Archive 2008 - 2019

My Thoughts on Holliston's OPEB Liability

by James Crews
4/21/2011

Collectively, non-pension benefits paid to retirees, including health care, are known as Other Post Employment Benefits, or OPEB. In 1964, the Town of Holliston adopted Mass General Law Chapter 32B, part of which extended health care benefits to its retirees. The adoption of this law also required the Town to pay 50% of the resulting premiums. In 2001, the Town voted to increase its share of premiums for coverage through health maintenance organizations from 50% to 60%. Since 1964, the Town has been paying OPEB to retirees in the same year in which the benefits are due. This method is commonly known as PAYGO, or “pay-as-you-go,” and is currently used by the majority of cities and towns in Massachusetts.

The downside of PAYGO is that it pays for benefits when they are due, not when they are earned. Because the dollar value of benefits earned by active employees in a given year is greater than the dollar value of benefits due to current retirees in that same year, the PAYGO method doesn’t set money aside to pay for future benefits. Nonetheless, as long as the Town is able to pay the benefits due its retirees as they are due, which it can for the near term, we do not face an immediate fiscal crisis. On the other hand, rising healthcare costs, increasing participant longevity, and a growing number of retirees are all factors that could create a fiscal crisis in the future if we don’t begin to address the situation now.

The dramatic increase in media coverage surrounding this issue has been largely driven by a relatively new accounting standard, The Government Accounting Standards Board (GASB) Statement 45, which requires public employers to begin calculating and disclosing both the present dollar value of benefits earned in the current year (i.e. the “normal” cost), as well as the present dollar value of all earned benefits that are payable in the future.

As an illustration of the impact of the accounting difference, consider a business that pays $10,000 in rent each year. If changes to disclosure rules required the business to report 30 years’ worth of future rent payments as a liability, assuming a 4.0% discount rate, that business would suddenly have a liability of over $170,000. The reporting change wouldn’t prompt the owner to begin selling assets so he could put $170,000 in the bank. Rather, as long as the business anticipated that revenues would continue to grow sufficiently to cover any increases in its annual rental expense, it would not change its financial planning.

The impact to Holliston’s financial statements of the change in accounting is certainly dramatic. As of July, 2009, with the assumption that we will continue funding benefits on a PAYGO method, our estimated unfunded liability is $46 million. However, if our OPEB was fully-funded, we would require less than $27 million to be set aside due to a higher assumed discount rate (8.25% instead of 4.5%). A number of other factors influence the magnitude of this liability, including assumptions for healthcare cost trend rates, interest rates, life expectancy, retirement rates, and others. As an example of a factor that would reduce our future payments, our latest valuation assumes that 80% of retirees will participate in the plan, whereas currently only 71% participate. On the other hand, the current liability valuation considers only the benefits that will be earned by our current employees, and does not consider those which will be earned by new employees. Simply put, although the development of estimate is complex and robust, it is still an estimate, and our actual payments could be significantly different than what has currently been presented.

One might argue that as long as our revenues keep up with our expenses, PAYGO is a reasonable method of continuing to fund OPEB obligations. This is true in the very short term, but it is also true that the annual cost increase using the PAYGO method will, over the medium to long term, result in ever-increasing pressure on other areas of the budget, including schools, police, COA, parks, library, etc. In addition, because of GASB 45, credit markets will begin to use OPEB liabilities as a factor in determining credit-worthiness, which directly affects the Town’s bond rating and borrowing cost.

We can attack this problem from a number of directions. First, the complexity of this issue, as well as the expertise required to develop workable solutions, is likely to be beyond the resources and capabilities of our elected officials. I believe a working group including the Treasurer/Collector and members of the Finance Committee and Board of Selectmen must engage an outside expert to develop specific, long-term solutions for the Town to consider. While this process begins, we must continue to work towards other objectives which can mitigate the problem.

