Like most American cities, Boston has promised to pay most of the health care premiums for its employees after they retire — which can be as early as age 45 or 50. Boston also subsidizes the Medicare premiums of its retired employees after age 65.
As a result, Boston reported an unfunded liability for retiree health care in 2013 of over $2 billion (that is a B!). This equated to a liability of over $3,000 per city resident — the fifth highest per capita of large American cities. And these figures did NOT include Boston’s share of another almost $2 billion in unfunded health care liabilities for retired employees from the MBTA.
The good news. In fiscal 2014, Boston contributed $154 million toward retiree health care — more than 10 percent of its total payroll (including schools) for that year. This sum covered its current benefit premiums plus $40 million to help pre-fund its future liabilities for retiree health care. Moreover, Boston committed to keep contributing current benefit premiums plus $40 million to pre-fund such future liabilities.
The bad news. Boston is using two overly optimistic assumptions in estimating what it would take to address its future costs for retiree health care.
Boston is assuming that it can meet its commitment by making large payments out of each year’s budget despite more retirees and rising premiums. This works out to be an average increase of 4.5 percent per year according to Stanford professor Josh Rauh. Can Boston really devote $400 million out of its 2035 budget to retiree health care given competing priorities like police and schools?
Similarly, Boston is assuming an investment return after expenses of 7.5 percent per year on its pre-funded contributions for retiree health care. Such a high investment assumption has gotten many pension funds in trouble; it can be achieved only by investing in stocks and other risky assets. But a more prudent approach would be a diversified portfolio of stocks and U.S. Treasury bonds.
If Boston assumed a more realistic 3 percent annual increase in its health care contributions and an annual investment return of 5 percent, Boston would have to report unfunded liabilities for retiree health care of $3 billion — instead of $2 billion — under the new accounting rules. In either case, Boston together with the Massachusetts Legislature should seriously consider adopting the following reforms:
• Raise the minimum eligibility for retiree health care from 10 years to 20 to 30 years of service. We want to reward long-term, not short-term, public service.
• Stop all city subsidies to retirees after they become eligible for Medicare at age 65. The premiums in Medicare are already progressive relative to income.
• Require higher premium contributions by Boston employees now under age 35 when they retire. This is a reasonable way to transition to more cost-sharing.
• Increase co-payments and deductibles, except for preventative care, for Boston employees once they retire. These will substantially reduce unnecessary tests and hospital visits.
More dramatically, Boston could reduce its health care costs by requiring its retirees to acquire their insurance policies through the Massachusetts exchange under Obamacare. For example, a gold policy (better than a bronze or silver) would cost $1,319 per month for a family of four with parents age 50 and income of $50,000 per year. But the federal premium subsidy would be $945, so Boston and its retirees would have to pay only $374.
Of course, the above reforms should be fully discussed with the relevant unions. Unlike pension benefits, retiree health care plans are not constitutionally protected. Indeed, the Supreme Court has recently ruled that health care benefits should generally be renegotiated at the expiration of a collectively bargaining agreement. So let the negotiations begin soon!
The Initiative is a partnership between the Economic Studies program at Brookings and the USC Schaeffer Center for Health Policy & Economics, and aims to inform the national health care debate with rigorous, evidence-based analysis leading to practical recommendations using the collaborative strengths of USC and Brookings.