OPEB: The Good, the Bad, and the Ugly

This Article was Originally Featured in the July 12th issue of Tax Notes State

Last year, we described other post-employment benefits (OPEB) as “The Trillion Dollar Acronym.”[i] Unfortunately, not much has changed in the past year. In addition to the nearly $5 trillion in unfunded public pension liabilities, states owe just under $1 trillion in unfunded OPEB liabilities to retired public employees. Other post-employment benefits can include items like health insurance, life insurance, Medicare supplemental insurance, and other types of benefits not classified as a pension.

The Center for State Fiscal Reform at the American Legislative Exchange Council recently released, “Other Post-Employment Benefit Liabilities: The Continuing Need for OPEB Reform,” the latest in a series of ALEC annual publication examining growing state financial liabilities.[ii] Our report continues to find that states with some of the highest tax rates (e.g., Illinois, California, New York, and New Jersey) have some of the highest unfunded OPEB liabilities as well.

Our new report details the positive changes to OPEB liabilities in places like Indiana, the negative changes such as the rapid growth of unfunded liabilities in many states, and the ugly consequences of what could happen if states do not make the necessary policy reforms.

The Good: States Increase Funding and Make Necessary Reforms

Last year, we made note of Nebraska and South Dakota as models for potential OPEB reform. Plan structures in both states offer the ability for current employees and retirees to purchase a health savings accounts (HSA), where employees and retirees make pre-tax contributions, and state government employers match contributions up to allowable annual amounts that are determined by the Internal Revenue Service.

In our new report, we discuss Indiana’s defined contribution OPEB option as well. Indiana has a defined-contribution OPEB plan that reimburses retirees and their covered dependents for insurance and medical costs through an established OPEB trust.[iii] Employees make contributions to their individual accounts and submit bills to be reimbursed through these accounts when they retire.[iv] The state also makes annual contributions to employee accounts where the contribution is based on the employee’s age, shown below.[v]

Table 1: Schedule of State Contributions to Defined Contribution OPEB Trust

Source: Indiana Comprehensive Annual Financial Report for Fiscal Year 2019

As the employee approaches retirement age, the annual contributions from the state increase, providing the highest payments to those closest to retirement. In addition, employees can receive bonus contributions from the state if they are eligible for an unreduced pension benefit from the Public Employee Retirement Fund (PERF) and completed at least 15 years of service, or 10 years of service as an elected or appointed officer. The bonus contribution is equal to the employee’s total years of service multiplied by $1,000.[vi]

These reforms have helped Indiana keep unfunded OPEB liabilities low. Since last year’s report, Indiana has reduced total unfunded liabilities by roughly 11%, from $620 million to $552 million.[vii] While the option to enter the defined contribution OPEB plan is available, the defined-benefit OPEB plans are still available to new hires after they have been vested. Indiana can improve OPEB solvency by automatically enrolling all new hires into the defined-contribution OPEB plan. In addition, the Indiana State Legislature OPEB Plan is still pay-as-you-go with zero assets listed. This makes the Legislature Plan especially vulnerable to economic shocks and growing unfunded liabilities.

By enrolling all new state employees in the defined-contribution plan and pre-funding defined-benefit plans that are still in place, Indiana will be better prepared for unexpected economic downturns.

The Bad and the Ugly: Rapidly Growing Unfunded OPEB Liabilities

In each edition of the ALEC OPEB report, we examine the 10 states with the fastest growing unfunded OPEB liabilities. The table’s purpose is to highlight how rapidly unfunded liabilities can accumulate, even during times of strong investment returns.

Table 2: Fastest Growing Unfunded Liabilities, FY 2017-2018

*Note: Unfunded OPEB Liabilities in Louisiana grew primarily from reporting component unit OPEB liabilities under new government accounting standards.

Source: Thomas Savidge, Jonathan Williams, and Skip Estes. Other Post-Employment Benefit Liabilities: The Continuing Need for OPEB Reform, American Legislative Exchange Council (June 2021).

