State Budgets

Learning from South Dakota and Nebraska on OPEB Reform

Other Post-Employment Benefit Liabilities shows once again that the status quo treatment of OPEB benefits for retired public employees is not sustainable.

The ALEC Center for State Fiscal Reform recently released the 6th edition of its annual report Other Post-Employment Benefit Liabilities: The Continuing Need for OPEB Reform. Unfunded other post-employment benefit (OPEB) liabilities totaled $1.14 trillion in the latest report, which amounts to just under $3,500 for every man, woman, and child in the United States. For good cause, OPEB is referred to as the “trillion-dollar acronym.” OPEB plans typically include the non-pension benefits states provide to public employees upon retirement, such as health insurance, Medicare supplement insurance, and life insurance.

Other Post-Employment Benefit Liabilities details the amount of unfunded OPEB liabilities each state faces. The latest report shows that total unfunded OPEB liabilities were highest in New Jersey, California, New York, Texas, and Illinois. Total unfunded OPEB liabilities per capita, which shows the burden on the average taxpayer, were highest in Hawaii, New Jersey, Alaska, Delaware, and Connecticut.

State OPEB plans face many of the same funding problems as public sector pension plans due to structural design flaws and chronic underfunding. Like most pension plans (see the annual ALEC report Unaccountable and Unaffordable), most OPEB plans are defined-benefit plans. These types of plans are set up to ensure retirees receive a pre-determined benefit amount based on a multitude of factors, including years of service, final pay, and typically a state multiplier. Often times these plans work in tandem with federal programs to provide non-pension retirement benefits such as Medicare.

The problem with the defined-benefit model is that there is no guarantee the state will be able to pay out the benefits; and, given that they often don’t receive the same legal protections as pension plans, OPEB plans can easily come under threat in a budget crunch. Unlike pension plans, which typically have prefunded assets intended to pay for future liabilities, defined benefit OPEB plans are not required to be prefunded. Plans without prefunded assets are referred to as “pay-as-you-go.”

Without real reforms, defined-benefit and pay-as-you-go OPEB plans have the potential to place a severe burden on taxpayers and break promises made by the state to public employees. By offering a range of defined-contribution options and by pooling retirees together with active employees, states can keep the promises made to both public employees and taxpayers.

In the latest report, New Jersey finds itself worthy of special mention, as the Garden State’s unfunded liabilities grew from $104 billion to nearly $175 billion (63.24%) in only one year. As a result, the state moved from having the fourth largest unfunded OPEB liability of any state to having the largest by far. New Jersey saw drastic growth in liabilities because it is one of only two states (the other being New York) that is fully pay-as-you-go. S&P Global Ratings recently noted that New Jersey’s high pension and OPEB liabilities “could pressure future budgets in the event of an economic downturn,” meaning taxpayers’ wallets could soon bear the burden of the state’s unfunded OPEB liabilities.

On the other hand, Nebraska and South Dakota have demonstrated that states need not saddle their taxpayers with unfunded OPEB liabilities. Both states require state employees to set up Health Savings Accounts (HSAs), to which those employees make tax-free contributions matched by the state up to a certain amount. Employees over age 55 can make “catch up” contributions up to an increased annual limit. Through their use of this system, Nebraska and South Dakota provide OPEB benefits while keeping state costs predictable and preventing the accumulation of unfunded liabilities.

Other Post-Employment Benefit Liabilities shows once again that the status quo treatment of OPEB benefits for retired public employees is not sustainable. However, structural reforms in the vein of defined-contribution plans like HSAs can set OPEB liabilities trending in the right direction and prevent them from unduly burdening taxpayers.

In Depth: State Budgets

Smart budgeting is vital to a state’s financial health. The ALEC State Budget Reform Toolkit offers more than 20 policy ideas for addressing today’s shortfalls in a forthright manner, without resorting to budget gimmicks or damaging tax increases. One way to stabilize budgets over time is to embrace…

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