and Fiscal Outlook
for Funding Future Costs:
Revised on November 15, 2007, to reflect a correction to a reference
to the New York comptroller, who is an elected official (not appointed
by the governor as originally reported). Changes were made on page 24,
third paragraph, and on page 25, footnote 38.
GAO-07-1156:
GAO Highlights:
Highlights of GAO-07-1156, a report to the Committee on Finance, U.S.
Senate.
Why GAO Did This Study:
State and local retiree benefits are not subject, for the most part, to
federal laws governing private sector retiree benefits. Nevertheless,
there is a federal interest in ensuring that all Americans have a
secure retirement, as reflected in the special tax treatment provided
for both private and public pension funds. In 2004, new government
accounting standards were issued, calling for the reporting of
liabilities for future retiree health costs. As these standards are
implemented and the extent of the related liabilities become known,
questions have been raised about whether the public sector can continue
to provide the current level of benefits to its retirees.
GAO was asked to provide an overview of state and local government
retiree benefits, including the following: (1) the types of benefits
provided and how they are structured; (2) how retiree benefits are
protected and managed, and; (3) the fiscal outlook for retiree benefits
and what governments are doing to ensure they can meet their future
commitments.
For this overview, GAO obtained data from various organizations, used
our model that simulates the fiscal outlook for the state and local
sector, and conducted site visits to three states that illustrate a
range of benefit structures, protections, and fiscal outlooks.
Cognizant agency officials provided technical comments which were
incorporated as appropriate.
What GAO Found:
The systems for providing retiree benefits to state and local
workers—who account for about 12 percent of the nation’s workforce—are
composed of two main components: pensions and retiree health care.
These two components are often structured quite differently, as
summarized in the table below. Importantly, state and local governments
generally have established protections and routinely set aside monies
to fund their retirees’ future pension costs, but this typically has
not been the practice for retiree health benefits.
Typical Differences in State and Local Government Retirement Systems:
How structured:
Pensions: Mostly a defined benefit based on a formula; once accrued,
cannot be diminished; Retiree health benefits: Extent of premium cost
sharing varies widely, and benefit plans can change for current as well
as future retirees.
How managed:
Pensions: As trusts, with oversight by boards of trustees. Retiree
health benefits: As operating expenses, managed with other employee
benefits.
How funded:
Pensions: Prefunded—that is, monies set aside and invested. Retiree
health benefits: Pay-as-you-go—that is, paid from annual operating
funds as costs are incurred.
Source: GAO analysis.
A model GAO developed to simulate the fiscal outlook for state and
local governments indicates that, for the sector as a whole:
* estimated future pension costs (currently about 9 percent of employee
pay) would require an increase in annual government contribution rates
of less than a half percent, and
* estimated future retiree health care costs (currently about 2 percent
of employee pay) would more than double by the year 2050 if they
continue to be funded on a pay-as-you-go basis.
Because the estimates are very sensitive to the assumed rates of return
and projected rates of health care inflation, the model also indicates
that if rates were to fall below historical averages, the funding
requirements necessary to meet future pension and health care costs
could become much higher. Nevertheless, state and local governments
generally have strategies to manage future pension costs. In contrast,
many are just beginning to respond to the newly issued standards
calling for the reporting of retiree health liabilities, and they
generally have not yet developed strategies to manage escalating
retiree health care costs.
Across the state and local government sector, the ability to maintain
current levels of retiree benefits will depend, in large part, on the
nature and extent of the fiscal challenges that lie ahead—challenges
driven primarily by the growth in health-related costs for Medicaid,
and for active employees as well as retirees. In future debates on
retiree benefits, policy makers, voters, and beneficiaries will need to
decide how to control costs, the appropriate level of benefits, and who
should pay the cost—especially for health care.
To view the full product, including the scope and methodology, click on
[hyperlink, http://GAO-07-1156]. For more information, contact Barbara
D. Bovbjerg at (202) 512-7215 or bovbjergb@gao.gov.
[End of section]
Contents:
Letter:
Results in Brief:
Background:
State and Local Retiree Benefits Typically Include a Defined Benefit
Plan, a Voluntary Savings Plan, and Partially Paid Health Coverage:
State and Local Law Generally Provides Legal Protections for Pensions,
but Less So for Other Retiree Benefits of Public Employees:
Strategies Exist to Manage Future Pension Costs, but Not to Meet
Escalating Costs for Retiree Health Care:
Concluding Observations:
Agency Comments:
Appendix I: Organizations, Associations, and State and Local Agencies
GAO Contacted:
Appendix II: Technical Background on Pension and Retiree Health Care
Simulations:
Development of Factors for Employment, Retirement, Wages, and Benefits:
Projections of Necessary Contributions to Pension Funds for State and
Local Government Sector:
Projections of Retiree Health Benefit Costs for State and Local
Retirees:
Appendix III: State and Local Government Retiree Benefit Plans in
California, Michigan, and Oregon:
Appendix IV: GASB Statements for Pensions and OPEB:
Appendix V: GAO Contacts and Staff Acknowledgments:
Bibliography:
Related GAO Products:
Tables:
Table 1: Different Types of Defined Contribution Plans for Voluntary
Tax-Deferred Savings for State and Local Government Employees:
Table 2: Constitutional Protections for Pension Benefits:
Table 3: Composition and Responsibilities of Boards of Primary Public
Employee Pension Plans in California, Michigan, and Oregon:
Table 4: GAO Simulation of the Projected Government Contribution Level
Needed to Fully Fund the Liability for Pension Benefits for the State
and Local Government Sector, in Aggregate:
Table 5: GAO Simulation of the Projected Government Cost for Retiree
Health Benefits for the State and Local Government Sector, in Aggregate:
Table 6: Different Vehicles for Prefunding Retiree Health Costs:
Table 7: GASB Statements for Pensions and OPEB:
Figures:
Figure 1: Projected Health and Non-Health Expenditures of State and
Local Governments through 2050:
Figure 2: Types of Pension Plans in Place for Newly Hired General State
Employees, as of 2007:
Figure 3: Percentage of Premium Paid by Employer for Health Insurance
Coverage for Retirees under Age 65 (Pre-Medicare-Eligible), by State in
2006:
Figure 4: Various Interests Represented on Boards of Each State's
Pension Plan for General State Employees:
Figure 5: Distribution of the Funded Ratios of 126 of the Nation's
Largest State and Local Defined Benefit Pension Plans:
Figure 6: Cumulative Percentage Distribution of Public Pension Fund
Revenue Sources Nationwide, 1982 to 2005:
Abbreviations:
CalPERS: California Public Employees' Retirement System:
CBO: Congressional Budget Office:
COLA: cost-of-living adjustment:
CPIU: consumer price index for all urban consumers:
DROP: deferred retirement option plan:
ECI: employment cost index:
ERISA: Employee Retirement Income Security Act:
FASB: Financial Accounting Standards Board:
GAAP: generally accepted accounting principles:
GASB: Governmental Accounting Standards Board:
GDP: gross domestic product:
HRET: Health Research and Educational Trust:
MEPS: Medical Expenditure Panel Survey:
MSERS: Michigan State Employees' Retirement System:
NASRA: National Association of State Retirement Administrators:
NIPA: National Income and Product Accounts:
OASDI: Old-Age and Survivors Insurance and Disability Insurance:
OPEB: other postemployment benefits:
OPERS: Oregon Public Employees' Retirement System:
VEBA: Voluntary Employees' Beneficiary Association:
[End of section]
United States Government Accountability Office:
Washington, DC 20548:
September 24, 2007:
The Honorable Max Baucus:
Chairman:
The Honorable Charles E. Grassley:
Ranking Member:
Committee on Finance:
United States Senate:
Over the past half-century, the number of state and local government
workers has grown significantly. In 2006, this sector accounted for
about 12 percent of the nation's workforce. Since 1996, accounting
standards calling for state and local governments to report their
liabilities for future pension costs have been in place, but standards
calling for similar treatment of the future costs of retiree health
benefits have only recently been issued. It is unclear, as yet, what
actions state and local governments may take once the future costs of
these benefits are known. However, future decisions about the
appropriate levels of benefits for retirees will likely occur in a
broader context of persistent fiscal challenges that state and local
governments will face in the next decade. Hence, concerns have been
raised about the public sector's capacity to meet the rising cost of
providing its retirees with promised pension and other postemployment
benefits, such as retiree health care.
State and local retiree benefits are not subject, for the most part, to
federal laws governing private sector retiree benefits. Nevertheless,
there is a federal interest in ensuring that all Americans have a
secure retirement, an interest that is reflected in preferential tax
treatment for contributions and investment earnings associated with
qualified pension plans in both the public and the private sectors. To
better understand these benefits and the future challenge state and
local governments may face, you requested that we provide an overview
of state and local government pension plans and retiree health benefit
programs.[Footnote 1] Specifically, we examined:
(1) the types of state and local retiree benefits provided and how they
are structured;
(2) how state and local retiree benefits are protected and managed,
and;
(3) the fiscal outlook for state and local retiree benefits and what
governments are doing to ensure they can meet their future commitments.
For nationwide information about state and local retiree benefits, we
spoke with experts, advocacy groups, and union officials from various
national organizations and associations (see app. I). To profile the
types of governance and benefits provided, we obtained data from these
organizations, from various federal agencies, and from various
nongovernmental entities that analyze government data and conduct
surveys on these topics. (See the selected bibliography at the end of
this report for brief descriptions of each of these studies.) Much of
the available data are self-reported, but we conducted data reliability
assessments and determined that the data are sufficiently reliable for
our purposes. We also used our model that simulates the fiscal outlook
for the state and local government sector to develop projections for
funding state and local government retiree benefits in aggregate
nationwide (see app. II). In addition, we conducted site visits and
gathered detailed information about the benefits provided and the
future fiscal implications in three states (California, Michigan, and
Oregon) and two local governments (San Francisco and Detroit). We
selected these sites to illustrate various types of plan structures,
legal protections, and levels of employer funding commitments. For
example, in California, the primary pension plan for most state and
local government employees is a defined benefit plan, with protections
in the state constitution,[Footnote 2] and with a funded ratio of 87.3
percent in 2005. In Michigan, the primary pension plan for general
state employees hired on or after March 31, 1997, is a defined
contribution plan, which is covered by the same state constitutional
provision applicable to the previous defined benefit plan; the previous
plan, now closed to new members, had a funded ratio of 79.8 percent in
2005. In Oregon, the primary pension plan for most state and local
government employees includes both a defined benefit and a defined
contribution component, with no explicit protections in the state
constitution; the defined benefit component's funded ratio was 104.2
percent in 2005. (See app. III for an overview of retiree benefit plans
in our site visit locations.) Finally, to illustrate a wider range of
retiree benefit system characteristics, in some instances, we
complemented information from our site visit locations with information
gathered about retiree benefits provided in other state and local
jurisdictions. We conducted our work from November 2006 to August 2007
in accordance with generally accepted government auditing standards.
Results in Brief:
State and local entities typically provide a pension plan with defined
benefits, a supplemental defined contribution plan for voluntary
savings, and partially paid health coverage. As of 2007, most states
still have traditional defined benefit plans as the primary retirement
plans for their workers. Only two states (Alaska and Michigan) and the
District of Columbia had adopted defined contribution plans as their
primary plans for general public employees; two states (Indiana and
Oregon) had adopted primary plans with both defined benefit and defined
contribution components; and one state (Nebraska) had adopted a cash
balance defined benefit plan as its primary plan. State and local
entities also typically offer tax-deferred supplemental voluntary plans
to encourage workers to save toward retirement. In terms of health
benefits, for virtually all state and local retirees age 65 or older,
Medicare provides the primary coverage. Survey data gathered by
Workplace Economics, Inc., indicate that most state and local
government employers provide supplemental health coverage for Medicare-
eligible retirees. For state and local retirees who are under age 65
(that is, not yet Medicare-eligible), state and local employers
generally provide access to group health coverage with varying levels
of support. As of 2006, 14 states provided no employer contribution for
retirees' coverage, while 14 other states picked up the entire cost,
and the remainder fell somewhere in between. States also typically
provide access to group rates for other postemployment benefits such as
dental and vision coverage, long-term care, and life insurance, but the
cost of these other benefits is often paid primarily, if not entirely,
by retirees.
How both pension plans and retiree health benefits are protected and
managed is typically spelled out in state statutes or in local
ordinances, but these laws generally provide greater protection for
pensions than for retiree health benefits. State or local statutes, and
state constitutions or local charters, often include explicit
protections for pension benefits, such as provisions stating that
pensions promised to public employees cannot be eliminated or
diminished. In addition, state constitutions and/or statutes often
require pension plans to be managed as trust funds and overseen by
boards of trustees. Our analysis of national organization data on
pension boards indicates that the size, composition, and
responsibilities of these boards vary. For example, we found that the
size of these boards ranged from 5 to 19 members, with various
combinations of those representing active members, retirees, union
members, state or local governments, or others having technical
knowledge such as investment specialists. Moreover, boards of trustees
typically establish overall policies for the operation and management
of the pension plans, which can include adopting actuarial assumptions
for calculating liabilities, establishing procedures for financial
control and reporting, and setting investment strategy. In contrast to
pensions, state and local law provides less legal protection for other
state and local government retiree benefits, such as retiree health
care, and any such protections more frequently stem from negotiated
agreements between unions and government employers. In addition, state
and local governments have generally treated their costs for retiree
health benefits as an operating expense on a pay-as-you-go basis, and
managed these benefits together with active employee benefits.
In general, we found that state and local governments have set aside
funds to meet most of their future pension costs, but have not yet
developed long-term strategies to finance future escalating health care
costs for retirees. We analyzed the expected future costs of pensions
and retiree health benefits for the state and local government sector
as a whole and found that, assuming that certain historical trends
continue, state and local governments would need to raise their
contribution rates only slightly to meet future pension costs. However,
this estimate is particularly sensitive to changes in rates of return,
and if rates were to fall below historical averages, the funding
requirements to meet future costs could become much more significant.
Moreover, according to our sector analysis, we found that future
retiree health care costs would likely more than double as a percentage
of salaries between 2006 and 2050, if the costs continued to be funded
on a pay-as-you-go basis. As with pensions, this estimate is
particularly sensitive to assumptions about the growth in health care
costs, and costs could rise more rapidly than projected. In addition,
the actual forecasts and outcomes for individual state and local
governments will, of course, vary from our analysis. For example,
although nationwide data gathered by the National Association of State
Retirement Administrators (NASRA) indicates that most state and local
governments are on track toward full funding of their pension plans, a
few plans have failed to maintain what is generally viewed as an
acceptable funding level. If efforts are not made to improve the
funding status of those plans, tough choices lie ahead about whether
and how to maintain the current level of pension benefits for future
retirees. State and local governments may be faced with the need to
raise taxes, cut spending, or reduce benefits in order to meet their
obligations. Across our site visit locations, we found that state and
local governments employ a variety of strategies to keep the funding
status of their pension plans on track, but that long-term strategies
to address escalating health care costs for retirees are generally
lacking. Officials told us that they are just beginning to estimate the
amount of their unfunded liability for retiree health care costs in
response to the newly issued accounting standards and that they had not
yet developed strategies to manage these future costs.
The Internal Revenue Service, state and local officials, and experts in
the field provided technical comments which we incorporated as
appropriate.
Background:
The state and local government sector is likely to face persistent
fiscal challenges within the next decade. In July 2007, we issued a
report based on simulations for the state and local government sector
that indicated that in the absence of policy changes, large and growing
fiscal challenges will likely emerge within a decade.[Footnote 3] Our
report found that, as is true for the federal sector, the growth in
health-related costs is a primary driver of these fiscal challenges
(see fig. 1). Two types of health-related costs are of particular
concern at the state and local level: (1) Medicaid expenditures, and
(2) the cost of health insurance for state and local government
employees, retirees, and their beneficiaries.
Figure 1: Projected Health and Non-Health Expenditures of State and
Local Governments through 2050:
[See PDF for image]
This figure is a line graph depicting two lines: non-health care
expenditures and health care expenditures. The vertical axis of the
graph represents percentage of GDP from 0.00 to 12.00. The horizontal
axis of the graph represents years from 2000 to 2050. The line for non-
health care expenditures begins at approximately 10.50 in year 200, and
after a slight rise, declines steadily to approximately 8.00 in 2050.
The line for health care expenditures begins at approximately 2.30 in
2000 and rises steadily to approximately 8.00 in 2050.
Source: GAO analysis.
Note: Historical data through 2006, projections from 2007 through 2050.
The primary data source is the National Income and Product Accounts
(NIPA). Interest expense is not included in this analysis. (GDP = gross
domestic product.)
[End of figure]
Retirement benefits consist primarily of two components: pensions and
retiree health benefits. According to Census data, in fiscal year 2004-
2005, state and local governments provided retirement benefits to
nearly 7 million retirees and their families. In addition to supporting
a secure retirement for state and local government employees and their
families, such benefits constitute an important component of the total
compensation package state and local governments offer to attract and
retain the skilled workers needed to protect lives and health, and to
promote the general welfare. These workers include highway patrol
officers, local police, firefighters, school teachers, and judges, as
well as general state and local government employees who staff the
broad array of state and local agencies.
Pension plans can generally be characterized as either defined benefit
or defined contribution plans. In a defined benefit plan, the amount of
the benefit payment is determined by a formula typically based on the
retiree's years of service and final average salary, and is most often
provided as a lifetime annuity. In defined benefit plans for state and
local government retirees, postretirement cost-of-living adjustments
(COLA) are frequently provided. But benefit payments are generally
reduced for early retirement, and in some cases, payments may be offset
for receipt of Social Security.[Footnote 4] State and local government
employees are generally required to contribute a percentage of their
salaries to their defined benefit plans, unlike private sector
employees, who generally make no contribution when they participate in
defined benefit plans. According to a 50-state survey conducted by
Workplace Economics, Inc., 43 of 48 states with defined benefit plans
reported that general state employees were required to make
contributions ranging from 1.25 to 10.5 percent of their salaries.
Nevertheless, these contributions have no influence on the amount of
benefits paid because benefits are based solely on the formula.