Louisiana saw the largest increase in unfunded liabilities from last year’s report because of changes in OPEB reporting. From FY 2015-2017, Louisiana stopped reporting OPEB liabilities for the state university system, and only reported OPEB liabilities for government employees in the state CAFR. Although the state did not report the OPEB liabilities, the liabilities did not vanish. Louisiana is marked with an asterisk because most of its unfunded liabilities growth from last year comes from improved government financial transparency. It is an important story to highlight because financial transparency provides a clearer picture of the true cost of these liabilities to taxpayers. Due to changes in government accounting requirements, Louisiana began reporting OPEB assets and liabilities for both primary government and component units. In addition, both of Louisiana’s OPEB plans (the LSU Health Plan and state OPEB plan) have no prefunded assets. In FY 2018, the LSU Health plan did not make its full actuarially determined contribution (ADC) payment, the annual payment the state must make to cover normal costs for the year and pay down unfunded liabilities. Not making the full ADC payment contributes to unfunded liability growth.[viii]

In total, 46 of the 140 OPEB plans examined in our report are “pay-as-you-go” plans (plans that have less than a 1% pre-funding ratio). Pay-as-you-go plans allow large unfunded liabilities to accumulate, especially when demographic changes (e.g., the state sees a large net outmigration of residents) cause the tax base to shrink. This is a slight improvement from last year’s report, in which 57 of the 132 plans were pay-as-you-go.[ix] Despite this improvement, OPEB funding ratios (the ratio of plan assets to plan liabilities, is still dangerously low at 9.4%.

Of the 10 states with the fastest growing unfunded liabilities, seven have no prefunded assets and are listed as pay-as-you-go plans. These states are Arkansas, Florida, Louisiana, Missouri, New Jersey and Virginia. In Arkansas, Florida, Louisiana, New Jersey and Tennessee, every OPEB plan is pay-as-you-go. Missouri had two out of three of its plans structured as pay-as-you-go, while Virginia had the Pre-Medicare Retiree Healthcare plan, functioning as pay-as-you-go. This plan covers one of the largest groups of Virginia public employees[x] and has $2.1 billion in unfunded OPEB liabilities. By not pre-funding OPEB plans, unfunded liabilities can grow rapidly in the span of a year.

Conclusion

Unfunded OPEB liabilities can grow rapidly and can strain state budgets and state taxpayers — especially when coupled with unfunded pension liabilities. With improvements to government financial transparency, thankfully states can no longer ignore the nearly $1 trillion in unfunded liabilities. Policymakers should be actively looking to find solutions that reduce the fiscal stress of unfunded liabilities.  States that introduced defined-contribution OPEB plans such as in Indiana, Nebraska, and South Dakota proved that this policy challenge is not insurmountable. Their reforms have reduced costs to taxpayers and improved long-run OPEB solvency for public employees.

[i] Jonathan Williams and Thomas Savidge, “OPEB: The Trillion Dollar Acronym” Tax Notes State Volume 95 Number 12 (March 23, 2020).

[ii] Thomas Savidge, Jonathan Williams, and Skip Estes. Other Post-Employment Benefit Liabilities: The Continuing Need for OPEB Reform, American Legislative Exchange Council (June 2021).

[iii] Auditor of the State of Indiana, Comprehensive Annual Financial Report for the Fiscal Year Ended June 30, 2018 Published June 30, 2019.

[iv] Id.

[v] Id.

[vi] Id.

[vii] Savidge, et al., supra note 2.

[viii] State of Louisiana Division of Administration. Comprehensive Annual Financial Report for the Fiscal Year Ended June 30, 2018. Published December 28, 2018.

[ix] Savidge, et al. supra note 2.

[x] Commonwealth of Virginia Department of Accounts. Comprehensive Annual Financial Report for the Fiscal Year Ended June 30, 2019. Published December 13, 2019.