We must lobby our state legislators to pass legislation offering towns and cities more flexibility in determining what health care plans we offer to employees. If all employees and retirees moved to a Rate Saver plan, for instance, we would not only save $400,000 per year, but our unfunded OPEB liability would be immediately reduced by over $3,000,000. State law currently prevents us from mandating such a move. In addition, we must lobby for legislation that gives us greater flexibility in determining plan eligibility and retirement age for new employees.

We should establish a fund that enables us to begin contributing towards this liability. However, we must be cautious about approving Section 20 of MGL 32B at Town Meeting, which allows us to establish just such a fund, as doing so would be irrevocable. If the legislature decided to attach a funding schedule to such a fund, the Town would be legally bound to follow it, which could have significant short-term impacts on Town services.

We should establish a policy that an agreed-upon percentage of both one-time monies and any year-end surpluses will be earmarked for funding retirement benefits. Because our obligation to pay OPEB is much less clear than our obligation to fund our pension liability, we may want to first contribute surplus funds towards accelerating the funding of our pension obligation. Our legal options and obligations on our OPEB liability will be much clearer long before we achieve full funding of that liability.

We must continue to look for opportunities to save money on an ongoing basis. Again, most significant cost-saving opportunities will result from increased flexibility in state law. Unfunded mandates cost Holliston hundreds of thousands of dollars each year, which could be directed toward more important purposes, including funding retirement obligations.

We must not turn a blind eye towards other fiscal responsibilities and objectives. The Town is close to attaining its target of having 5% of its annual operating budget held in reserve accounts. This is significant in that it is a major factor viewed by credit agencies in establishing our bond rating, and achieving this target should continue to be a top priority. In addition, we must continue to fund our Town Departments at levels appropriate to ensure we retain skilled employees and retain valuable Town services.

We must study the problem from a 30 year perspective. We must develop a comprehensive 30 year model that allows us to change assumptions and model best, worst, and most likely case cost and funding scenarios.

In closing, we must recognize that the solutions to the very complex OPEB issue will be reached and implemented over 30 years. Developing these solutions will require the use of independent experts who are experienced and knowledgeable to help us craft solutions. Most importantly, however, we must remain respectful in our efforts to solve these issues. Only by challenging ourselves to understand the issues, to seek additional information, and to volunteer our time to work towards solutions, will we be able to succeed.
 


Still Have Questions on My OPEB Views?

Please join me for an OPEB Q&A at Coffee Haven this Saturday, April 23rd, from 8am - 10am. Have a cup of coffee and feel free to ask my views on OPEB and other issues.

Upcoming Calendar

Saturday, April 23rd, 8:00am - 10:00am: OPEB Discussion at Coffee Haven
Monday, April 25th,   7:30 pm  Candidates' Forum at HS Library
Tuesday, April 26th, 7:30pm - 10:00pm: Finance Committee Meeting

Thanks for reading.

Sincerely,
Jim Crews
Candidate for Selectman
 

Comments (2)

Hi Jim, I have been trying to learn more about OPEB issues in Watertown, MA where I live and found this to be a very helpful article. You are right that the issue is complex and outside help for communities is probably needed. What I think is even more important is increasing public awareness of this issue so that it is one of the primary topics on Council agendas and water cooler talk. Without the voters having a solid grasp of the issue the elected officials won't have the backing of the public to make difficult choices to pay down long term unfunded debt vs. improving or keeping existing benefits and services. I've been blogging about my ongoing efforts to learn more about municipal and school budgets here: http://www.mattmacdonald.com/2011/04/28/massachusetts-municipal-retiree-healthcare-benefits-and-a-proposal-from-the-massachusetts-municipal-association/ Thanks again for the great overview, Matt MacDonald http://www.mattmacdonald.com

Matt MacDonald | 2011-05-18 08:31:33

Jim you did excellent work on your comments on the OPEB issue. Your explanation no doubt made a complicated issue into an understandable issue. Thank you for your insight! This will help Holliston residents at Town Meeting where we must discuss and vote on Warrent Articles dealing with OBEB.

J. Michael Norton | 2011-04-23 12:08:13