In a defined contribution plan, the key determinants of the benefit
amount are the employee's and employer's contribution rates, and the
rate of return achieved on the amounts contributed to an individual's
account over time. The employee assumes the investment risk: The
account balance at the time of retirement is the total amount of funds
available, and unlike with defined benefit plans, there are generally
no COLAs. Until depleted, however, a defined contribution account
balance may continue to earn investment returns after retirement, and a
retiree could use the balance to purchase an inflation-protected
annuity. Also, defined contribution plans are more portable than
defined benefit plans, as employees own their accounts individually and
can generally take their balances with them when they leave government
employment. There are no reductions based on early retirement or for
participation in Social Security.[Footnote 5]
Accounting standards governing public sector pensions were established
by the Governmental Accounting Standards Board (GASB) in 1994.
Comprehensive accounting and financial reporting standards governing
other postemployment benefits (OPEB) in the public sector, such as
health care, were issued in 2004 (superseding the interim standards
issued previously). Implementation of the new OPEB standards is
currently being phased in (see app. IV). The purpose of these standards
is to prescribe accounting and financial reporting requirements that
apply broadly to state and local government employers' benefit plans.
Reporting by employers and plan administrators helps keep the municipal
bond market, taxpayers, elected public officials, plan members, and
other interested parties informed about employers' OPEB costs and
obligations, and the operation and funded status of the plans. As with
the Financial Accounting Standards Board (FASB) in the private sector,
it is not the GASB's function to enforce compliance with the standards
it promulgates. Rather, the GASB functions as an independent standard
setter, and its statements and interpretations constitute the highest
source of generally accepted accounting principles (GAAP) for state and
local governments, as specified in the Code of Professional Conduct of
the American Institute of Certified Public Accountants. State and local
governmental entities issue annual financial reports prepared in
conformity with GAAP for a variety of reasons--such as to comply with
general or specific state laws requiring GAAP financial reporting, or
to protect the highest possible credit rating on the government's bonds
in order to reduce the government's cost of borrowing. Compliance with
GASB standards is necessary in order to obtain an independent auditor's
report that the financial statements are fairly presented in conformity
with GAAP, and a failure to do so would result in a modification of the
auditor's report if the effects were material.
Although the Employee Retirement Income Security Act of 1974 (ERISA)
imposes participation, vesting, and other requirements directly upon
employee pension plans, governmental plans such as those provided by
state and local governments to their employees are excepted from these
requirements. In addition, ERISA established an insurance program for
defined benefit plans under which promised benefits are paid (up to a
statutorily set amount), if an employer cannot pay them--but this too
does not apply to governmental plans. However, for participants in
governmental pension plans to receive preferential tax treatment (that
is, for plan contributions and investment earnings to be tax-deferred),
plans must be deemed qualified by the Internal Revenue
Service.[Footnote 6]
State and Local Retiree Benefits Typically Include a Defined Benefit
Plan, a Voluntary Savings Plan, and Partially Paid Health Coverage:
State and local governments typically provide their employees with
retirement benefits that include a defined benefit plan, a supplemental
defined contribution plan for voluntary savings, and group health
coverage. However, the way each of these components is structured and
the level of benefits provided varies widely--both across states, and
within states based on such things as date of hire, employee
occupation, and local jurisdiction.
Defined Benefit Plans Still Provide the Core Benefits for Most Retirees:
Most state and local government workers still are provided traditional
pension plans with defined benefits. In 1998, all states had defined
benefit plans as their primary pension plans for their general state
workers except for Michigan and Nebraska (and the District of
Columbia), which had defined contribution plans as their primary plans,
and Indiana, which had a combined plan with both defined benefit and
defined contribution components as its primary plan.[Footnote 7] Almost
a decade later, we found that as of 2007, only one additional state
(Alaska) had adopted a defined contribution plan as its primary plan;
one additional state (Oregon) had adopted a combined plan, and Nebraska
had replaced its defined contribution plan with a cash balance defined
benefit plan. (See fig. 2.) Although still providing defined benefit
plans as their primary plans for general state employees, some states
also offer defined contribution plans (or combined plans) as optional
alternatives to their primary plans. These states include Colorado,
Florida, Montana, Ohio, South Carolina, and Washington.
Figure 2: Types of Pension Plans in Place for Newly Hired General State
Employees, as of 2007:
[See PDF for image]
Defined contribution: Michigan;
Combined (with both definite benefit and defined contribution
components: Indiana, Oregon;
Cash balance defined benefit: Nebraska;
Traditional defined benefit: all other states.
Source: GAO analysis of data from various national organizations and
from individual states' reports and publications.
Note: Plans depicted are those in which newly hired general state
employees in each state are required to participate as their primary
pension plan. In some states, employees may opt to participate in
alternative or supplementary defined contribution plans, but
participation in these plans is not mandatory.
[End of figure]
In the states that have adopted defined contribution plans as their
primary plans, most employees continue to participate in defined
benefit plans because employees are allowed to continue their
participation in their previous plans (which is rare in the private
sector).[Footnote 8] Thus, in contrast to the private sector, which has
moved increasingly away from defined benefit plans over the past
several decades, the overwhelming majority of states continue to
provide defined benefit plans for their general state employees.
Most states have multiple pension plans providing benefits to different
groups of state and local government workers based on occupation (such
as police officer or teacher) and/or local jurisdiction. According to
the most recent Census data available, in fiscal year 2004-2005, there
were a total of 2,656 state and local government pension plans. We
found that defined benefit plans were still prevalent for most of these
other state and local employees as well. For example, a nationwide
study conducted by the National Education Association in 2006 found
that of 99 large pension plans serving teachers and other school
employees,[Footnote 9] 79 were defined benefit plans, 3 were defined
contribution plans, and the remainder offered a range of alternative,
optional, or combined plan designs with both defined benefit and
defined contribution features.
Supplementary Savings Plans Are Largely Voluntary, with No Employer
Match:
In addition to primary pension plans (whether defined benefit or
defined contribution), data we gathered from various national
organizations show that each of the 50 states has also established a
defined contribution plan as a supplementary, voluntary option for tax-
deferred retirement savings for their general state employees, and such
plans appear to be common among other employee groups as well.[Footnote
10] These supplementary defined contribution plans are typically
voluntary deferred compensation plans under section 457(b) of the
federal tax code.[Footnote 11] (See table 1.)
Table 1: Different Types of Defined Contribution Plans for Voluntary
Tax-Deferred Savings for State and Local Government Employees:
Plan name (based on section of the Internal Revenue Code): 401(k)
plans;
Description of plan: Cash or deferred arrangements that permit
employees to defer a portion of their pay to a qualified tax-deferred
plan. Employee deferrals are held in trust for the sole benefit of the
participants and their beneficiaries. The employee typically directs
the investments. Employers may also make contributions. These plans are
intended primarily for private sector employees; the Tax Reform Act of
1986 prohibited state and local governments from establishing any new
401(k) plans after May 6, 1986, but existing plans were allowed to
continue. (Pub. L. No. 99-514, § 1116(b)(3), 100 Stat. 2085, 2455.)
Plan name (based on section of the Internal Revenue Code):
403(b) plans;
Description of plan: Tax-sheltered annuity plans that permit public
education employees to defer a portion of their pay to a qualified tax-
deferred plan. Employee deferrals are invested in annuity contracts
provided through insurance companies or custodial accounts invested in
mutual funds. Employers may also make contributions, and employee
rights under such plans generally are not forfeitable.
Plan name (based on section of the Internal Revenue Code): 457(b)
plans;
Description of plan: Deferred compensation plans that permit employees
to defer a portion of their pay, which is immediately vested and set
aside for their exclusive benefit. Since taxation of the amounts in
457(b) accounts is deferred, this portion of the employee's pay is not
taxed until the funds are paid from the plan. Most state and local
government employees today have such plans available to them as
supplementary retirement plans.
Source: Internal Revenue Code.
Note: This table describes the various types of defined contribution
plans that may be used for supplemental retirement saving plans for
state and local government workers. When the defined contribution plan
is the primary retirement plan, it is generally a 401(a) plan.
[End of table]
While these defined contribution plans are fairly universally
available, state and local worker participation in the plans has been
modest. In a 2006 nationwide survey conducted by the National
Association of Government Defined Contribution Administrators,[Footnote
12] the average participation rate for all defined contribution plans
was 21.6 percent.
One reason cited for low participation rates in these supplementary
plans is that, unlike in the private sector, it has been relatively
rare for employers to match workers' contributions to these plans, but
the number of states offering a match has been increasing. According to
a state employee benefit survey of all 50 states conducted by Workplace
Economics, Inc., in 2006, 12 states match the employee's contribution
up to a specified percent or dollar amount.[Footnote 13] Among our site
visit states, none made contributions to the supplementary savings
plans for their general state employees, and employee participation
rates generally ranged between 20 to 50 percent. In San Francisco,
however, despite the lack of an employer match, 75 percent of employees
had established 457(b) accounts. The executive director of the city's
retirement system attributed this success to several factors, including
(1) that the plan had been in place for over 25 years, (2) that the
plan offers good investment options for employees to choose from, and
(3) that plan administrators have a strong outreach program. In the
private sector, a growing number of employers are attempting to
increase participation rates and retirement savings in defined
contribution plans by automatically enrolling workers and offering new
types of investment funds.[Footnote 14]
Sidebar:
States Providing Matched Contributions to Supplementary Voluntary
Savings Plans:
State: Colorado;
Maximum monthly match: 1.0% of salary.
State: Delaware;
Maximum monthly match: $10.00.
State: Indiana;
Maximum monthly match: $32.50.
State: Iowa;
Maximum monthly match: $50.00.
State: Minnesota;
Maximum monthly match: $25.00.
State: Missouri;
Maximum monthly match: $25.00.
State: Oklahoma;
Maximum monthly match: $25.00.
State: South Carolina;
Maximum monthly match: $30.00.
State: Tennessee;
Maximum monthly match: $30.00.
State: Utah;
Maximum monthly match: 1.5% of salary.
State: Virginia;
Maximum monthly match: $40.00.
State: Wyoming;
Maximum monthly match: $20.00.
Source: Workplace Economics, Inc., 2006 State Employee Benefits Survey,
and individual states' reports and publications.
[End of sidebar]
Group Health Coverage Is Widely Available with Varying Levels of
Employer Support:
State and local governments typically provide their active employees
with health coverage,[Footnote 15] and they often pay the bulk of their
premiums. According to the Workplace Economics, Inc., 2006 survey, on
average, state employers paid over 90 percent of the cost for single
employee coverage, and over 80 percent of the cost of family coverage,
for active workers. Once workers retire, access to group coverage
generally continues, but the extent of the employer contribution often
declines, and different benefits are often provided depending on
whether or not the retiree is eligible for Medicare.[Footnote 16]
For virtually all state and local retirees age 65 or older, Medicare
provides the primary coverage. Most state and large local government
employers offer supplemental group health coverage, but do not always
contribute to the cost of the premiums. According to the Workforce
Economics, Inc., 2006 survey, all states but one provide access to such
supplemental coverage. Only Nebraska provides no access to group
coverage for retirees age 65 and over.[Footnote 17] In 12 states,
retirees are provided access to coverage through a state health care
program, but the state provides no support for the coverage.[Footnote
18] At the other end of the spectrum, in 16 states, employers pay the
entire cost for at least one coverage plan under some circumstances. Of
those states contributing to the premium costs, the maximum employer
payments for employee-only coverage ranged from $40 per month (in
Tennessee) to $850 per month (in Alaska).
For state and local retirees who are under age 65 (that is, not yet
Medicare-eligible), most state and large local employers provide the
primary health care coverage. According to the Workplace Economics,
Inc., 2006 survey, all states provide access to group health coverage
for pre-Medicare retirees,[Footnote 19] but in 14 states, the plan
participants pay the entire cost of the coverage (see fig. 3). In 14
other states, employers pay the entire cost for at least one coverage
plan in some circumstances. Of those states providing an employer
contribution, the maximum payments for retiree-only coverage ranged
from $105 per month (in Oklahoma) to $850 per month (in Alaska).
Figure 3: Percentage of Premium Paid by Employer for Health Insurance
Coverage for Retirees under Age 65 (Pre-Medicare-Eligible), by State in
2006:
[See PDF for image]
This figure is a map of the United States depicting the percentage of
premium paid by employer for health insurance coverage for retirees
under age 65 (Pre-Medicare-Eligible), by state in 2006. States are
depicted in four categories by the percentage of payment offered. Those
categories, and states that offer those plans are as follows:
No employer payment: West Virginia; Mississippi; Indiana; Wisconsin;
Minnesota; Iowa; South Dakota; Nebraska; Kansas; Montana; Wyoming;
Idaho; Washington; Oregon.
1-49 percent: Virginia; Florida; Oklahoma; Arizona.
50-99 percent: Vermont; New York; Massachusetts; Connecticut; Delaware;
Maryland; South Carolina; Georgia; Alabama; Tennessee; Louisiana;
Arkansas; Missouri; Michigan; Colorado; Utah; Nevada.
100 percent: Maine; Rhode Island; New Jersey; Pennsylvania; North
Carolina; Ohio; Kentucky; Illinois; Texas; New Mexico; California;
Alaska; Hawaii.
Source: Workplace Economics, Inc., 2006 State Employee Benefits Survey,
and individual states' reports and publications.
Note: When employer contributions to the cost of premiums vary for
those hired or retired before a certain date, percentages depicted are
for payments provided to the latest group of workers who retire. When
contributions vary based on a retiree's years of service, plan
selected, or other criteria, the maximum amount of payment is depicted.
For states with no set maximum, the percentage shown is for retirees
with 30 years of service. The Workplace Economics, Inc., 2006 survey
instructed states to provide information on benefits that cover the
largest number of employees, or that were otherwise deemed
representative. For further details on this survey, see the selected
bibliography at the end of this report.
[End of figure]
In most cases, states are continuing to provide retirees with
prescription drug coverage following the rollout of the Medicare
prescription drug program beginning in January 2006.[Footnote 20] In
May 2006, the Segal Company, in cooperation with the Public Sector
HealthCare Roundtable, conducted a survey of 109 state and local
entities concerning retiree health care, and found that most of the
public entities surveyed continued to provide prescription drug
coverage to their retirees, and that only one entity planned to
eliminate drug coverage entirely.[Footnote 21]
Nationwide survey data indicate that while the vast majority of state
and local government active workers participate in employer-sponsored
health benefit plans,[Footnote 22] participation rates among retirees
in these employer-sponsored health benefit programs are relatively low.
According to data from the Department of Health and Human Services, in
2004, about 42 percent of state and local retirees participated in
employer-sponsored health insurance programs.[Footnote 23] Among our
site visit locations, we found that participation rates varied widely
based on level of employer cost sharing. For example, in California,
where the state may pay up to the full premium in some cases (depending
on the retiree's date of hire, years of service, and choice of coverage
plans);[Footnote 24] and in Michigan, where the state pays as much as
95 percent of the retirees' premium for those under the defined benefit
plan, we estimated participation rates to be approximately 70 percent
and 90 percent of all state retirees, respectively. In contrast, in
Oregon, where the state pays nothing toward retirees' premiums for
coverage under the pre-Medicare-eligible health care program
administered by the Public Employees Benefit Board, it has been
estimated that the participation rate among eligible retirees is about
30 percent.
The Cost of Other Benefits, when Provided, Is Primarily Paid by
Retirees:
Beyond basic health care, other postemployment benefits (OPEB) that are
sometimes offered to state and local government retirees include stand-
alone supplemental dental or vision benefits, long-term care, or life
insurance. When such benefits are made available, state and local
government entities typically provide access to group rates, but the
cost of the benefits is often paid primarily, if not entirely, by
retirees.
For example, among our site visit locations, postemployment benefits
provided to retirees in addition to health care include the following:
* State employees in California generally have access to group term
life insurance with a lump-sum benefit of $5,000, paid by the state.
Retirees also are provided access to group dental benefits, which may
be partially funded by the state in some cases, and a retiree vision
program with premiums fully paid by retirees. Long-term care insurance
is also available to all public employees in the state (active or
retired), as well as their family members, generally as a fully member-
paid program with no state contribution.
* In Michigan, dental and vision (as well as health) coverage is
provided to general state employees at retirement. For those under the
defined contribution plan (that is, hired on or after March 31, 1997),
payments range from none for those with less than 10 years of service,
to 30 percent of the premium cost for those with 10 years of service,
plus 3 percent per year additional up to a maximum of 90 percent of the
premium cost for those who have 30 or more years of service. The state
also negotiated a group plan for long-term care insurance for active
and retired workers, and their family members, but it is administered
completely through a third party with no state support.
* Oregon's other postemployment benefits for state retirees include
group coverage for dental and vision benefits, but not life insurance.
Long-term care insurance is also available, but only for some retirees.
No employer contribution is provided for any of these benefits.
State and Local Law Generally Provides Legal Protections for Pensions,
but Less So for Other Retiree Benefits of Public Employees:
How both pension plans and retiree health benefits are protected and
managed is typically spelled out in statutes or in local ordinances,
but these laws generally provide greater protections for pensions than
for retiree health benefits. Laws protecting pensions are often
anchored by provisions in state constitutions and local charters.
Across the multiple plans providing benefits, state and local law
typically requires that pensions be managed as trust funds and overseen
by boards. In contrast, state and local law provides much less
protection for retiree health benefits. Retiree health benefits are
generally treated as an operating expense for that year's costs on a
pay-as-you-go basis and managed together with active employee benefits.
Laws Protecting Pensions Are Often Anchored in State Constitutions and
Local Charters:
State and local laws generally provide the most direct source of any
specific legal protections for the pensions of state and local workers.
Provisions in state constitutions often protect pensions from being
eliminated or diminished. In addition, constitutional provisions often
specify how pension funds are to be managed, such as by mandating
certain funding requirements and/or requiring that the funds be
overseen by boards of trustees.[Footnote 25] Moreover, we found that at
the sites we visited, locally administered plans were generally
governed by local laws. However, state employees, as well as the vast
majority of local employees, are covered by state-administered plans.
Sidebar:
Percentage of State and Local Workers Served by State-Administered
versus Locally Administered Pension Plans Nationwide:
[See PDF for image]
This figure is a pie-chart depicting the following data:
State administered plans (222 total): 90%;
Locally administered plans (2,434 total): 10%.
Source: GAO analysis based on fiscal year 2004-2005 Census data.
[End of sidebar]
Protections for pensions in state constitutions are the strongest form
of legal protection states can provide because constitutions--which set
out the system of fundamental laws for the governance of each state--
preempt state statutes and are difficult to change. Furthermore,
changing a state constitution usually requires broad public support.
