The Retirement Surprise In Detroit’s Bankruptcy

When Detroit recently filed for bankruptcy, one number surprised a lot of observers–$6.4 billion in other post-employment benefits (OPEB). OPEB is primarily comprised of unfunded obligations to pay health care costs for municipal employees.

By contrast, the unfunded pension obligations of Detroit were $3 billion–less than half the size of its OPEB. So municipal officials and city residents should focus on slowing the growth of unfunded healthcare obligations, which typically receive much less publicity than pension deficits.

Detroit is not unique in this respect. The unfunded health care obligations of most cities are much larger than their unfunded pension obligations.

The Pew Charitable Trust did a study in 2013 of both pension and OPEB shortfalls in the 30 largest cities in the United States. The three cities other than Detroit with the largest pension shortfalls were:

$14,302 per city household in New York City;
$12,170 per city household in Philadelphia; and
$11,389 per city household in Portland, Oregon.

But the shortfalls for OPEB, primarily healthcare obligations, were significantly larger. According to Pew, the three cities other than Detroit with the largest OPEB shortfalls were:

$22,857 per city household in New York City,
$18,962 per city household in Boston
$13,487 per city household in San Francisco.

Unfunded retiree healthcare benefits are generally larger than unfunded pension deficits for regulatory reasons. Only in 2006 did the government accounting board begin to require that local governments report their unfunded retiree healthcare obligations in their public financial statements. Until then, these unfunded obligations were below the radar screen and allowed to increase rapidly.

But the government accounting board did not require any city to fund its OPEB shortfalls. As a result, even the worst funded city pension funds are 50% or 60% funded. By contrast, the funded healthcare obligations in the average city are 5% and zero in many cities.

The only silver lining is that it is legally much easier for a city to change its health care obligations than its pension promises. Accrued pension obligations are often protected by the state constitution. By contrast, accrued healthcare benefits may usually be modified, unless the political opposition is too strong.

So if health care benefits can be legally reduced, subject to political constraints, what are the most fruitful strategies for cities to pursue? Here are six strategies that various cities have utilized; they are listed in order from easiest politically to the most difficult.

  1. Many cities have reduced retiree healthcare promises for new municipal employees. Although politically palatable, these reductions will take years to have a material impact on a city’s unfunded healthcare liabilities.
  2. Cities could require all public employee retirees to join Medicare when they reach age 65. While more cities are asking their retirees to take advantage of their Medicare eligibility, some cities continue to pay a significant portion of Medicare premiums for their retirees.
  3. Cities could require public retirees before age 65 to obtain their health insurance through the new state connectors under the Affordable Healthcare Act. But such health insurance would still require premiums to be paid by public retirees, although some would receive partial federal subsidies.
  4. Cities could change their health care policies for retired workers by increasing deductibles and co-payments. Cities could also cut back on the scope of health care provided–for example, by making retirees pay the full cost of dental and eyeglasses.
  5. Cities could increase the number of working years for their employees to become eligible for retiree healthcare. In some cities, public employees are eligible for retiree healthcare after 10 or 15 years of full-time work; this period for eligibility could be extended to 20 or 25 years of full-time city work.
  6. Cities could begin to fund their health care obligations in advance, as they do for their pension obligations. This funding, which could come partly from general municipal revenues and partly from public employees, would be invested in a separate trust.

In sum, most cities need to reduce their unfunded healthcare obligations to retirees. Although such reductions will be politically controversial, they are necessary for most cities–in the short term to avoid a spike in the interest rates paid on their municipal bonds, and in the long term to avoid a fiscal crisis like the current one in Detroit.