For example, often a supermajority (such as three-fifths) of a state's
legislature may need to first approve changes to its constitution. If a
change passes the legislature, voters typically must approve it before
it becomes part of the state's constitution.
The majority of states have some form of constitutional protection for
their pensions. According to AARP data compiled in 2000, 31 states have
a total of 93 constitutional provisions explicitly protecting
pensions.[Footnote 26] (The other 19 states all have pension
protections in their statutes or recognize legal protections under
common law.) These constitutional pension provisions prescribe some
combination of how pension trusts are to be funded, protected, managed,
or governed. (See table 2.)
Table 2: Constitutional Protections for Pension Benefits:
Constitutional provisions requiring: Certain standards are to be in
place for how the retirement system should be funded;
States: Arizona, Florida, Georgia, Louisiana, Maine, Michigan,
Mississippi, Montana, New Hampshire, New Mexico, North Dakota, South
Carolina, Texas, and Virginia;
Number of states: 14.
Constitutional provisions requiring: Assets in a trust fund are to be
for the exclusive purpose of the retirement system;
States: Alabama, Arizona, California, Louisiana, Maine, Mississippi,
Montana, New Hampshire, New Mexico, North Carolina, Oklahoma, Texas,
Virginia, and Wyoming;
Number of states: 14.
Constitutional provisions requiring: Trust fund assets are not to be
diverted for nonretirement uses;
States: Alabama, Louisiana, Maine, Mississippi, Montana, Nevada, New
Hampshire, New Mexico, North Carolina, Oklahoma, South Carolina, Texas,
and Virginia;
Number of states: 13.
Constitutional provisions requiring: Retirement system boards of
trustees are to be off limits to the legislature;
States: California, Montana, Nevada, New Mexico, and Texas;
Number of states: 5.
Constitutional provisions requiring: Participants in a retirement
system have a guaranteed right to a benefit, and that accrued financial
benefits cannot be eliminated or diminished;
States: Alaska, Arizona, Hawaii, Illinois, Louisiana, Michigan,
Missouri, New Mexico, and New York;
Number of states: 9.
Constitutional provisions requiring: States have investment authority
for their retirement systems;
States: Indiana, Michigan, Montana, Nebraska, South Carolina,
Washington, and West Virginia;
Number of states: 7.
Constitutional provisions requiring: Retirement system money is to be
held in a separate trust fund;
States: Arizona, California, Nevada, New Mexico, and Virginia;
Number of states: 5.
Constitutional provisions requiring: Retirement benefits may be
increased;
States: Georgia, Nebraska, Pennsylvania, Washington, and Wisconsin;
Number of states: 5.
Constitutional provisions requiring: A retirement system is required;
States: Louisiana, Texas, and Virginia;
Number of states: 3.
Constitutional provisions requiring: The payment of retirement benefits
is authorized;
States: Georgia and Oklahoma;
Number of states: 2.
Constitutional provisions requiring: Other protections are in place,
such as prohibiting constitutional changes to the retirement system
through the initiative process;
States: Mississippi, Missouri, Nebraska, and Nevada;
Number of states: 4.
Source: AARP, 2000.
[End of table]
Pension Benefits, Once Accrued, Are Generally Protected:
In nine states, constitutional provisions take the form of a specific
guarantee of the right to a benefit. In two of the states we visited,
the state constitution provided protection for pension benefits. In
California, for example, the state constitution provides that public
plan assets are trust funds to be used only for providing pension
benefits to plan participants.[Footnote 27] In Michigan, the state
constitution provides that public pension benefits are contractual
obligations that cannot be diminished or impaired and must be funded
annually.[Footnote 28]
The basic features of pension plans--such as eligibility,
contributions, and types of benefits--are often spelled out in state or
local statute. State-administered plans are generally governed by state
laws. For example, in California, the formulas used to calculate
pension benefit levels for employees participating in the California
Public Employees' Retirement System (CalPERS) are provided in state
law.[Footnote 29] Similarly, in Oregon, pension benefit formulas for
state and local employees participating in the Oregon Public Employees
Retirement System (OPERS) plans are provided in state statute.[Footnote
30] In addition, we found that at the sites we visited locally
administered plans were generally governed by local laws. For example,
in San Francisco, contribution rates for employees participating in the
San Francisco City and County Employees' Retirement System are spelled
out in the city charter.[Footnote 31]
Legal protections usually apply to benefits for existing workers or
benefits that have already accrued; thus, state and local governments
generally can change the benefits for new hires by creating a series of
new tiers or plans that apply to employees hired only after the date of
the change. For example, the Oregon legislature changed the pension
benefit for employees hired on or after January 1, 1996, and again for
employees hired on or after August 29, 2003, each time increasing the
retirement age for the new group of employees.
For some state and local workers whose benefit provisions are not laid
out in detail in state or local statutes, specific provisions are left
to be negotiated between employers and unions. For example, in
California, according to state officials, various benefit formula
options for local employees are laid out in state statutes, but the
specific provisions adopted are generally determined through collective
bargaining between the more than 1,500 different local public employers
and rank-and-file bargaining units. In all three states we visited,
unions also lobby the state legislature on behalf of their members. For
example, in Michigan, according to officials from the Department of
Management and Budget, unions marshal support for or against a proposal
by taking such actions as initiating letter-writing campaigns to
support or oppose legislative measures.
Role of Unions:
The influence of unions on public employee benefits is stronger than in
the private sector. Over 40 percent of public sector workers—including
federal, state, and local government—are covered by union agreements,
compared with about 10 percent of private sector workers. Across the
nation, in 2005, the percentage of public sector workers covered ranged
from lows of about 13 percent in North and South Carolina, to highs of
about 70 percent in Rhode Island and 72 percent in New York.
Source: Bureau of National Affairs, Inc., 2006.
Pensions Are Typically Managed as Trust Funds with Board Oversight:
In accordance with state constitution and/or statute, the assets of
state and local government pension plans are typically managed as
trusts and overseen by boards of trustees to ensure that the assets are
used for the sole purpose of meeting retirement system obligations and
that the plans are in compliance with the federal tax code.[Footnote
32] Boards of trustees, of varying size and composition, often serve
the purpose of establishing the overall policies for the operation and
management of the pension plans, which can include adopting actuarial
assumptions, establishing procedures for financial control and
reporting, and setting investment strategy. On the basis of our
analysis of data from the National Education Association, the National
Association of State Retirement Administrators (NASRA), and reports and
publications from selected states, we found that 46 states had boards
overseeing the administration of their pension plans for general state
employees.[Footnote 33] These boards ranged in size from 5 to 19
members, with various combinations of those elected by plan members,
those appointed by a state official, and those who serve automatically
based on their office in state government (known as ex officio
members). (See fig. 4.)
Figure 4: Various Interests Represented on Boards of Each State's
Pension Plan for General State Employees:
[See PDF for image]
This figure is a pie-chart, depicting the following data:
Appointed (43 of 50 plans have appointed board members representing
various groups or areas of expertise, such as an investment
specialist): 51.7%;
Elected (24 of 50 plans have board members elected by various groups,
such as retired or active plan members): 29.1%;
Ex officio (36 of 50 plans have ex officio board members who serve
automatically based on their office, such as the treasurer from the
state or local jurisdiction): 19.1%.
Source: GAO analysis of board membership for the primary pension plans
for general state employees in each state, based on data from various
national organizations and from individual states' reports and
publications.
Note: Percentages do not total 100 because of rounding.
[End of figure]
Different types of members bring different perspectives to bear, and
can help to balance competing demands on retirement system resources.
For example, board members who are elected by active and retired
members of the retirement system, or who are union members, generally
help to ensure that members' benefits are protected. Board members who
are appointed sometimes are required to have some type of technical
knowledge, such as investment expertise. Finally, ex officio board
members generally represent the financial concerns of the state
government.
Some pension boards do not have each of these perspectives represented.
For example, boards governing the primary public employee pension plans
in all three states we visited had various compositions and
responsibilities. (See table 3.) At the local level, in Detroit,
Michigan, a majority of the board of Detroit's General Retirement
System is composed of members of the system. According to officials
from the General Retirement System, this is thought to protect pension
plan assets from being used for purposes other than providing benefits
to members of the retirement system. Regarding responsibilities, the
board administers the General Retirement System and, as specified in
local city ordinances, is responsible for the system's proper operation
and investment strategy.
Table 3: Composition and Responsibilities of Boards of Primary Public
Employee Pension Plans in California, Michigan, and Oregon:
State: California;
Pension plan: California Public Employees' Retirement System (CalPERS);
Number of board members: 13;
Composition of board members: 3 appointed; 6 elected; 4 ex officio[A];
Board responsible for: Management and control of CalPERS, including the
exclusive control of the administration and investment of the
retirement fund.[B].
State: Michigan;
Pension plan: Michigan State Employees' Retirement System (MSERS);
Number of board members: 9;
Composition of board members: 4 appointed; 5 ex officio[C];
Board responsible for: Administering and managing the defined benefit
plan by making investment decisions and arranging for an actuarial
valuation.[D].
State: Oregon;
Pension plan: Oregon Public Employees' Retirement System (OPERS);
Number of board members: 5;
Composition of board members: 5 appointed[E];
Board responsible for: Managing the retirement system, including
responsibilities such as arranging for actuarial services and
publishing an annual report on the retirement system.
Source: Statutes, as cited below.
[A] Cal. Govt. Code § 20090 (Deering, 2007).
[B] Cal. Gov't. Code § 20120 (Deering, 2007).
[C] Mich. Comp. Laws § 38.3 (2007).
[D] Mich. Comp. Laws § 38.2 (2007). The defined contribution plan is
administered and its assets invested by the state treasurer. Mich.
Comp. Laws § 38.9 (2007).
[E] Or. Rev. Stat. § 238.660 (2005).
[End of table]
Pension boards of trustees typically serve as pension plan fiduciaries,
and as fiduciaries, they usually have significant independence in terms
of how they manage the funds. Boards make policy decisions within the
framework of the plan's enabling statutes, which may include adopting
actuarial assumptions,[Footnote 34] establishing procedures for
financial control and reporting, and setting investment policy. In the
course of managing pension trusts, boards generally obtain the services
of independent advisors, actuaries, or investment professionals.
Also, some states' pension plans have investment boards in addition to,
or instead of, general oversight boards. For example, three of the four
states without general oversight boards have investment boards
responsible for setting investment policy. While public employees may
have a broad mandate to serve all citizens, board members generally
have a fiduciary duty to act solely in the interests of plan
participants and beneficiaries. Likely at least partially because of
this specific duty, one study of approximately 250 pension plans at the
state and local level found that plans with boards overseeing them were
associated with greater funding than those without boards.[Footnote 35]
When state pension plans do not have a general oversight board, these
responsibilities tend to be handled directly by legislators and/or
senior executive officials. For example, in the state of Washington,
the pension plan for general state employees is overseen by the Pension
Funding Council--a six-member body whose membership, by statute,
includes four state legislators.[Footnote 36] The council adopts
changes to economic assumptions and contribution rates for state
retirement systems by majority vote. In Florida, the Florida Retirement
System is not overseen by a separate independent board; instead, the
pension plan is the responsibility of the State Board of
Administration, composed of the governor, the chief financial officer
of the state, and the state attorney general.[Footnote 37] In New York,
the state comptroller, an elected official, serves as sole
trustee and administrative head of the New York State and Local
Employees' Retirement System.[Footnote 38]
Laws Provide Less Protection for Retiree Health Benefits:
In contrast with pensions, there are less likely to be statutory
protections applicable to retiree health benefits. To the extent that
any such legal protections exist, they more frequently stem from the
negotiated agreements between unions and government employers. In
addition, the cost of annual retiree health benefits typically have
been treated as an operating expense and managed together with active
employee benefits, although the benefits offered retirees may differ
from those offered active employees. Despite the general absence of a
fund to manage, retiree health programs frequently still have boards
that help to determine the terms of the health plans to be offered.
Retiree Health Benefits Are Subject to Change:
Unlike the law governing pensions, the law governing retiree health
benefits for state and local government workers generally does not
include the same type of explicit protections. To the extent retiree
health benefits are legally protected, it is generally because they
have been collectively bargained and are subject to current labor
contracts.
In cases where reductions to retiree health benefits are challenged in
court, the ultimate outcome depends on the specific facts and
circumstances and the applicable state and/or local law in each
jurisdiction. In Segal's 2006 survey of over 100 state and local plans,
62 percent of respondents said that statutory or regulatory obligations
affected their ability to change retiree health coverage; 25 percent
said that retiree health coverage was subject to collective bargaining;
and 17 percent said that other factors affected their ability to change
retiree health coverage.[Footnote 39] In two recent cases, however, the
courts have upheld the state's right to modify retiree health benefits
(see sidebar).
Sidebar:
Courts Uphold States Rights to Modify Retiree Health Benefits:
Alaska:
In 1999 and 2000, Alaska made changes in its health plan for retired
state employees by improving coverage in some ways but also increasing
the deductible and co-insurance, and retirees sued. The state supreme
court held that plan coverage—not just a certain financial
contribution—was protected under the Alaska Constitution. However, the
court found that the benefits could still be modified so long as the
changes resulted in equivalent coverage for the group and individuals
who experienced serious hardships could retain their previous coverage.
Duncan v. Retired Pub. Emples. of Alaska, Inc., 71 P.3d 882 (Alaska
2003).
Michigan:
In 2000, Michigan increased the co-payments and deductibles to be paid
under its health plan for public school retirees, and retirees sued.
The state supreme court held that retiree health benefits were not
accrued financial benefits within the meaning of the Michigan
Constitution and that the statute establishing the plan did not create
a contractual right to such benefits. Studier v. Mich. Pub. Sch.
Emples. Ret Bd., 472 Mich. 642 (2005).
Source: GAO analysis of court cases, as cited.
[End of sidebar]
Retiree Health Benefits Are Treated as an Operating Expense:
Retiree health benefits generally have been treated by state and local
governments as an operating expense for that year's costs on a pay-as-
you-go basis. State and local governments typically do not set aside
funds while employees are working to pay their future retiree health
benefits. Moreover, retiree health benefits are mostly managed together
with active employee benefits, although the actual benefits offered to
retirees and to active employees may be different. In most cases,
retiree health benefits are administered under the state or local
employee benefit system.
Despite the general absence of a fund to manage, the administrators of
retiree health benefits may still look to boards to help determine the
health coverage to be offered. For example, in California, the same
CalPERS board that oversees the pension fund also oversees a health
care program. With respect to this health care program, the CalPERS
board is responsible for selecting insurers through which participants
can receive coverage.[Footnote 40] The CalPERS board negotiates, for
example, the specific services covered, premiums, and participant co-
payments. Although many local governments participate in the CalPERS
program, the City and County of San Francisco has chosen to administer
its own separate program. The Health Service System (a city department)
is responsible for administering the benefits for both active and
retired employees, with oversight from the Health Service Board (a city
board). The Health Service Board is charged with establishing rules and
regulations for the Health Service System and for conducting an annual
review of the costs for medical and hospital care. In Oregon, the
Public Employees Benefit Board, a separate entity from OPERS, is
responsible for managing the health benefits of both active and pre-
Medicare-eligible retired employees, with authority to negotiate the
terms of their coverage.[Footnote 41]
Strategies Exist to Manage Future Pension Costs, but Not to Meet
Escalating Costs for Retiree Health Care:
While state and local governments generally have strategies to manage
future pension costs, they have not yet developed strategies to fund
future health care costs for public sector retirees. We analyzed the
state and local sector's fiscal outlook with respect to the sector's
ability to maintain current retiree benefits--that is, the sector's
ability to fund its future liabilities--from two perspectives and came
to similar conclusions. First, in our simulation of the fiscal outlook
for the state and local sector, we developed projections of the likely
cost of pensions and retiree health benefits that already have been and
will continue to be earned by employees. Our simulation shows that the
additional pension contributions that state and local governments will
need to make in future years to fully fund their pensions on an ongoing
basis are only slightly higher than the current contribution rate. Our
simulation also shows that health care costs for retirees will likely
rise considerably as a component of state and local budgets, if these
costs continue to be funded on a pay-as-you-go basis. Second, we
analyzed data on the funded status of 126 of the nation's largest
public sector retirement systems and found that with some notable
exceptions, most are relatively well funded, but that long-term
strategies to fund future health care costs for retirees are generally
lacking.
Current Contribution Rates Are Generally on Track, but Could Still Fall
Short of Future Pension Needs:
Our simulation indicates that state and local governments, in
aggregate, will need to make contributions to pension systems at a
somewhat higher rate than in recent years in order to fully fund their
pension obligations on an ongoing basis.[Footnote 42] Assuming certain
historical trends continue and that there is a steady level of pension
contributions in the future, contribution rates would need to rise to
9.3 percent of salaries--less than a half percent more than the 9.0
percent contribution rate in 2006.
Our model is based on a variety of assumptions regarding employee
contributions, future employment, retirement, wages, rates of return,
pension characteristics, and other factors. For example, our analyses
relate to defined benefit plans only. (For details on our assumptions
and our model, see app. II.) We assume that employee contribution rates
to these pension funds will remain the same, relative to wages, as in
the past. We also assume that in the future, the real rate of return on
pension assets will be about 5 percent, which is based on the real
returns on various investment instruments over the last 40 years.
Our findings regarding the required contribution to pension funds on an
ongoing basis were, however, extremely sensitive to assumptions about
the future rate of return on invested pension funds. Some economists
and financial analysts have expressed concern that returns in the
future may not be quite as high as those in the past. Future investment
returns may not match past returns because, for example, slower labor
force growth may lead to slower economic growth, which may, in turn,
reduce investment returns. Also, pension managers may choose to invest
in less risky, lower-return investments in the future. If future rates
of return are more or less in line with historic experience, then our
simulation should provide a reasonable estimate of the contribution
rates that will be needed in the future. But if future rates of return
decline, then contribution rates would need to be higher than 9.3
percent of salaries, as indicated by our base case simulation results.
(See table 4.) Moreover, the results for individual state and local
governments may vary substantially.
Sidebar:
Sensitivity of Estimates to Various Future Rates of ReturnReal returns
on various investment instruments over the last 40 years have been
about 5 percent, which is the rate of return used in our simulation.
However, if future returns are lower, such as 4 percent, the necessary
contribution rate would rise to 13.9 percent of salaries. Conversely,
if returns are higher, such as 6 percent, the necessary contribution
rate would fall by an equivalent amount—to 5.0 percent of salaries.
Some analysts believe that an analysis of this type should only
consider riskless returns. Under such an approach, we would assume that
all pension funds are invested in very safe financial instruments such
as government bonds. If such a risk-free return were assumed, our
analysis indicates that contribution rates would need to be much
higher—nearly 18.6 percent of salaries.
[End of sidebar]
Table 4: GAO Simulation of the Projected Government Contribution Level
Needed to Fully Fund the Liability for Pension Benefits for the State
and Local Government Sector, in Aggregate:
Simulation assumption for the rate of return on investment[A]: Higher
return scenario: 6 percent real rate of return;
Projected government contribution level needed to fully fund the
liability for pension benefits on an ongoing basis: 5.0 percent of
salaries per year;
Difference between the projected ongoing government contribution level
needed and the actual contribution level in 2006 (at 9.0 percent of
salaries): - 4.0 percent of salaries per year.
Simulation assumption for the rate of return on investment[A]: Base
case: 5 percent real rate of return;
Projected government contribution level needed to fully fund the
liability for pension benefits on an ongoing basis: 9.3 percent of
salaries per year;
Difference between the projected ongoing government contribution level
needed and the actual contribution level in 2006 (at 9.0 percent of
salaries): + 0.3 percent of salaries per year.
Simulation assumption for the rate of return on investment[A]: Lower-
return scenario: 4 percent real rate of return;
Projected government contribution level needed to fully fund the
liability for pension benefits on an ongoing basis: 13.9 percent of
salaries per year;
Difference between the projected ongoing government contribution level
needed and the actual contribution level in 2006 (at 9.0 percent of
salaries): + 4.9 percent of salaries per year.
Simulation assumption for the rate of return on investment[A]: Risk-
free scenario: 3 percent real rate of return;
Projected government contribution level needed to fully fund the
liability for pension benefits on an ongoing basis: 18.6 percent of
salaries per year;
Difference between the projected ongoing government contribution level
needed and the actual contribution level in 2006 (at 9.0 percent of
salaries): + 9.6 percent of salaries.
Source: GAO simulation. For details, see appendix II.
Note: All scenarios assume prefunded pension funds across the sector.
[A] According to NASRA's Public Fund Survey, the predominant rate of
return used by states in determining their unfunded liabilities is 8
percent.
[End of table]
Retiree Health Care Costs Could More than Double as a Percentage of
Salaries over the Next Several Decades:
Our simulation indicates that projected costs for retiree health
benefits, while not as large a component of state and local government
budgets as pensions, will more than double as a percentage of salaries
over the next several decades, if these costs continue to be funded on
a pay-as-you-go basis. In 2006, these costs amounted to approximately
2.0 percent of salaries, but according to our simulation, by 2050, they
will grow to 5.0 percent of salaries--a 150 percent increase. The key
reason for this substantial increase is the more general rise in health
care costs, which, if left unconstrained, will continue to cause costs
to rise as a percentage of salaries.
As with the projections of necessary pension contributions, our
estimates of retiree health benefit costs are also dependent on certain
assumptions, and are particularly sensitive to assumptions about the
growth in health care costs. For example, on the basis of research and
discussions with experts, we assumed that health care costs would grow
at a higher rate than the growth in the nation's gross domestic product
(GDP).[Footnote 43] If health care costs were to rise only at the same
rate as GDP, then by 2050, our projected costs would grow only from 2.0
percent to 2.9 percent of salaries, instead of 5.0 percent. Also,
because our model is based on data that did not incorporate possible
savings attributable to the Medicare Part D drug subsidy that began in
2006, the estimates may slightly overstate retiree health costs.
However, if health care costs were to rise more rapidly than they have
over the past 35 years, then the cost of retiree health benefits would
exceed our projected costs of 5.0 percent of salaries. (See table 5.)
Table 5: GAO Simulation of the Projected Government Cost for Retiree
Health Benefits for the State and Local Government Sector, in Aggregate:
Simulation assumption for the rate of "excess cost growth" of health
care above per capita GDP growth: Lower health care cost inflation: no
excess cost growth;
Projected government cost for retiree health benefits in 2050: 2.9
percent of salaries;
Difference between the projected contribution level needed in 2050 and
the actual contribution level in 2006 (at 2.0 percent of salaries): +
0.9 percent of salaries.
Simulation assumption for the rate of "excess cost growth" of health
care above per capita GDP growth: Base case: average of 1.4 percent
excess cost growth through 2035, declining to 0.6 percent by 2050;
Projected government cost for retiree health benefits in 2050: 5.0
percent of salaries;
Difference between the projected contribution level needed in 2050 and
the actual contribution level in 2006 (at 2.0 percent of salaries): +
3.0 percent of salaries.
Simulation assumption for the rate of "excess cost growth" of health
care above per capita GDP growth: Higher health care cost inflation:
average of 2.8 percent excess cost growth through 2035, declining to
1.2 percent by 2050;
Projected government cost for retiree health benefits in 2050: 8.4
percent of salaries;
Difference between the projected contribution level needed in 2050 and
the actual contribution level in 2006 (at 2.0 percent of salaries): +
6.4 percent of salaries.
Source: GAO simulation. For details, see appendix II.
Note: All scenarios assume pay-as-you-go financing across the sector.
[End of table]
State and Local Governments Generally Have Strategies to Manage Costs
for Their Future Pension Commitments:
State and local governments typically set aside funds to finance the
cost of future pension obligations and use a variety of strategies to
keep the funding status of their plans on track. Funding status is a
measure that captures a government's ongoing effort at one point in
time to prefund its future pension liability, generally expressed as
the ratio of assets to liabilities (also referred to as the funded
ratio). Assessing the funding status of public sector pension plans
provides a second perspective on the fiscal outlook of state and local
government efforts to fund future pension benefits. According NASRA's
Public Fund Survey as of 2007, the most recent reports from 126 of the
largest state and local pension plans in the country indicate that over
three-fifths of the plans were at least 80 percent funded--a level
generally viewed as being acceptable to support future pension
costs.[Footnote 44] However, funding levels across the different plans
ranged from about 32 to 113 percent. (See fig. 5.) Those state and
local governments with plans that are funded below acceptable levels
may face tough choices in the future between the need to raise taxes,
cut spending, or reduce benefits in order to meet their obligations.
Figure 5: Distribution of the Funded Ratios of 126 of the Nation's
Largest State and Local Defined Benefit Pension Plans:
[See PDF for image]
This figure is a vertical bar graph depicting percent of plans funded.
The vertical axis of the graph represents number of plans from 0 to 40.
The horizontal axis of the graph represents various percentages, with
the total number of plans funded in each percentage group indicated by
a bar as follows:
1.0-9.9 percent funded: 0;
10.0-19.9 percent funded: 0;
20.0-29.9 percent funded: 0;
30.0-39.9 percent funded: 1;
40.0-49.9 percent funded: 2;
50.0-59.9 percent funded: 4;
60.0-69.9 percent funded: 15;
70.0-79.9 percent funded: 26;
80.0-89.9 percent funded: 37;
90.0-99.9 percent funded: 23;
100.0-109.9[a] percent funded: 16;
110-119.9 percent funded: 2.
Source: GAO analysis of data from NASRA's Public Fund Survey, 2007.
Note: The Public Fund Survey updates its database continuously as new
data become available. Nevertheless, as of July 2007, when we accessed
the database, although most plans had reported actuarial valuations for
2005 or 2006, a small number of plans reflected earlier valuations.
(For further details, see the selected bibliography at the end of this
report.)
[A] Of nine plans reporting that they were 100 percent funded, eight
used the aggregate cost valuation method. Under this method, the
actuarial value of liabilities is equal to the actuarial value of
assets and no unfunded liability is identified.
[End of figure]
Governments Use Various Strategies to Keep Their Funding Status on
Track:
A primary way state and local governments keep the funding status of
their pension funds on track is to make their actuarially required
contributions. There are three sources of revenues for pension
benefits: investment earnings, employee contributions, and employer
contributions. Investment earnings provide the major source of funding
(see fig. 6). The amount that employees are required to contribute is
generally fixed by state statute as a percentage of salary, while state
and local governments determine the level of employer contributions
based on their plans' funding status--that is, the extent to which
liabilities already accrued are funded. Actuaries calculate the
contribution amount needed to cover the liability that accrues each
year and to pay an installment on any unfunded liability. If a plan
sponsor (that is, a state or local government employer) is making these
actuarially required contributions, the plan can have a funded ratio
below 100 percent yet still be on track toward full actuarial funding.
Figure 6: Cumulative Percentage Distribution of Public Pension Fund
Revenue Sources Nationwide, 1982 to 2005:
[See PDF for image]
This figure is a pie-chart, depicting the following data:
Investment earnings: 63.7%;
Employer contributions: 24.3%;
Employee contributions: 12.0%.
Source: NASRA, 2007 (based on U.S. Census data).
[End of figure]
Governments use various strategies to help them make their actuarially
required pension fund contributions. One strategy that governments use
to lessen the volatility of fluctuations in their actuarially required
contribution is to average the value of plan assets over a number of
years (referred to as "smoothing"). For example between 1999 and 2005,
California's contribution rate for one of CalPERS' pension plans ranged
from 1.5 percent of salaries to 17 percent of salaries. In 2005,
California began using smoothing techniques, and the contribution rate
over the last 2 years changed only slightly--from 15.9 percent of
salaries in 2006 to an estimated 15.7 percent in 2007.
Another strategy government sponsors use to control their pension fund
contribution rates is to implement new, less costly benefit levels for
newly hired employees. Plan sponsors create a new "tier," with
different benefits, for all employees hired after the date the new tier
goes into effect. For example, New York has four tiers in its State and
Local Retirement System, based on an employee's occupation and date of
hire. General employees in tier 1 (hired before July 1, 1973) can
retire at age 55 after 20 years of service with no reduction for early
retirement. However, general employees in tier 3 (hired between July
26, 1973, and September 1, 1983) must be age 62 with 5 years of service
or age 55 with 30 years of service to retire with no reduction in
benefit.
In addition to creating new tiers within the same pension plan,
government sponsors can also lower costs by adopting entirely new plans
for future hires. For example, Alaska recently switched from its
previous defined benefit plans to defined contribution plans for all
general public employees and teachers hired on or after July 1, 2006.
According to the state's 2006 comprehensive annual financial report,
the new pension system was adopted to help stabilize contribution rates
for all public employers within the state. Also, in 2003, Oregon
adopted a new program with both a defined benefit and a defined
contribution component as its primary plan for public employees. Under
the new program, Oregon continues to provide a defined benefit funded
by employer contributions (with a lower benefit formula for new
employees), while the employees' contributions are now placed in
individual accounts with no state matching (the defined contribution
component). Oregon officials estimate that its pension reforms save
public employers over $400 million per year.
Yet another strategy plan sponsors use to manage their costs is to seek
higher contribution rates from its employees. For example, in 2005,
Louisiana enacted legislation to raise the employee contribution rate
for general state employees participating in the State Employees'
Retirement System hired on or after July 1, 2006, from 7.5 to 8.0
percent.[Footnote 45]
Finally, another strategy that some plan sponsors have used as part of
an overall strategy for managing pension costs is to issue bonds to
reduce their unfunded actuarial liabilities. If the interest rate on
the bond is less than the rate of return earned on pension assets,
sponsors can achieve some savings. For example, in 2005, Detroit issued
$1.44 billion in bonds to pay down the unfunded accrued actuarial
liabilities of its two retirement systems. Similarly, Oregon recently
issued pension obligation bonds to help reduce its employer
contribution rate for the Public Employees Retirement System. According
to officials from Oregon's Legislative Fiscal Office, by issuing the
pension bonds, they were paying a lower interest rate on the debt
service for the bonds (about 5.75 percent) than they were currently
earning on the bond proceeds. OPERS officials said that earnings on the
bond proceeds have averaged over 15 percent over the last 4 years.
However, it should be noted that issuing bonds to make the employer
contribution increases the government's overall exposure to financial
risks to the extent that the bond proceeds are invested in equities or
highly leveraged portfolios for returns to exceed the borrowing costs.
Also, if rates of return were to move lower than the bond rates, state
and local governments would no longer realize an advantage to having
issued the bonds, because the rate they could earn on the proceeds may
no longer cover the debt service costs.
Failure to Maintain Acceptable Funding Levels May Place Future
Taxpayers and/or Beneficiaries at Risk:
Public pension plan funding levels are sensitive to a variety of
external influences, such as the rate of return on the funds'
investments, the annual stream of contributions to the fund, and
changes to the levels of benefits that ultimately affect future
liabilities. Although strategies are being used to keep the funding of
most plans on track, we found some notable exceptions where the failure
to use such strategies caused the funding status to drop significantly.
Over time, state and local governments could be faced with the need to
raise taxes, cut spending, or reduce benefits in order to meet their
obligations.
As investment earnings are the major source of pension funding, timely
payment of contributions is key to maximizing the compound interest
earned. However, sometimes a combination of factors makes it difficult
for state and local governments to make their actuarially required
contribution, and funding levels can drop. For instance, the sharp and
prolonged decline in the stock market that occurred in the early 2000s
reduced the value of many plans' assets and increased the amount many
states and local governments needed to contribute to remain on track
toward full funding. Furthermore, to the extent state and local
governments experience slower economic growth, revenues might not keep
up with expenditures, making it difficult for the governments to meet
their funding commitments for pensions. For example, from 2001 to 2007,
Michigan's contribution rate for the State Employees' Retirement System
(MSERS) dramatically increased--from 4.7 percent to 18.1 percent of
payroll. During this period of slow revenue growth, Michigan used money
transferred from a pension fund subaccount to supplement the amount it
contributed to MSERS to make its full actuarially required
contribution. Even so, from 2002 through 2005, MSERS's funded ratio
dropped steadily from 98.7 percent to 79.8 percent.[Footnote 46]
In some cases, employers fell short of making their actuarially
required contributions at the same time that they adopted significant
increases in pension benefits for their employees, and did so for
years. For example, a New Jersey state treasury department official
told us that in 1997, the state viewed the status of its pension funds
as "overfunded," and began substituting "excess" pension assets for
their actuarially required contributions. The state skipped payments to
the retirement plans over a 7-year period, totaling $8 billion. While
in this "overfunded" position, the state also approved costly benefit
enhancements and early retirement packages. According to the official,
as a result of these enhancements and less than prudent funding
arrangements, compounded by the downturn in the market conditions
beginning in 2001, the funded ratios of several New Jersey pension
plans fell below acceptable levels. For instance, since 1999, the
funded ratio of New Jersey's Public Employees' Retirement System
declined from 113.5 to 79.1 percent as of June 30, 2005. Overall, the
state now faces an $18.9 billion unfunded liability for all of its
retirement plans combined. Similarly, in San Diego, the city did not
make its actuarially required contribution to the San Diego City
Retirement System by about $80 million from 1999 through 2004. At the
same time, the city increased benefits to current employees, and in a
litigation settlement, increased benefits to current retirees. As of
June 30, 2006, the actuarial valuation report for the system stated
that the funding status had dropped from 97.3 percent in 2000 to a low
of 65.8 percent in 2004, with an unfunded liability of $1.37 billion.
However, as of 2006, the system had regained ground up to 79.9 percent,
with an unfunded liability of about $1.0 billion.
Most State and Local Governments Have Yet to Develop Long-Term
Strategies for Financing Future Health Care Costs for Retirees:
Most state and local governments generally lack long-term strategies to
address future health care costs. In addition, many of the governments
are still in the process of responding to the new GASB statement
calling for valuations of the liability for the future cost of other
postemployment benefits (OPEB), including health care benefits for
retirees, as the standard is being implemented in phases. Officials for
the governments we visited said that once the valuations were
completed, they would consider options for addressing these costs, if
needed.
Sidebar:
Effective Dates for Phased Implementation of GASB Statement 45 for
Financial Reporting of Future OPEB Liabilities:
Phase: 1;
In the first fiscal year ending after June 15, 1999, for governments
with total annual revenues of: $100 million or more;
Statement effective for periods beginning after December 15: 2006.
Phase: 2;
In the first fiscal year ending after June 15, 1999, for governments
with total annual revenues of: $10 million or more, but less than $100
million;
Statement effective for periods beginning after December 15: 2007.
Phase: 3;
In the first fiscal year ending after June 15, 1999, for governments
with total annual revenues of: Less than $10 million;
Statement effective for periods beginning after December 15: 2008.
Source: GASB.
[End of sidebar]
Several funding vehicles are available under the federal tax code to
help facilitate state and local government efforts to accumulate funds
to meet their future health care liabilities. (See table 6.) As noted
earlier, of the state and local governments that contribute to retiree
health benefits, most treat the cost of the benefits as an operating
expense and do not prefund the future obligation. Of the states that
provide an explicit contribution to the premiums for retiree health
coverage,[Footnote 47] it has been reported that 13 partially prefund
their future health care costs.[Footnote 48] But these prefunding
efforts have been slow to get started. For example, in 1989, the
Connecticut Teacher's Retirement System created a Health Insurance
Premium Account, using a 1 percent of salary contribution from active
teachers to fund health benefits for retirees. The fund was facing
insolvency by 1999. To address the shortfall, in 2004, Connecticut
increased active teachers' contributions to the fund from 1 percent to
1.25 percent of salary. In Michigan, state budget officials said that
they would like to prefund retiree health care benefits for state
employees, but other state priorities have prevented them from doing
so. However, a fund was recently set up for local employees in
Michigan. In 2004, the Municipal Employees' Retirement System of
Michigan created a Retiree Health Funding Vehicle to allow
municipalities to contribute to a trust fund for retiree health
benefits. As of September 2007, system officials reported that 55
employers were participating in the program, and that the fund had over
$95 million available for retiree health care costs.[Footnote 49] More
recently, in March 2007, CalPERS launched the California Employers'
Retiree Benefit Trust Fund, an investment vehicle that allows public
employers that contract with CalPERS for employee health benefits to
prefund their future OPEB costs.
Table 6: Different Vehicles for Prefunding Retiree Health Costs:
Section of the Internal Revenue Code: 501(c)(9);
Vehicle description: Voluntary Employees' Beneficiary Association
(VEBA): A tax-advantaged exempt entity, usually a trust, for the
benefit of a voluntary membership of active and retired employees, and
from which tax-free distributions may be made for qualifying health
care expenses of retirees.
Section of the Internal Revenue Code: 401(h);
Vehicle description: Health benefits subaccount: A separate subaccount
of a defined benefit pension trust that allows up to 25 percent of the
total employer contribution to the pension fund to be allocated to
retiree health benefits. Investment income on assets in the subaccount
accumulates tax free, and retiree health benefit payments made from the
subaccount are not taxable to retirees.
Section of the Internal Revenue Code: 115;
Vehicle description: Governmental trust: A trust established by a
governmental employer to fund an essential government function, which
may include providing retiree health benefits. Contributions to the
trust are not limited, unlike contributions to a VEBA or health
benefits subaccount. The investment income on the trust is not taxed,
and the benefits ought to be tax free to the retiree when received,
with confirmation from the Internal Revenue Service.
Source: Internal Revenue Code and Congressional Research Service, 2006.
[End of table]
At the sites we visited, state and local government officials we spoke
with said that the rising cost of health care was one of the biggest
fiscal challenges confronting them in the near term. They said the
drivers of their health care costs mirror those of the nation as a
whole: rapidly escalating costs for prescription drugs, medical care,
and hospital care. Further, they noted that the health care industry's
practice of shifting costs not paid by the Medicare and Medicaid
programs to employers is causing employers' costs for health insurance
premiums to rise even faster. In addition to the costs associated with
providing health care benefits for their active and retired workers,
states also must contend with rising costs for their uninsured
residents and federal changes to Medicaid. Officials who administer
health benefits for California state and local governments noted that
much of the cost increase for the health care market is due to health
care inflation and demographic factors that are outside of their
control. At the same time, with respect to health care, there are also
factors that are within their control to help manage these costs, such
as their program's benefit design and eligibility criteria.
Aside from prefunding through establishment of a trust, several states
have taken steps to address escalating costs of retiree health benefits
by negotiating lower premium costs and/or reducing benefits. For
example, as in the private sector, some public employers have
negotiated lower premiums by increasing the deductibles, co-payments,
and coinsurance that employees must pay out of pocket. In addition,
several states have introduced requirements that employees must work a
certain number of years before becoming eligible for various levels of
retiree health benefits. California introduced such vesting
requirements for partially paid retiree health benefits for workers
hired in 1985 and thereafter; and Michigan introduced similar
requirements in 1997. In 2006, North Carolina enacted legislation
requiring that employees hired after February 1, 2007, must have 20
years of service to be eligible for retiree health benefits.[Footnote
50] Other states have reduced the benefits provided and/or instituted
health savings accounts. Oregon has discontinued its retiree health
care support for those hired since 2003. Also, to reduce state costs,
Utah recently discontinued its policy of providing retirees a month of
health insurance for every day of unused sick leave (a policy initiated
when health insurance costs were substantially lower). Instead, Utah
now deposits wage amounts equal to unused sick leave into health
savings accounts that retirees can use to purchase their own health
insurance.
Sidebar:
Percentage of public employers indicating that they would be likely, or
very likely, to take the following actions in response to GASB 45:
Funding their retiree health plan: 31%;
Raise retiree contributions: 21%;
Cut other spending: 9%;
Raise taxes: 6%;
Cut retiree benefits: 5%;
Take no action: 9%.
Source: Mercer Health & Benefits LLC, 2006 (based on responses from 58
state, county, and city governments, public school boards, colleges,
and universities).
[End of sidebar]
State and local governments indicated that they may take a range of
actions in response to the new GASB standards. At the locations we
visited, all the officials we spoke with said that their governments
were planning to comply with the new standards and report their
liability for retiree health benefits. However, while various options
were being discussed, none of the officials we spoke with said that
their governments had developed plans to address their unfunded
liabilities. In California, for example, the governor had established a
12-member Public Employee Post-Employment Benefits Commission to
propose ways to address the state's growing postemployment benefits and
retiree health care obligations, with a recommended plan due by January
1, 2008. According to Oregon retirement system officials, their state
had also formed a workgroup to study options related to GASB 45. In
Detroit, the city budget director said that city officials would wait
to find out if any practices emerge that gain wide support before
deciding their next steps. San Francisco is also taking a wait-and-see
approach with respect to devising a strategy for dealing with the
unfunded liability. A senior city official said that the city wants to
have several years' experience estimating the unfunded liability to
feel confident that the estimates are valid before negotiating any
remedies with the unions. Otherwise, he noted, if the costs end up
being greater than anticipated, it could be difficult to reopen
negotiations with the unions and the city would then have to deal with
the greater costs on its own.
Concluding Observations:
Across the state and local government sector, the ability to maintain
current levels of public sector retiree benefits will depend, in large
part, on the nature and extent of the fiscal challenges these
governments face in the years ahead. While public sector workers have
thus far been relatively shielded from many of the changes that have
occurred in the private sector, provisions that lend stability for
public sector pensions and retiree health benefits are subject to
change. Pension benefits are often protected by state constitutions and
city charters, but these protections can be amended if voters feel the
need to rebalance priorities as fiscal pressures increase. In fact, our
recent work on state and local government fiscal conditions indicated
that persistent fiscal challenges will likely emerge within the next
decade. Retiree health benefits are generally easier to change simply
through the annual budget process.
As we heard from some state officials, the impetus for changing retiree
benefits often surfaces when the projected costs for these benefits
starts to grow faster than expected. When this occurs, governments may
eventually have little choice but to reduce future benefits or raise
taxes. One way state and local governments can address unexpected gaps
in funding is to prefund the promised benefits. Even though our
simulation suggests that the sector as a whole is generally on track
with funding its pension obligations, continued diligence will be
necessary to ensure that funding is adequate in the future. When state
and local governments take breaks from their regular contribution
schedules, such as when investment returns are high, they may be
putting their ability to pay future retiree benefits at risk. According
to our simulation for state and local governments, to ensure that they
have the resources they need to meet future costs, they will have to
maintain (and as a sector, increase slightly) their contributions to
their pension funds. Moreover, our long-term projections indicate that
if future returns turn out lower than expected, governments may need to
ratchet up their contributions substantially.
The provision of retiree health benefits presents an entirely different
scenario. Given that our simulations show that over the next several
decades, the cost of providing health care benefits for public sector
retirees will more than double as a share of salaries, state and local
governments may find it difficult to maintain current benefits levels.
It is clear from our model and from discussions with budget officials
that health care inflation is driving these future costs. Budget
officials with whom we spoke said that they will face challenges
financing future health care benefits in general--including Medicaid
benefits and health benefits for active government employees, not just
for their retirees. As state and local governments begin to comply with
GASB reporting standards, information about the future costs of the
retiree health benefits will become more transparent. Policy makers,
voters, and beneficiaries can use this new information to begin a
debate on ways to control escalating health care costs, the appropriate
level of future benefits to be provided to public sector retirees, and
who should pay for them.
Agency Comments:
We provided officials from the Internal Revenue Service with a draft of
this report. These officials provided us with informal technical
comments that we have incorporated in the report, where appropriate. In
addition, we provided GASB officials and officials from the states and
cities we visited with portions of the draft report that addressed
aspects of the pension funds and retiree health benefit programs in
their jurisdictions. They, too, provided us with comments that we
incorporated in this report, where appropriate. Finally, we also
benefited from comments provided by two external reviewers
knowledgeable about the subject area.
As agreed with your office, unless you publicly announce the contents
of this report earlier, we plan no further distribution until 30 days
from the report date. At that time, we will send copies of this report
to relevant congressional committees, the Acting Commissioner of
Internal Revenue, and other interested parties. We will also make
copies available to others:
upon request. In addition, the report will be available at no charge on
the GAO web site at [hyperlink, http://www.gao.gov]. If you or your
staff have any questions concerning this report, please call me at
(202) 512-7215. Key contributors are listed in appendix V.
Signed by:
Barbara D. Bovbjerg:
Director, Education, Workforce, and Income Security Issues:
[End of section]
Appendix I: Organizations, Associations, and State and Local Agencies
GAO Contacted:
National Level:
AARP (formerly, American Association of Retired Persons):
American Federation of Labor and Congress of Industrial Organizations
(AFL-CIO):
American Federation of State, County and Municipal Employees:
American Federation of Teachers:
Employee Benefit Research Institute:
Fitch Ratings, credit rating firm:
Governmental Accounting Standards Board:
Gabriel, Roeder, Smith & Company, consulting firm:
International Association of Fire Fighters:
International Brotherhood of Teamsters:
Lussier, Gregor, Vienna, & Associates, Inc., consulting firm:
Moody's Investors Service, financial research firm:
National Association of State Auditors, Comptrollers and Treasurers:
National Association of State Budget Officers:
National Association of State Retirement Administrators:
National Conference of State Legislatures:
National Conference on Public Employee Retirement Systems:
National Coordinating Committee for Multiemployer Plans:
National Education Association:
Pew Center on the States:
The Segal Company, consulting firm:
Service Employees International Union:
Standard & Poor's, credit rating firm:
State and Local Level:
California State:
California Legislative Analyst's Office:
California Public Employees' Retirement System:
California State Controller's Office:
California State Association of County Retirement Systems:
California Local:
Alameda County Employees' Retirement Association:
Los Angeles County Employees Retirement Association:
Orange County Retirement System:
Sacramento County Employees' Retirement System:
San Francisco Office of the Controller:
San Francisco Employees' Retirement System:
San Francisco Health Service System:
San Joaquin County Employees' Retirement System:
Michigan State:
Michigan Department of Civil Service:
Michigan Office of the Auditor General:
Michigan Office of Retirement Services:
Michigan Office of the State Budget:
Michigan Senate Fiscal Agency:
Municipal Employees' Retirement System of Michigan:
Michigan Local:
Detroit Budget Department:
Detroit Finance Department, General Retirement System:
Detroit Finance Department, Policemen and Firemen Retirement System:
Detroit Human Resources Department:
Detroit City Council, Fiscal Analysis Division:
Detroit Office, American Federation of State, County and Municipal
Employees (Council 25):
Detroit Office of the Auditor General:
Oregon State:
Oregon, American Federation of State, County and Municipal Employees
(Retirees Local 155):
Oregon Department of Administrative Services, Budget and Management
Division:
Oregon Department of Administrative Services, State Controller's
Division:
Oregon Education Association Oregon Legislative Fiscal Office:
Oregon Office of the Secretary of State, Audits Division:
Oregon Public Employees' Benefit Board:
Oregon Public Employees Retirement System:
Oregon State Legislature, Office of the Legislative Counsel:
[End of section]
Appendix II: Technical Background on Pension and Retiree Health Care
Simulations:
One of the primary costs of state and local governments is the salaries
and benefits of employees, and part of those costs are the pensions and
other postemployment benefits of retirees of state and local
governments. This appendix provides information on the development of
simulations of future pension and health care costs for retirees of
state and local governments. These analyses are part of a larger GAO
effort that examines the potential fiscal condition of the state and
local sector for many years into the future,[Footnote 51] and are an
aggregate analysis of the entire state and local sector--no individual
governments are examined. This appendix provides information on (1) the
development of several key demographic and economic factors such as
future employment, retirement, and wages for the state and local
workforce that are necessary for the simulations of future pension and
retiree health care costs; (2) how we project the necessary
contribution rate to pension funds of state and local governments; and
(3) how we project the future yearly pay-as-you-go costs of retiree
health benefits.
Development of Factors for Employment, Retirement, Wages, and Benefits:
Key underlying information for the pension and health care cost
simulations relates to future levels of employment, retirees, and
wages. In particular, to understand the postretirement promises that
the sector has and will continue to make, we need to project the number
of employees and retirees in each future year, as well as the dollar
value of pension benefits that will be earned and the extent to which
those benefits will be funded through employee contributions to pension
funds.[Footnote 52] These analyses relate to defined benefit plans
only. We project the following key factors for each year during the
simulation time frame: (1) the number of state and local government
employees, (2) the state and local government real wages, (3) the
number of pension beneficiaries, (4) average real benefits per
beneficiary, and (5) yearly employee contributions to state and local
government pension plans.
1. Steps to Project Future Employment Levels:
Future growth in the number of state and local government retirees--
many of whom will be entitled to pension and health care benefits--is
largely driven by the size of the workforce in earlier years. To
project the level of employment in each future year, we assume that
state and local employment grows at the same rate as total population
under the intermediate assumptions of the Old-Age and Survivors
Insurance and Disability Insurance (OASDI) Trustees.[Footnote 53] The
implication of these assumptions is that the ratio of state and local
employment to the total population remains constant.[Footnote 54] The
Trustees assume that population growth gradually declines from 0.8
percent during the next decade to a steady rate of 0.3 percent per year
beginning in 2044. Accordingly, state and local government employment
displays the same pattern in our projections. The relationship used to
project total state and local government employment (egslall) is shown
in equation 1:
[See PDF for equation]
1) egslall[t] equals egslall[t-1] times (np[t] divided by np[t-1]).
where: np is population in the indicated year:
egslall is the number of state and local employees in the indicated
year:
2. Steps to Project Future State and Local Government Real Wage:
The pension benefits that employees become entitled to are a function
of the wages they earned during their working years. As described
below, we developed a rolling average real wage index for different
cohorts of workers to estimate the average real pension benefit of the
recipient pool in each future year.
First, we assume that the real employment cost index for the state and
local sector (jecistlcr) will grow at a rate equal to the difference
between the Congressional Budget Office (CBO) assumptions for the
growth in the employment cost index (ECI) for private sector wages and
salaries and inflation as measured by the consumer price index for all
urban consumers (CPIU), as published in the January 2007 CBO Budget and
Economic Outlook. These data are available through 2017. For later
years, we hold the growth rate constant at the rate that CBO assumes
between 2016 and 2017.
CBO's assumptions for growth in the ECI and the CPIU are 3.3 percent
and 2.2 percent per year respectively, implying a real wage growth of
1.1 percent per year during the simulation time frame. Since the
analysis is scaled to the real wage bill over the simulation time
frame, we calculate that aggregate amount for each future year. As
shown in equation 2, aggregate real wages are assumed to grow at the
combined rate of growth in the real employment cost index (jecistlcr)
and employment (egslall).
[See PDF for equation]
2) gslcwageallr[t] equals gslcwageallr[t-1] times [(jecistlcr[t] time
egslall[t]) divided by (jecistlcr[t-1] time egslall[t-1]].
where: jecistler is the real employment cost index in a given year:
gsclwageallr is the real wage bill of the state and local sector:
As noted previously, population growth slows from 0.8 percent in the
upcoming decade to a steady rate of 0.3 percent after 2044. Because
population growth drives employment in our projections, this slowdown
implies that aggregate real wage growth slows from 1.9 percent per year
to a steady long-run rate of 1.4 percent.
3. Steps to Project Growth in the Number of Pension Beneficiaries:
While actuaries use detailed information and assumptions regarding the
age, earnings, service records, and mortality rates applicable to the
entities they evaluate, information in such detail is not available for
the state and local government sector as a whole. This lack of detailed
data necessitated the development of a method of projecting aggregate
state and local beneficiary growth that is much simpler than the
methods that actuaries employ.
The method we developed reflects the logic that each year's growth in
the number of beneficiaries is linked to past growth in the number of
employees. Total state and local government employment from 1929
through 2005 was obtained from the National Income and Product Accounts
(NIPA) tables 6.4a, b, c, and d. The Census Bureau provided a
continuous series of data on the number of state and local pension
beneficiaries from 1992 through 2005 during which continuous
observations were available.
Cyclical swings in the employment series were removed using a Hodrick-
Prescott filter. Then, both the employment and beneficiary series were
logged and first-differenced, transforming the data from levels to
proportionate changes. We developed a routine that searched across 45
years of lagged employment growth to select a set of weights for the
years in which past employment growth best explained a given year's
growth in beneficiaries.[Footnote 55] The routine included the
restrictions that the weights must be non-negative and sum to 1. The
method produced the relationship shown in equation 3, where
beneficiaries is equal to the state and local pension benefit
recipients, eglsall is state and local employees, and the coefficients
are weights, derived from the estimation, that reflect the contribution
of a particular past year's employment change in explaining a given
year's change in retirees. In particular, the estimated relationship
suggests that beneficiary growth in a given year is largely determined
by employment growth 34, 21, 22, and 23 years prior to the given
period. This pattern appears consistent with the categories of workers
that the sector employs. Many fire and police positions, for example,
offer faster pension accrual or early retirement due to the physical
demands and risks of the work, while many other state and local workers
have longer careers.
[See PDF for equation]
3) d log (beneficiaries{t]) equals 0.56d log (egslall[t-34]) plus 0.02d
log (egslall[t-23]) plus 0.19d log (egslall[t-22]) plus 0.23d
log(egslall[t-21]).
where: beneficiaries is the number of retirees receiving pensions in
the indicated year.
4. Steps to Project Real Benefits per Beneficiary:
While, in the long run, the average real benefit level should grow at
the same rate as real wages--that is, at 1.1 percent per year--in the
first decades of the projection the average real benefit will be
affected by real wage changes that occurred before the projection
period. Accordingly, we developed a relationship that reflects how the
average real benefit level will change over time according to changes
in the number and average real benefit level of three subsets of the
retiree population: (1) new retirees entering the beneficiary pool, (2)
new decedents leaving the pool, and (3) the majority of the previous
year's retirees who continue to receive benefits during the given
period. Each group's real benefit is linked to the real wage level in
the average year of retirement for that group. Thus, to determine the
average real benefit overall in any future year, we need weights and
real wage indexes for the three groups that can be used to develop a
rolling average real wage of the recipient pool in each future year.
Equation 3 above projects the percentage change in the total number of
beneficiaries between two successive years, but this difference is
actually composed of two elements: the percentage change in new
retirees minus the percentage change in decedents. Therefore, to
determine the weight for new retirees, we also need an estimate of the
number of new decedents in each year. In order to estimate a "death
rate," we utilize Social Security Administration data on terminated
benefits[Footnote 56] and total OASDI recipients, which excludes
disability recipients.[Footnote 57] Our estimate of the "death rate"
for the forecast period is assumed to be equal to the number of
terminated Social Security recipients divided by the total number of
OASDI recipients in 2003 (3.67 percent). This analysis then enables a
derivation of weights for each of the three groups as follows:
* weight for new retirees: the number of beneficiaries this year, less
the number of beneficiaries last year who are still alive, divided by
the number of beneficiaries this year (Wn,t):
* weight for continuing recipients is equal to last year's
beneficiaries divided by this year's beneficiaries (Wc,t):
* weight for the deceased is the death rate (3.67 percent) multiplied
by last year's beneficiaries divided by this year's beneficiaries
(Wd,t):
Mathematically the weights are calculated as follows:
4a) Wn,t equals (beneficiaries[t] minus (1 minus .0367)beneficiaries[t-
1]) divided by beneficiaries[t];
Wc,t equals beneficiaries[t-1] divided by beneficiaries[t];
Wd,t equals .0367 times beneficiaries[t-1] divided by beneficiaries[t].
Next, we need to identify the real employment cost index that
determines the real benefit level for each of these three groups. We do
so by estimating the average retirement year applicable to each of the
three groups. First, we assume the average retirement age is 60. We
developed this estimate based on an analysis of the March Supplement to
the Current Population Survey (CPS) for 2005-2006, which indicated that
the average state and local government retiree had retired at 60 years
of age. We also analyzed detailed data on the age distribution of OASDI
recipients provided by the Office of the Actuary of the Social Security
Administration. These data showed that the average age for new
decedents is about 81 during the initial years of OASDI's simulations,
and we thus used a 21-year lag--81 minus 60--to estimate the real wage
applicable to this group. For the newly retired group, we use the
current year's employment cost index. For the remaining retirees--those
already retired and remaining in the group--we use information from CPS
for 2005 that indicated that the average age of a retired state or
local retiree was 68. Therefore, we apply an 8-year lag to the real
employment cost index to determine real benefits of this group.
Using the weights shown in equation 4a and the appropriate periods'
values for the real employment cost index (jecistlcr), the rolling
average jecistlcr is constructed as follows:
[See PDF for equation]
4aa) (Wn,t jecistlcr[t] plus Wc,t jecistlcr[t-8] minus Wd,t jecistlcr[t-
2] equals wjecistlcrt:
where: wjecistlcr is the rolling average employment cost index for
retirees in year t.
This equation approximates the average employment cost index at
retirement of the retiree pool in a given year. To do this we take the
employment cost index 8 years prior to the given year and weight this
by the portion of the total retirees in the given year who were already
retired last year. We add to this a factor to account for new retirees
who have a higher employment cost index because they just retired.
Finally, because some of the retirees from last year have deceased, the
first factor overstates the number of retirees, and therefore we
subtract a factor for those who have died, weighted by the cost index
21 years ago, when, on average, this group entered retirement.
The ratio of the given year's weighted average real wage index to the
previous year's weighted average real wage index should equal the ratio
of the current to the previous year's average real benefit levels.
Thus, as shown in equation 4b, a given year's average real benefit
level grows at the same rate as the rolling index of real wages. The
relationship has the desired property of capturing the effect of
historical real wage growth in the initial decades of the projection
before converging to a long-run average annual growth rate of 1.1
percent, which is consistent with our assumption for real wage growth.
To calculate aggregate real pension benefit payments penbenr, the
average real benefit derived using equation 4b is multiplied by the
number of beneficiaries projected using equation 3.
[See PDF for equation]
4b) penbenr[t] divided by beneficiaries[t] equals penbenr[t-1] divided
by beneficiaries[t-1]times [(Wn,t jecistlcr[t] plus Wc,t jecistlcr[t-8]
minus Wd,t jecistlcr[t-21]) divided by (Wn,t jecistlcr[t-1] plus Wc,t
jecistlcr[t-9] minus Wd,t jecistlcr[t-22])].
5. Steps to Project Employee Contributions to Pension:
Employee contributions represent an important funding source for state
and local government pension plans. In 2006, for example, NIPA data
indicate that employees contributed 4.7 percent of their wages and
salaries to their retirement funds. To estimate future employee
contributions, we simply assume that the 2006 contribution level is
held constant as a share of aggregate wages (see equation 5).
[See PDF for equation]
5) eeconpenr[t] divided by glscwageallr[t] equals eeconpenr[t-1]
divided by glscwageallr[t-1].
where:eeconpenr is the real aggregate employee contribution to pension
funds:
Projections of Necessary Contributions to Pension Funds for State and
Local Government Sector:
The purpose of the pension simulations is to estimate the level of
contribution that state and local governments would need to make each
year going forward to ensure that their pension systems are fully
funded on an ongoing basis. In the previous section we calculated a
variety of critical demographic and economic factors that are necessary
for this analysis. In the following section, we describe our basic
formulation and sensitivity analysis for employer contributions to
pension funds.
Basic Formulation of Necessary Steady Level of Employer Contributions:
The necessary contribution rate can now be derived according to a
simple concept: the present value of future pension benefits minus the
sum of 2006 pension fund financial assets and the present value of
employee contributions, all divided by the present value of future
wages. The starting value of pension assets for state and local
government pension plans--approximately $2.979 trillion in 2006--is
obtained from the Federal Reserve Flow of Funds Accounts. Future wages
are simulated within our model. The logic of this estimation is that
the benefits that are promised to employees (including liabilities
already made and promises that will be made in the future) must be paid
from three sources: existing pension funds in 2006, contributions that
employees will continue to make to those funds in the future, and
contributions that employers will make to those funds in the future.
Our analysis estimates the steady level of employer contribution,
relative to wages, that would need to be made in every year between
2006 and 2050 to fully fund promised pension benefits. Although we are
only interested in developing necessary contribution rates over the
simulation time frame--that is, until 2050--we actually have to derive
the contribution rate for a longer time frame in order to find the
steady state level of necessary contributions. This longer time frame
is required because the estimated contribution rate increases as the
projection horizon increases and eventually converges in a steady
state. If the projection period is of insufficient length, the steady
level of contribution is not attained and the contribution rate
necessary is understated.[Footnote 58] As such, all of the flows in the
calculation extend 400 years into the future. We use a real rate of
return on pension assets of 5.0 percent (rpenreal) to discount future
flows when deriving present values.[Footnote 59] Equation 6 shows
mathematically the estimate of the employer contribution rate.
[See PDF for equation]
where: rpenreal is the real rate of return on pension assets:
Applying this analysis, we found that in aggregate, state and local
government contributions to pension funds would need to increase by
less than half a percent to fund, on an ongoing basis, the pension
liabilities they have and will continue to accrue. In particular, the
2006 pension contributions for the sector amounted to 9 percent of
wages, and our base case estimate is that the level would need to be
9.3 percent each year to fully fund pensions.
Sensitivity Analyses of Necessary Steady Level of Employer
Contributions:
We altered certain of our assumptions to examine the sensitivity of our
model results. We found that the model results are highly sensitive to
our assumptions regarding the expected real yield. For our primary
simulations, we based the expected real yield on actual returns on
various investment instruments over the last 40 years as well as the
disposition of the portfolio of assets held by the sector over the last
10 years. This generated a real yield of 5 percent. But some pension
experts have expressed concern that returns on equities in the future
may not be quite as high as those in the past. In fact, some analysts
believe that an analysis of this type should consider only "riskless
returns." Under such an approach we would assume that all pension funds
are invested in very safe financial instruments such as government
bonds. We estimated the necessary steady level of employer
contributions holding all elements in the model stable except the real
expected yield. In particular, we analyzed a 4 percent real yield and a
3 percent real yield--that latter of which is a reasonable proxy for a
riskless rate of return. We found that if returns were only 4 percent,
the necessary contribution rate would rise to 13.9 percent, and if we
used a risk-free return of roughly 3 percent, the necessary
contribution rates would need to be much higher--nearly 18.6 percent of
wages. On the other hand, if real returns were higher than our base
case level--perhaps 6 percent--the necessary contribution rate would
only be only 5.0 percent, much lower than their current contribution
rate.
Projections of Retiree Health Benefit Costs for State and Local
Retirees:
Most state and local government pay for retiree health benefits on a
pay-as-you-go basis--that is, these benefits are generally not
prefunded. We made projections of the pay-as-you-go cost of retiree
health benefits for the sector, as a percentage of wages, in each year
until 2050. To estimate the costs of retiree health benefits in future
years, we made many of the same assumptions as for the pension
analysis. In particular, we use the same method to develop projections
of employment in the sector, the number of retirees, and the level of
wages. An additional assumption for the health care analysis is that in
future years, the same percentage of retirees of state and local
governments will be enrolled in health insurance through their previous
employer as we observe were enrolled in 2004--the most recent year for
which data were available. To develop this measure, we use data from
two sources. The Census Bureau's State and Local Government Employee-
Retirement System survey provided data on the total number of state and
local retirees, and the Health and Human Services Department's Medical
Expenditure Panel Survey provided data on state and local government
retirees who are covered by prior employer-provided health insurance.
On the basis of these data sources, we found that the share of retirees
with health insurance is 42 percent, and we hold this constant through
the simulations. From the latter data source we also obtain the most
recent year state and local government spending on health care for
retirees.
One of the most central assumptions we must make to estimate the pay-
as-you-go health care costs for retirees in future years is the cost
growth of health insurance. The cost of health care has been growing
faster than gross domestic product (GDP) for many years. As such, we
developed assumptions about how much faster health care costs would
grow, relative to the economy, in future years. The extent to which the
per person cost of health care is expected to grow beyond GDP per
capita is called the "excess cost factor." We developed these estimates
based on our own research and discussions with experts. In particular,
we assume that the excess cost factor averages 1.4 percentage points
per year through 2035, and then begins to decline, reaching 0.6
percentage points by 2050.
Using these assumptions, we develop a growth projection for the per
capita costs of health care for retirees each year through 2050. The
following equation shows that health care costs are assumed to grow
with GDP per capita plus this excess cost factor.
7) (retgslchlth/rethlth ) = (retgslchlth(-1)/rethlth (-1))*:
(hlthnheexcgr)*((gdp/np)/(gdp(-1)/np(-1))):
where: retgslchlth is the aggregate health care cost for the sector:
rethlth is the number of retirees with health insurance:
hlthnheexcgr is the excess cost factor for health insurance:
We found that the projected costs for retiree health benefits, while
not a large component of state budgets, will more than double as a
percentage of wages over the next several decades. In 2006, these costs
amounted to approximately 2.0 percent of wages, and we project that by
2050, they will grow to nearly 5.0 percent of wages--a 150 percent
increase. As with the projections of necessary pension contributions,
our estimates of retiree health benefit costs are highly sensitive to
certain of our assumptions. In particular, the assumptions regarding
health care cost growth are critical. For example, if health costs were
to only rise at the rate of GDP per capita, these costs would only
grow, as a percentage of wages, from 2 percent today to 2.9 percent by
2050. Conversely, if health costs were to grow by twice the rate we
assume in the base case, these costs, as a percentage of wages, would
constitute 8.4 percent by 2050.[Footnote 60]
[End of section]
Appendix III: State and Local Government Retiree Benefit Plans in
California, Michigan, and Oregon:
California:
State and local government workers:
Total number (2006)[A]: 2,199,700;
State and local government workers:
* State workers; 473,500;
* Local workers; 1,726,200.
Percentage covered by unions (2005)[B]; 57.5%;
Percentage participating Social Security (2004)[C]; 42.0%.
State and local government pension plans:
Pension plans, by level of administration: State-administered plans (6
total)[D];
Occupations covered: Approximately 81% of all state and local workers
statewide[E];
Number of members: [Empty];
Number of employers: [Empty];
Retiree health benefits: [Empty].
Pension plans, by level of administration: State-administered plans (6
total)[D]: CalPERS Public Employees' Retirement Fund;
Occupations covered: Safety (law enforcement, correctional officers,
and firefighters); Schools (nonteaching employees); State industrial
(non-sworn correctional employees); Miscellaneous (all others);
Number of members: 1,490,172;
Number of employers: 1,545;
Retiree health benefits: CalPERS health care program provides coverage
to state employees, retirees, and their families, by law. In addition,
most local public agencies and school employers can contract to have
CalPERS provide these benefits to their employees (whether or not they
contract for CalPERS retirement program). As of 2006, 1,137 entities
participated in the program. Health plans offered, covered benefits,
monthly rates, and co-payments are determined by the CalPERS Board,
which reviews health plan contracts annually. Employers make a
contribution toward the member's monthly premiums, with members
covering the difference between the employer's contribution and the
actual premium amount. The employer contribution rate is normally
established through collective bargaining agreements.
Pension plans, by level of administration: State-administered plans (6
total)[D]: CalPERS Judges' Retirement Fund; Tier I: Appointed/elected
before 11/9/94; Tier II: Appointed/elected on or after 11/9/94;
Occupations covered: Supreme court judges; Courts of appeal judges;
Superior courts judges;
Number of members: 3,329;
Number of employers: 59;
Retiree health benefits: (CalPERS health care program--see above).
Pension plans, by level of administration: State-administered plans (6
total)[D]: CalPERS Legislators' Retirement Fund;
Occupations covered: State legislators (closed to legislators elected
on or after 11/7/90); Constitutional officers; Legislative statutory
officers;
Number of members: 309;
Number of employers: 1;
Retiree health benefits: (CalPERS health care program--see above).
Pension plans, by level of administration: State-administered plans (6
total)[D]: CalPERS Volunteer Firefighters' Award Fund;
Occupations covered: Volunteer firefighters;
Number of members: 4,301;
Number of employers: 54;
Retiree health benefits: (Not eligible for CalPERS health care
program).
Pension plans, by level of administration: State-administered plans (6
total)[D]: California State Teachers' Retirement System (CalSTRS);
Occupations covered: Teachers/educators employed by: School districts;
Community college districts; County offices of education; Regional
occupational programs;
Number of members: 794,812;
Number of employers: About 1,400;
Retiree health benefits: According to a report from the Legislative
Analyst's Office, schools and community college districts vary widely
in the health benefits they provide their retirees. For example, in
2004: 114 contracted with CalPERS for employee and retiree health
coverage; about 265 purchased coverage through 11 benefit trusts, which
allow multiple districts to join together to achieve economies of
scale; 250 participate in the Self-Insured Schools of California joint
powers agency, administered by Kern County; and; the remaining
districts either secure health benefits on their own or do not provide
these benefits.
Pension plans, by level of administration: State-administered plans (6
total)[D]: University of California Retirement Plan (UCRP);
Occupations covered: Senate faculty and non-faculty academics;
Management/senior professional; Professional/support staff;
Number of members: 212,154;
Number of employers: 1;
Retiree health benefits: The University of California offers
continuation of medical, dental, and legal insurance to eligible
members who elect monthly retirement income. Health and welfare
benefits are not accrued or vested benefit entitlements. The University
of California's contribution toward the cost of medical and dental
coverage is determined by the University of California and may change
or stop altogether. (If a retiree elects a lump-sum cashout, all rights
to continue retiree medical, dental, and legal benefits are waived.)
Pension plans, by level of administration: Locally administered plans
(55 total)[D]: 21 county; 24 city; 10 special district;
Occupations covered: Approximately 19% of all state and local workers
statewide.[E];
Number of members: [Empty];
Number of employers: [Empty];
Retiree health benefits: A September 2005 survey by the California
State Association of Counties found that of the 49 counties responding
(of 58 total), including 8 of the 10 largest counties, 48 reported that
retired employees are eligible for some type of health benefits.
Pension plans, by level of administration: State-administered plans (6
total)[D]: Locally administered example: City and County of San
Francisco;
Occupations covered: Firefighters; Police; General (all others);
Number of members: 53,246;
Number of employers: 1;
Retiree health benefits: Retirees are entitled to continue membership
in the city's Health Services System. Any premiums payable for coverage
may be deducted from the retirement payment.
Michigan:
State and local government workers:
Total number (2006)[A]: 615,700;
State workers: 170,700;
Local workers: 445,000;
Percentage covered by unions (2005)[B]: 59.9%;
Percentage participating Social Security (2004)[C]: 88.0%.
State and local government pension plans:
Pension plans, by level of administration: State-administered plans (6
total)[D]:
Occupations covered: Approximately 87% of all state and local workers
statewide.[E];
Number of members: [Empty];
Number of employers: [Empty];
Retiree health benefits: [Empty].
State and local government pension plans:
Pension plans, by level of administration: State-administered plans (6
total)[D]: Michigan State Employees Retirement System (MSERS); Defined
benefit plan: Hired before 3/31/97; Defined contribution plan: Hired on
or after 3/31/97;
Occupations covered: State civil service employees; Executive appointed
officials; Employees of the legislature and judiciary;
Number of members: 85,772;
Number of employers: 1;
Retiree health benefits: Michigan's Department of Civil Service,
Employee Benefits Division, administers health insurance contracts for
both active and retired state employees. For those in the defined
benefit retirement plan (i.e., those hired before 3/31/97), current
health plan premiums are 95% state-paid for retirees under age 65, and
100% state-paid for Medicare-eligible retirees. Dental and vision
premiums are 90% state- paid. For those in the defined contribution
retirement plan, there is a 10-year vesting requirement with an
employer contribution of 3% for each year of service, capped at 90%.
State and local government pension plans:
Pension plans, by level of administration: State-administered plans (6
total)[D]: Michigan Public School Employees' Retirement System;
Occupations covered: Employees of: Kindergarten-through-12th-grade
public school districts; Public school academies; District libraries;
Tax-supported community colleges; Certain universities (7 total);
Number of members: 478,347;
Number of employers: 716;
Retiree health benefits: Retirees have the option of health coverage,
which is funded on a cash disbursement basis by the employers. The
system has contracted to provide the comprehensive group medical,
hearing, dental, and vision coverage for retirees and beneficiaries. A
significant portion of the premium is paid by the system, with the
balance deducted from the monthly pension. (Pension recipients
generally are eligible for fully paid master health plan coverage and
90% paid dental, vision, and hearing plan coverage.)
State and local government pension plans:
Pension plans, by level of administration: State-administered plans (6
total)[D]: Michigan State Police Retirement System;
Occupations covered: State police officers;
Number of members: 4,530;
Number of employers: 1;
Retiree health benefits: Under the Michigan State Police Retirement
Act, all retirees have the option of continuing health, dental, and
vision coverage. Retirees with this coverage contribute 5%, 10%, and
10% of the monthly premium amount for the health, dental, and vision
coverage, respectively. The state funds 95% of the health and 90% of
the dental and vision insurance.
State and local government pension plans:
Pension plans, by level of administration: State-administered plans (6
total)[D]: Michigan Legislative Retirement System; Defined benefit
plan: Elected before 3/31/97; Defined contribution plan: Elected on or
after 3/31/97;
Occupations covered: State legislators;
Number of members: 351;
Number of employers: 1;
Retiree health benefits: Under state law, all retirees and their
dependents and survivors receive health, dental, and vision insurance
coverage.
State and local government pension plans:
Pension plans, by level of administration: State-administered plans (6
total)[D]: Michigan Judges Retirement System; Defined benefit plan:
Hired before 3/31/97; Defined contribution plan: Elected or appointed
on or after 3/31/97;
Occupations covered: State judges; Governor; Lieutenant governor;
Secretary of state; Attorney general; Legislative auditor general;
Constitutional court administrator;
Number of members: 840;
Number of employers: 159;
Retiree health benefits: The Supreme Court Justice, Court of Appeals,
or elected officials may enroll in the state health plan when they
retire and their premium rate is subsidized. All other judges may
enroll in the state health plan if they wish to, but they must pay the
entire premium cost.
State and local government pension plans:
Pension plans, by level of administration: State-administered plans (6
total)[D]: Municipal Employees Retirement System (MERS);
Occupations covered: Local government employees;
Number of members: 65,200;
Number of employers: 685;
Retiree health benefits: MERS Premier Health provides group health
coverage for public employers including employee and retiree medical,
prescription drug, dental and vision benefits. (MERS also offers a
Group Life and Disability Insurance Program.)
State and local government pension plans:
Pension plans, by level of administration: Locally administered plans
(134 total)[D]: 24 county; 101 city; 9 municipality;
Occupations covered: Approximately 13% of all state and local workers
statewide[E];
Number of members: [Empty];
Number of employers: [Empty];
Retiree health benefits: [Empty].
State and local government pension plans:
Pension plans, by level of administration: Locally administered
example: City of Detroit[F];
Occupations covered: General city employees and those employed by:
Department of Transportation; Water; Sewage; Housing; Library;
Number of members: 21,216;
Number of employers: 1;
Retiree health benefits: The city will continue to pay the cost of
hospitalization insurance, in accordance with collective bargaining
agreements and city council resolutions in effect at the time of
retirement. After age 65, if you are eligible for Medicare, the city
will provide a supplement to your Medicare benefits. According to city
officials, in the early 1980s, the city instituted a cost-sharing
formula with general city employees and retirees for the cost of
hospitalization insurance. The formula included multiple tiers
reflecting various collective bargaining agreements and city council
resolutions. In the last round of contract negotiations, however, the
cost-sharing formula for general city employees was modified to an 80%
city, 20% employee/retiree split.
OREGON:
State and local government workers:
Total number (2006)[A]: 257,500;
State workers: 75,000;
Local workers: 182,500;
Percentage covered by unions (2005)[B]: 52.4%;
Percentage participating Social Security (2004)[C]: 91.0%.
State and local government pension plans:
Pension plans, by level of administration: State-administered plans (1
total)[D];
Occupations covered: Approximately 99% of all state and local workers
statewide.[E];
Number of members: [Empty];
Number of employers: [Empty];
Retiree health benefits: [Empty].
State and local government pension plans:
Pension plans, by level of administration: State-administered plans (1
total)[D]; Oregon Public Employees' Retirement System (OPERS); Tier I:
Hired before 1/1/96; Tier II: Hired on or after 1/1/96 and before
8/29/03; Oregon Public Service Retirement Plan: Hired on or after
8/29/03; Judges;
Occupations covered: State government employees; School district and
community college employees; Employees of local political subdivisions
(optional, but irrevocable once elected);
Number of members: 289,223;
Number of employers: 881;
Retiree health benefits: Under state law, the board contracts for
medical and hospital insurance on behalf of retired members. Members
and their dependents are eligible for OPERS health care coverage if the
member is receiving a retirement allowance or benefit under the
system.
State and local government pension plans:
Pension plans, by level of administration: Locally administered plans
(3 total)[D]; 2 county; 1 city;
Occupations covered: Approximately 1% of all state and local workers
statewide.[E];
Number of members: [Empty];
Number of employers: [Empty];
Retiree health benefits: [Empty].
Sources: U.S. Bureau of Labor Statistics, U.S., Census Bureau, Bureau
of National Affairs, Social Security Administration, and various state
and local government 2006 comprehensive annual financial reports and
other publications.
[A] U.S. Bureau of Labor Statistics Data. State and Area Employment,
Hours, and Earnings. Not seasonally adjusted. State and Local
Governments, 2006.
[B] Barry T. Hirsch and David A. Macpherson. Union Membership and
Earnings Data Book. The Bureau of National Affairs, Inc., Washington,
D.C.: 2006, Table 5a.
[C] Office of Research, Evaluation and Statistics, U.S. Social Security
Administration. Table 1-8: Estimated Social Security Coverage of
Workers with State and Local Government Employment.
[D] U.S. Census Bureau Data. State and Local Governments Employee-
Retirement Systems. 2005 data file.
[E] U.S. Census Bureau. Employee-Retirement Systems of State and Local
Governments: 2002 (2002 Census of Governments, Volume 4, Number 6,
GC02(4)-6) U.S. Government Printing Office, Washington, D.C.: December
2004, Table 10.
[F] As we went to press, the most recent annual report available online
for the Detroit General Retirement System was for 2005.
[End of table]
[End of section]
Appendix IV: GASB Statements for Pensions and OPEB:
The Governmental Accounting Standards Board (GASB) is an independent,
private sector, not-for-profit organization that establishes standards
of financial accounting and reporting for U.S. state and local
governments. Governments and the accounting industry recognize the GASB
as the official source of generally accepted accounting principles
(GAAP) for state and local governments. GASB standards are intended to
result in useful information for users of financial reports, and to
guide and educate the public--including issuers, auditors, and users--
about the implications of those financial reports. Standards relevant
to state and local government retiree benefits are listed below.
Table 7: GASB Statements for Pensions and OPEB:
Year issued, Statements for pensions: 1994;
Statement number: No. 25;
Title and summary of statement: Financial Reporting for Defined Benefit
Pension Plans and Note Disclosures for Defined Contribution Plans:
Establishes financial reporting standards for defined benefit pension
plans and for the notes to the financial statements of defined
contribution plans of state and local governmental entities. (Effective
for periods beginning after June 15, 1996.)
Year issued, Statements for pensions: 1994;
Statement number: No. 27;
Title and summary of statement: Accounting for Pensions by State and
Local Governmental Employers: Establishes standards for the
measurement, recognition, and display of pension expenditures/expense
and related liabilities, assets, note disclosures, and, if applicable,
required supplementary information in the financial reports of state
and local governmental employers. (Effective for periods beginning
after June 15, 1997.)
Year issued, Statements for pensions: 2007;
Statement number: No. 50;
Title and summary of statement: Pension Disclosures--an amendment of
GASB Statements No. 25 and No. 27: This statement more closely aligns
the financial reporting requirements for pensions with those for OPEB
and, in doing so, enhances information disclosed in notes to financial
statements or presented as required supplementary information by
pension plans and by employers that provide pension benefits.
(Effective for periods beginning after June 15, 2007.)
Year issued, Statements for other postemployment benefits (OPEB): 2004;
Statement number: No. 43[A];
Title and summary of statement: Financial Reporting for Postemployment
Benefit Plans Other Than Pension Plans: Establishes uniform financial
reporting standards for OPEB plans and supersedes the interim guidance
included in Statement No. 26. (Effective dates were phased in between
2005 and 2007 based on the government's total annual revenues.)
Year issued, Statements for other postemployment benefits (OPEB): 2004;
Statement number: No. 45;
Title and summary of statement: Accounting and Financial Reporting by
Employers for Postemployment Benefits Other Than Pensions: Establishes
standards for the measurement, recognition, and display of OPEB
expense/expenditures and related liabilities (assets), note
disclosures, and, if applicable, required supplementary information in
the financial reports of state and local governmental employers.
(Effective dates are being phased in between 2006 and 2008 based on the
government's total annual revenues.)
Source: GASB, 2007.
[A] Statement No. 43 superseded previous statement No. 26, issued in
1994, entitled "Financial Reporting for Postemployment Healthcare Plans
Administered by Defined Benefit Pension Plans.":
[End of table]
[End of section]
Appendix V: GAO Contacts and Staff Acknowledgments:
GAO Contacts:
Barbara D. Bovbjerg (202) 512-7215 or bovbjergb@gao.gov:
Staff Acknowledgments:
In addition to the contact named above, Bill J. Keller, Assistant
Director; Amy D. Abramowitz; Joseph A. Applebaum; Susan C. Bernstein;
Gregory J. Giusto; Richard S. Krashevski; Bryan G. Rogowski; Jeremy S.
Schwartz; Margie K. Shields; Jacquelyn D. Stewart; Craig H. Winslow;
and Walter K. Vance made important contributions to this report.
[End of section]
Bibliography:
Articles and Books:
CanagaRetna, Sujit M. America's Public Retirement System [Stresses in
the System]. The Council of State Governments: October 2004.
Employee Benefit Research Institute. Fundamentals of Employee Benefit
Programs, Part Five: Public-Sector Benefits. Chapters 39 through 46.
EBRI: Washington, D.C.: 2005.
Legislative Analyst's Office. Retiree Health Care: A Growing Cost for
Government. LAO, Sacramento, California: February 17, 2006.
Mattoon, Richard H. "Issues Facing State and Local Government
Pensions." Federal Reserve Bank of Chicago: Economic Perspectives,
third quarter, 2007.
National Conference on Public Employee Retirement Systems. Public
Pensions & You. NCPERS, Washington, D.C.: 2006.
Rajnes, David. State and Local Retirement Plans: Innovation and
Renovation. (EBRI Issue Brief Number 235) EBRI, Washington, D.C.: July
2001.
Ruppel, Warren. Wiley GAAP for Governments 2007: Interpretation and
Application of Generally Accepted Accounting Principles for State and
Local Governments. John Wiley and Sons, Inc., Hoboken, New Jersey:
February 2007.
Schneider, Marguerite. "The Status of U.S. Public Pension Plans: A
Review with Policy Considerations." Review of Public Personnel
Administration, Vol. 25, No. 2. June 2005. 107-137.
Schneider, Marguerite, and Fariborz Damanpour. "Public Choice Economics
and Public Pension Plan Funding: An Empirical Test," Administration &
Society, Vol. 34, No. 1 (March 2002). The article bases its findings on
an analysis of data from the PENDAT (pension data) survey data of
several hundred pension plans (see Harris listing below).
Surveys and Studies:
Brainard, Keith. Public Fund Survey Summary of Findings for FY 2005.
NASRA, Georgetown, Texas: September 2006. The source of data for this
survey is primarily public retirement system annual financial reports,
and also includes actuarial valuations, benefits guides, system Web
sites, and input from system representatives. The survey is updated
continuously as new data, particularly annual financial reports, become
available.
Harris, Jennifer D. 2001 Survey of State and Local Government Employee
Retirement Systems Survey Report. Public Pension Coordinating Council:
March 2002. This report presents summary statistical analysis of state
and local government employee retirement systems surveyed by the Public
Pension Coordinating Council in the summer of 2001. The purpose of the
survey was to obtain in-depth information about the current practices
of public retirement systems regarding their administration,
membership, benefits, contributions, funding, and investments. In 2001,
152 public employee retirement systems responded to the council's
survey, representing 263 retirement plans. The data set from this
survey is referred to as PENDAT.
Hirsch, Barry T., and David A. Macpherson. Union Membership and
Earnings Data Book. The Bureau of National Affairs, Inc., Washington,
D.C.: 2006. The Data Book has been published annually since 1994. Each
year's edition includes current earnings and unionization figures based
on compilations from the Current Population Survey (CPS), the survey of
U.S. households conducted monthly by the U.S. Census Bureau. While data
on earnings and unionization at the national level and highly
aggregated groups of workers are provided by the Bureau of Labor
Statistics, the purpose of the Data Book is to provide these data for
states and metropolitan areas, and for workers within narrowly defined
industries and occupations.
Kaiser Family Foundation and Health Research and Educational Trust.
Employee Health Benefits: 2006 Annual Survey. Kaiser/HRET, Washington,
D.C.: 2006. For this survey, telephone interviews were conducted with
human resource and benefits managers from January to May 2006, based on
a sample of 2,122 employers drawn from a Dun & Bradstreet list of the
nation's private and public employers with three or more workers. The
sample included 227 state and local governments. Each employer was
asked as many as 400 questions about its largest health plans,
including questions on the cost of health insurance, offer rates,
coverage, eligibility, health plan choice, enrollment patterns,
premiums, employee cost sharing, covered benefits, prescription drug
benefits, retiree health benefits, health management programs, and
employer opinions.
Mercer. Results of Mercer's Survey of Governmental Employers on GASB
45. Mercer Health & Benefits LLC: 2006. These results were based on 58
responses received from a survey, sent in May 2006, to state, county
and city governments, and to public school boards, colleges, and
universities. The survey was a follow-up to the state and local
employers with at least 500 employees that had participated in the 2005
National Survey of Employer-Sponsored Health Plans.
Moore, Cynthia L., Nancy H. Aronson, and Annette S. Norsman. Is Your
Pension Protected? A Compilation of Constitutional Pension Protections
for Public Educators. AARP, Washington, D.C.: 2000. This publication
provides a compilation of constitutional pension protections in 50
states, specifically concentrating on retirement systems that serve
retired educators. The descriptions were reviewed by AARP and National
Retired Teachers Association staffs, including the AARP Office of
General Counsel. The constitutional context is current as of July 1998.
According to one of the authors, however, although the report was done
several years ago, there have been few changes in constitutional
pension protections in recent years.
National Association of Government Defined Contribution Administrators,
Inc. 2006 Biennial State and Local Government Defined Contribution Plan
Survey. NAGDCA, Lexington, Kentucky: 2006. This survey is conducted
every 2 years, to obtain specific information on state and local
governments' 457 and 401(k) plans, and beginning with the 2006 survey,
on their public 401(a) and 403(b) plans as well. The survey includes
defined contribution plans that are the governments' primary pensions
plans, as well as those that are supplemental voluntary plans. In 2006,
responses were received with information on a total of 105 state and
local defined contribution plans, including 40 state 457 plans, 33
local government 457 plans, 10 state 401(k) plans, 3 local 401(k)
plans, 11 state 401(a) plans, 4 local government 401(a) plans, 2 higher
education 401(a) plans, 1 state 403(b) plan, and 1 higher education
403(b) plan. According to respondents, these plans held $87.9 billion
in assets, received $6.2 billion in annual deferrals, and had
approximately 1.6 million active participants in 2005.
National Education Association. Characteristics of Large Public
Education Pension Plans. NEA, Washington, D.C.; December 2006.
Information for this publication was gathered between July and
September 2006, and was based on consolidated annual financial reports,
state treasurers' reports, actuarial valuations, system audits,
legislative or plan-related review commissions, plan handbooks and
newsletters, departments of human resources' guidelines for electing
trustees, state legislators' and governors' Web sites containing
information on legislative changes, state or local statutes, and
publicly available communications between government officials and plan
participants.
Ranade, Neela K. Employer-Sponsored Retiree Health Insurance: An
Endangered Benefit? Congressional Research Service, Domestic Social
Policy Division, Washington, D.C.: April 13, 2006. This report
summarizes the current coverage levels for retiree health insurance for
public and private sector retirees. It outlines the provisions that
govern employer accounting for postretirement health insurance plans in
both the public and private sectors, and describes the public policy
options that may be considered by Congress to address the problems
created by the erosion of employer-sponsored retiree health insurance
plans.
Segal. Results of the Segal Medicare Part D Survey of Public Sector
Plans. The Segal Group, Inc., New York, New York: Summer 2006. In May
2006, the Segal Company, in cooperation with the Public Sector
HealthCare Roundtable, asked public entities about the actions they
were considering for their retiree health care programs as the Medicare
Part D program was being implemented. Responses were received from 109
state and local plans.
U.S. Bureau of Labor Statistics. Employee Benefits in State and Local
Governments, 1998. (Bulletin 2531) U.S. Department of Labor, Bureau of
Labor Statistics, Washington, D.C.: December 2000. This bulletin
presents the results of the 1998 Bureau of Labor Statistics Employee
Benefits Survey, conducted jointly with the bureau's Employment Cost
Index. It is a survey of the incidence and detailed provisions of
selected employee benefit plans in state and local governments. In
1998, the survey provides representative data for 16.5 million
employees, and estimates cover all state and local government
establishments in the United States. Data were collected from June 1998
to November 1998, from a sample of 1,011 government establishments
chosen from unemployment insurance reports. The survey is to be updated
again in 2008.
U.S. Census Bureau. Census of Governments. A census of governments is
taken at 5-year intervals as required by law under title 13, United
States Code, Section 161. The 2002 census, similar to those taken since
1957, covers three major subject fields: government organization,
public employment, and government finances. The unique and important
nature of public employee retirement system data in the world of
government finance requires the Census Bureau to conduct a universe
survey each year (see next listing below). Thus, the starting point for
this census of governments was the 2001 survey listing, which generated
a final universe mail file of approximately 2,670 retirement systems.
Results of the 2002 census are summarized in Employee-Retirement
Systems of State and Local Governments: 2002 (2002 Census of
Governments, Volume 4, Number 6, GC02(4)-6) U.S. Government Printing
Office, Washington, D.C.: December 2004.
U.S. Census Bureau. State and Local Governments Employee-Retirement
Systems. An annual survey of public employee retirement systems
administered by state and local governments throughout the nation. The
2005 State and Local Government Public Employee-Retirement Systems
survey covered 2,656 public employee retirement systems for the fiscal
years that ended between July 1, 2004, and June 30, 2005.
U.S. Department of Health and Human Services, Agency for Healthcare
Research and Quality, Medical Expenditure Panel Survey (MEPS).The
Medical Expenditure Panel Survey, which began in 1996, is a set of
large-scale surveys of families and individuals, their medical
providers (doctors, hospitals, pharmacies, etc.), and employers across
the United States. MEPS collects data on the specific health services
that Americans use, how frequently they use them, the cost of these
services, and how they are paid for, as well as data on the cost,
scope, and breadth of health insurance held by and available to U.S.
workers. The insurance component of the survey is conducted annually. A
nationwide sample of employers, including state and local governments,
is specifically designed so that national and state estimates of health
insurance offerings can be made each year.
Wisniewski, Stan, and Lorel Wisniewski. State Government Retiree Health
Benefits: Current Status and Potential Impact of New Accounting
Standards. (Workplace Economics, Inc., #2004-08) AARP, Washington,
D.C.: July 2004. This publication is based on information from the
Workplace Economics, Inc., proprietary database, developed over 15
years, on benefits provided to state government employees in all 50
states. The database is the product of an annual survey of state
governments on their employee benefits as well as an analysis of state
employee health insurance plan documents. In addition, data were
gathered and analyzed from state governments' annual financial reports.
Workplace Economics, Inc. 2006 State Employee Benefits Survey.
Workplace Economics, Inc., Washington, D.C.: 2006. The information in
this report was collected by means of a written survey sent to all 50
states, followed by telephone and e-mail contacts to clarify
information, and in some cases by confirmation with official documents
or contacts with employee organizations. Because most states offer
multiple sets of benefits to different groups or categories of
employees, survey respondents were instructed to provide information on
benefits that cover the largest number of employees or that were
otherwise deemed representative. The information reported reflects
benefits in effect January 1, 2006.
Zion, David, and Amit Varshney. "You Dropped a Bomb on Me, GASB."
(Americas/United States Equity Research, Accounting & Tax) Credit
Suisse, New York: March 22, 2007. This report focuses on the OPEB
obligations for each of the 50 states, along with the 25 largest cities
in the United States, based on a review of each state's comprehensive
annual financial report, as well as other documents such as actuarial
studies, bond offering documents, and U.S. Census data, and phone calls
with state officials. Information was obtained on unfunded OPEB
liabilities for 31 states. Among the other 19 states, it was determined
that 3 states--Mississippi, Nebraska, and Wisconsin--had no OPEB plans.
For the remaining 16 states, estimates were made by multiplying the
number of full-time equivalent employees for each state (based on 2004
Census data) by $100,000, a rough estimate based on the data gathered
on the 31 states.
[End of section]
Related GAO Products:
State and Local Governments: Persistent Fiscal Challenges Will Likely
Emerge within the Next Decade. GAO-07-1080SP. Washington, D.C.: July
18, 2007.
Retiree Health Benefits: Majority of Sponsors Continued to Offer
Prescription Drug Coverage and Chose the Retiree Drug Subsidy. GAO-07-
572. Washington, D.C.: May 31, 2007.
Employer-Sponsored Health and Retirement Benefits: Efforts to Control
Employer Costs and the Implications for Workers. GAO-07-355.
Washington, D.C.: March 30, 2007.
Private Pensions: Information on Cash Balance Pension Plans. GAO-06-42.
Washington, D.C.: November 3, 2005.
State Pension Plans: Similarities and Differences Between Federal and
State Designs. GAO/GGD-99-45. Washington, D.C.: March 19, 1999.
Public Pensions: Section 457 Plans Pose Greater Risk than Other
Supplemental Plans. GAO/HEHS-96-38. Washington, D.C.: April 30, 1996.
Public Pensions: State and Local Government Contributions to
Underfunded Plans. GAO/HEHS-96-56. Washington, D.C.: March 14, 1996.
An Actuarial and Economic Analysis of State and Local Government
Pension Plans. PAD-80-1. Washington, D.C.: February 26, 1980.
Funding of State and Local Government Pension Plans: A National
Problem. HRD-79-66. Washington, D.C.: August 30, 1979.
[End of section]
Footnotes:
[1] This report reflects the findings of one of two GAO studies that
were conducted in response to this request. The other study is focused
on providing a more detailed look at the funding status of state and
local retiree benefit plans, with a report estimated to be published in
late 2007. Other ongoing GAO work is focused on examining pension fund
investment choices in the public and private sector.
[2] Throughout this report, our discussion of constitutional
protections refers only to provisions specifically applicable to the
funding, protection, management, or governance of employee benefit
plans.
[3] GAO, State and Local Governments: Persistent Fiscal Challenges Will
Likely Emerge within the Next Decade, GAO-07-1080SP (Washington, D.C.:
July 18, 2007).
[4] Unlike in the private sector, there are large groups of state and
local government workers who are not covered by Social Security.
According to data from the Social Security Administration, about 30
percent of all state and local government workers nationwide are not
covered, although the extent of coverage varies widely by state and by
occupation.
[5] There could, however, be federal tax penalties if funds are
withdrawn before the employee reaches a certain age. 26 U.S.C. § 72(t).
[6] Contributions to qualified pension plans that meet certain
requirements--whether defined benefit or defined contribution--are not
counted as taxable income to employees when the contributions are made.
However, when pension benefits are paid, amounts not previously taxed
are subject to federal and perhaps state tax. This also applies to the
interest income such contributions generate.
[7] See GAO, State Pension Plans: Similarities and Differences Between
Federal and State Designs, GAO/GGD-99-45 (Washington, D.C.: Mar. 19,
1999). Also, as of 1998, across all state and local employees
nationwide, Bureau of Labor Statistics survey data indicate that 90
percent were covered by defined benefit plans. (For further details on
this survey, see the selected bibliography at the end of this report.
The survey is to be updated again in 2008.)
[8] In the private sector, when a new plan is adopted, the previous
plan is often frozen. Existing employees keep the benefits they have
accrued to date, but cannot continue to participate in the previous
plan from that point forward. In the public sector, when a new plan is
adopted, existing employees generally are allowed to continue to
participate in the previous plan. Generally only new employees, hired
after adoption of the new plan, are required to participate in the new
plan from that point forward.
[9] For further details on the National Education Association study,
see the selected bibliography at the end of this report.
[10] In addition, over the past 10 years, many public sector employers
have established deferred retirement option plans (DROP). DROPs were
created to retain experienced employees by permitting those eligible to
retire to stay on the job and earn a lump-sum payment at retirement in
addition to their defined benefit annuity.
[11] 26 U.S.C. § 457(b).
[12] For further details on the National Association of Government
Defined Contribution Administrators' 2006 survey, see the selected
bibliography at the end of this report.
[13] The Workplace Economics, Inc., 2006 survey instructed states to
provide information on benefits that cover the largest number of
employees, or that were otherwise deemed representative. For further
details on this survey, see the selected bibliography at the end of
this report.
[14] GAO, Employer-Sponsored Health and Retirement Benefits: Efforts to
Control Employer Costs and the Implications for Workers, GAO-07-355
(Washington, D.C.: March 30, 2007).
[15] About 82 percent of state and local governments with 200 or more
employees offer health benefits to active workers, according to a 2006
survey conducted by the Kaiser Family Foundation and the Health
Research and Educational Trust (HRET). (For further details on the
Kaiser/HRET 2006 survey, see the selected bibliography at the end of
this report.)
[16] According to a more comprehensive study of state retiree health
benefits in 2004, some states offered a single health care plan
statewide, but typically retirees had about three or four plans
available. The plans offered to pre-Medicare retirees were generally
similar to those for active employees, while Medicare-eligible retirees
had somewhat different plans available. For further details, see Stan
Wisniewski and Lorel Wisniewski, State Government Retiree Health
Benefits: Current Status and Potential Impact of New Accounting
Standards, Workplace Economics, Inc., #2004-08, AARP, Washington, D.C.:
July 2004. (For further details on this survey, see the selected
bibliography at the end of this report.)
[17] Indiana also provides no coverage under a state plan, but provides
access to a Medicare complementary plan that retirees can purchase on
their own. In addition, Oregon provides no coverage under a state plan
for retirees eligible for Medicare if they were hired on or after
August 29, 2003.
[18] In four additional states, no employer funding is provided unless
the retiree meets certain years of service or other requirements.
Similar requirements generally exist for both pre-Medicare and Medicare-
eligible retirees. For example, in Arizona, a retiree must have 10
years of service to receive any employer contribution in either case.
[19] Often state and local employees are eligible to retire before age
65. According the Workplace Economics, Inc., 2006 survey, several
states allow government employees to retire at age 50 or 55, or at any
age with a specific number of years of service.
[20] The Medicare Prescription Drug, Improvement, and Modernization Act
of 2003 created a prescription drug benefit for beneficiaries called
Medicare Part D. Pub. L. No. 108-173, tit. I, 117 Stat. 2066, 2066.
Under Part D, sponsors of employment-based prescription drug benefit
plans (including state and local governments) qualify for a federal
subsidy payment if they provide benefits meeting certain requirements.
For further information, see GAO, Retiree Health Benefits: Majority of
Sponsors Continued to Offer Prescription Drug Coverage and Chose the
Retiree Drug Subsidy, GAO-07-572 (Washington, D.C.: May 31, 2007).
[21] Although not changing the benefits they offer, almost half of the
entities indicated that they now terminate prescription drug coverage
for those retirees enrolled in a Medicare plan on their own, and a
growing number of entities were considering contracting with a
prescription drug plan or Medicare-Advantage prescription drug plan to
provide prescription drug coverage for their retirees in the future.
(For further details on Segal's 2006 survey, see the selected
bibliography at the end of this report.)
[22] About 92 percent of eligible state and local workers participate
in employer-sponsored health plans, according to the Kaiser/HRET 2006
survey. (For further details on this survey, see the selected
bibliography at the end of this report.)
[23] This estimate is based on participation data from the Department
of Health and Human Services, Agency for Healthcare Research and
Quality, Medical Expenditure Panel Survey (MEPS); and data on the
number of retired employees from the Census Bureau's annual survey,
State and Local Governments Employee-Retirement Systems. (For further
details on these surveys, see the selected bibliography at the end of
this report.)
[24] In California, the state's contributions to retirees' health
benefits are equal to 100 percent of a weighted average of retiree
health premiums for single enrollees in the four basic health plans
with the largest state employee enrollment during the prior year.
Employees hired before January 1, 1985, vest for the full weighted
average premium contribution at retirement after 5 years of service.
Employees hired between January 1, 1985, and December 31, 1988, vest
for the full weighted average premium contribution at retirement if
they have at least 10 years of service. Employees hired after January
1, 1989, if represented (or January 1, 1990, if unrepresented) vest for
the full weighted average premium contribution at retirement only after
20 years of service.
[25] Given the ways in which defined contribution plans differ from
defined benefit plans, these types of provisions may be less readily
applicable or relevant to them.
[26] Although the AARP study focused on pension plans for a particular
group of public employees (retired educators), our analysis revealed
that the provisions identified in all but two states were applicable to
pension plans for all state employees. (For further details about the
AARP study, see the selected bibliography at the end of this report.)
In addition, we learned that subsequent to this study, Oregon adopted a
constitutional provision in 2003 to authorize the issuance of pension
obligation bonds.
[27] Cal. Const., art. XVI § 17.
[28] Mich. Const., art. IX § 19 and 24.
[29] For example, see Cal. Gov't. Code § 21353 (Deering 2007).
[30] Or. Rev. Stat. § 238.300 (2005).
[31] San Francisco City Charter A8.525.
[32] A trust established by an employer for the exclusive benefit of
its employees, and any income it generates, is exempt from federal
income tax. 26 U.S.C. § 501(a).
[33] The four states that do not have boards overseeing the operation
and management of their pension plans for general state employees are
Florida, Iowa, New York, and Washington. (In addition, the District of
Columbia does not have a board overseeing its pension plan for its
general employees.)
[34] Actuarial assumptions are assumptions as to the occurrence of
future events affecting pension costs, such as mortality, retirement,
and rates of investment earnings.
[35] Marguerite Schneider and Fariborz Damanpour, "Public Choice
Economics and Public Pension Plan Funding: An Empirical Test,"
Administration & Society, vol. 34, no. 1 (2002). (For further details
on this study, see the selected bibliography at the end of this
report.)
[36] Wash. Rev. Code § 41.45.100 (2007).
[37] Fla. Stat. § 215.44 (2007).
[38] N.Y. Const. Art. V, § 1 and N.Y. Retire. & Soc. Sec. Law §§ 11
and 13 (Consol. 2007).
[39] Segal, Results of the Segal Medicare Part D Survey of Public
Sector Plans. The Segal Group, Inc., New York, N.Y.: Summer 2006. (For
further details on this survey, see the selected bibliography at the
end of this report.)
[40] Cal. Govt Code § 22850 (Deering 2007).
[41] Or. Rev. Stat. § 238.410 (2005).
[42] By "ongoing basis" we mean that pension promises continue to be
made to current and new employees, and that state and local hiring
remains at a level such that the state-local workforce, relative to the
population, remains constant. We estimated the steady level of employer
contributions, relative to wages, that would need to be made in every
year between 2006 and 2050 to fully fund promised pension benefits.
(For further details, see app. II.)
[43] Through 2050, the excess cost factor we used averages 1.2 percent
per year above per capita GDP growth. By way of comparison, since the
early 1970s, the excess cost factor for all medical expenditures in the
economy has averaged 1.4 percent per year above per capita GDP growth.
[44] A funded ratio of 80 percent or more is within the range that many
public sector experts, union officials, and advocates view as a healthy
pension system.
[45] La. Rev. Stat. Ann. 11:62 (2007).
[46] When Michigan closed the defined benefit plan to new members in
1997, new actuarial methods were adopted, such as reporting investments
at their fair market value rather than cost, and the funded ratio
jumped from 91.5 to 109.0 percent. Since then, the funded ratio has
been on a general decline.
[47] Employer-provided retiree health benefits include not only
explicit employer contributions (that is, those that a government
previously has identified and labeled as OPEB contributions), but also
implicit employer contributions resulting from arrangements in which
the age-adjusted premiums attributable to retirees exceed the
contributions required from the retirees, and the employer effectively
pays the difference. Thus, among those states not providing an explicit
payment for a share of their retirees' health insurance premiums, some
may still incur implicit costs that are to be included in their
calculation of their annual costs and long-term obligations for OPEB
under GASB standard 45. According to GASB, "In health insurance plans
where a government's retirees and current employees are insured
together as a group, the premiums paid by the retirees may be lower
than they would have been if the retirees were insured separately--this
is called an implicit rate subsidy." GASB adds, "Implicit rate
subsidies should be included by governments...as OPEB."
[48] Survey conducted by Credit Suisse, Americas United States/Equity
Research, 2007. (For further details on this study, see the selected
bibliography at the end of this report.)
[49] Additionally, the Municipal Employees' Retirement System of
Michigan offers a health care savings program from the same trust fund.
This employer-sponsored program provides tax-favored individual medical
savings accounts for tax-free reimbursement of postemployment medical
expenses, including health insurance premiums. According to system
officials, as of September 2007, this program had over 75 enrolled
employers (representing over 2,000 employees) and about $10 million
invested.
[50] N.C. Gen. Stat. § 135-40.2(a)(2) (2007).
[51] GAO, State and Local Governments: Persistent Fiscal Challenges
Will Likely Emerge within the Next Decade, GAO-07-1080SP (Washington,
D.C.: July 18, 2007).
[52] The estimated cost of health care expenditures is described later
in this appendix.
[53] See The 2007 Annual Report of the Board of Trustees of the Federal
Old-Age and Survivors Insurance and Disability Insurance Trust Funds.
Washington, D.C.: May 1, 2007, Table A2.
[54] This assumption implies that if there were no growth in the
productivity of state and local workers, the output of services per
person served would remain the same. As such, any increased growth in
services provided per citizen hinges on the degree to which
productivity in public sector services advances.
[55] The Excel Solver function was used to find the weights that
minimized the sum of the squared residuals between actual and fitted
beneficiaries.
[56] See Annual Statistical Supplement to the Social Security Bulletin,
2005 (Washington, D.C.: February, 2006), Table 6.F1: Number of benefits
terminated, by type, 1940-2004.
[57] See Annual Statistical Supplement to the Social Security Bulletin,
2005 (Washington, D.C.: February, 2006) Table 5.A4 Number and total
monthly benefits, by trust fund and type of benefit, December 1940-
2004, selected years.
[58] Pension funds hold substantial assets, amounting to $3.0 trillion
at year-end 2006. Because the calculation we make implies that all
assets are used to pay benefits, the estimated contribution rate would
be negative over short intervals. But, in fact, some of the assets
already in the pension funds are related to liabilities that will not
be paid for many years into the future. As the time horizon increases,
the present value of liabilities grows relative to assets, resulting in
an increase in the estimated contribution rate. When the projection
horizon lengthens sufficiently, however, the contribution rate
stabilizes. That is, at some point there is virtually no difference in
contribution rates estimated over successively longer projection
periods. A 400-year projection horizon is long enough to provide an
estimated contribution rate invariant to further increases in the
projection period. The result is an estimate of the contribution rate
necessary to fund pension payments on a sustainable basis.
[59] When evaluating state and local government pensions, standard
practice is to use a discount rate based on the expected rate of return
on pension fund investments. To develop a measure of the expected
pension return, we analyzed data from Flow of Funds Accounts table
L.119 (State and Local Employee Government Retirement Funds.) We
calculated each asset category's annual share of total fund assets and
assigned a rate of return to each category. The asset groups included
money-like assets (sum of checkable deposits and currency, time and
savings deposits, money market mutual funds, and repurchase agreement
securities), open market paper, Treasury securities, agency-and
government-sponsored enterprise-backed securities, municipal
securities, corporate and foreign bonds, mortgages, corporate equities,
mutual fund shares, and other miscellaneous assets. Although data are
available beginning in 1952 for pension fund assets, yields for all of
the asset categories are only available starting in 1965. Accordingly,
for each year from 1965 through 2005 we calculated the weighted average
nominal return by summing the product of each asset's share and its
return. Factoring out each year's CPIU increase provides an estimate of
the real pension fund return. Because there has been a long-term shift
in pension fund portfolios away from fixed assets toward equities, the
average real return over this period is not representative of likely
future returns. To find an estimated real pension yield more
representative of the recent composition of retirement fund
investments, we used the average asset shares during the most recent 10-
year period as portfolio weights. Multiplying these 10-year weights by
each asset category's average real return over the entire period from
1965 through 2005 and summing the products results in an estimated real
pension return of 5.0 percent. In our base case, therefore, we use a
real discount rate (rpenreal) of 5.0 percent to find the present value
of future cash flows.
[60] Because our state and local government retiree health care cost
estimates are based on data that did not incorporate possible savings
attributable to the Medicare Part D drug subsidy that began in 2006,
the estimates may overstate retiree health slightly.
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