State Retiree Healthcare Costs Could Double Over Next Nine Years

Mark J. Magyar | September 1, 2010 | Budget, Health Care
On the hook for nearly $70 billion, New Jersey already tops all states in unfunded liability

The annual cost of providing healthcare benefits for retired teachers and state government employees will more than double over the next nine years from $1.27 billion to almost $2.75 billion, adding to New Jersey’s long-term budget woes, according to the state’s actuarial consultant.

In a 65-page report delivered July 20 to the state Division of Pension and Benefits, Aon Consulting projected that healthcare costs for retirees under age 65 will grow 8.5 percent to 9.5 percent per year for medical coverage and 10.5 percent for prescription benefits. The Somerset firm projected a 5 percent annual increase in medical and prescription costs for retirees over age 65, for whom the federal government’s Medicare Plan B picks up much of the expense.

Aon also concluded that New Jersey is on the hook for $68 billion in future health benefit payments to current and retired teachers and government workers, a figure in line with an analysis from the Pew Center for the States six months ago showing New Jersey with an unfunded liability for retiree health benefits of $68.9 billion by the end of 2007, the highest in the nation.

“The exponential growth of retiree healthcare coverage is driven by the overall growth of the number of retirees and the high year-to-year growth in the cost of healthcare,” said David J. Rosen, budget and finance director for the non-partisan Office of Legislative Services. “To the extent that healthcare costs rise faster than revenues, it creates a budget problem.”

Burden on Taxpayers

Unfunded Benefits Chart

In New Jersey, state, county and municipal government workers and public-school employees receive free healthcare coverage for life after 25 years of service. New Jersey is one of the few states in which the state government pays the full cost of retiree health benefits not only for state workers, but also for teacher and other public school employees.

County and municipal governments pay the healthcare costs of their retired workers, and those costs — not included in the state expenses — are expected to rise from $202.6 million in fiscal 2010 to $476.8 million by fiscal 2019. Healthcare costs are one of the few items excluded from the 2 percent cap on municipal spending signed into law in July, and with state aid to local government expected to be frozen again next year, the increased burden will fall on property taxpayers.

The expected increases in retiree healthcare costs far outstrip the 3 percent annual revenue growth that was considered normal prior to the recession that has wreaked havoc on the last three state budgets. These annual increases, coupled with the need for the state to begin contributing an estimated $3.5 billion a year to its pension fund for teachers and government workers, will force hard choices between increasing taxes or making further cuts in state programs, including school aid, municipal aid and property tax relief.

No Option to Skip Payments

Furthermore, because retiree health benefits are funded on a pay-as-you-go basis, the state does not have the option to skip payments, as it has for years on its pension liability.

(The state’s failure to inform purchasers of state bonds from 2001 to 2007 that it was not making pension payments led the Securities and Exchange Commission to take the unprecedented step of charging a state government with securities fraud. The case was settled on Aug. 19, when New Jersey, while not admitting wrongdoing, agreed to cease misleading investors.)

In the Pew study, New Jersey ranked third among the 50 states in the size of its unfunded pension liability, with a shortfall in the fund of $34.4 billion. The state’s total unfunded liability for pensions and retiree health benefits totaled $103.3 billion at the end of 2007, second only to the $112 billion liability for California, which has more than four times the population of New Jersey. Furthermore, after three more years of failing to make pension payments, New Jersey’s unfunded pension liability rose to $45.6 billion last year, bringing the state’s total liability to retirees to $114.5 billion at the latest estimate — or $13,700 for every one of the state’s 8,224,000 residents.

Magyar unfunded liabilities

The twin issues of unfunded pension and unfunded retiree health benefit liability emerged for the first time in a gubernatorial campaign last year, when Jon Corzine, under attack by Chris Christie and independent Chris Daggett, noted that he had been the only governor in 15 years to make substantial contributions to the pension system, including a $1 billion infusion in fiscal 2007, before the recession sent state revenues plummeting.

Gov. Christie, who inherited a deep budget deficit when he took office, followed Corzine’s lead in making no contribution to the pension system for this budget year. However, he signed legislation in March obligating payment of at least one-seventh of the estimated pension contribution in the next budget year and increasing that amount over the next six years until the state is fully funding its pension system.

Such a graduated payment schedule would probably require a $4.5 billion to $5 billion annual payment by fiscal 2018. When Treasurer Andrew Sidamon-Eristoff said he anticipated making that first $512 million pension payment, Christie quickly jumped in to say that the state would make the pension payment only if it could afford to do so.

Covering the Difference

Christie has no such flexibility on retiree health benefit costs, however. If, as Aon projects, the costs for former teachers and state employees rise from $1.457 billion in the 2011 budget to $1.634 billion for fiscal 2012, Christie and the Democratic-controlled Legislature will have to come up with the difference — even if they have to cut other, more popular government programs or put off a pension payment to do so.

“It’s counterintuitive,” said Dudley Burdge, a senior staff representative for Local 1032 of the Communications Workers of America, the state government’s largest public employee union, who serves as an AFL-CIO representative on the state Pension and Health Benefits Review Commission. “You would think that a system like the pension system that is prefunded and collects interest on its investments to help pay for future benefits would be more stable. But with the state failing to make the required payments into the pension system, that’s not the way it has worked out in New Jersey.

“At least a pay-as-you-go system forces the state to pay each year for retiree health benefits,” he continued. “That’s something we haven’t been doing for pensions.”

Pension Liability Rises Faster

While the $68.9 billion unfunded liability for retiree health benefits is much larger than the $45.6 billion pension liability, it seems a more manageable budget problem because it rises steadily and predictably from year to year and is dependent mainly on inflation in healthcare costs, according to the OLS’s Rosen.

“You don’t get a big jump,” he noted. The projected nine-year increase in New Jersey is not all that different from the rate of growth in the $5 billion Medicaid program.

On the other hand, the amount of money New Jersey will need to contribute to its pension system annually soars every year the state fails to make the required contribution, and when investments fail to hit what many regard as an unreasonable 8.25 percent projected rate of return.

Rosen projected that New Jersey needed to make a $2.5 billion pension contribution in 2009 and upped that projection to $3.5 billion for next year’s budget. Some experts expect the annual amount required to top $4.5 billion or $5 billion by 2018.

Higher Co-Pays and Contributions Ahead?

Christie and Sidamon-Eristoff have been working on a series of initiatives to attack rising pension and health benefit costs for both current and retired government workers.

Christie, who has clashed with the public employee unions since his election, is widely expected to seek higher co-pays for healthcare benefits and greater contributions to pensions from state employees when he goes to the bargaining table to negotiate new contracts to replace the four-year deals that expire June 30, 2011.

The negotiations between the administration and the labor unions are expected to be particularly contentious, with the state facing another large budget deficit and the 18-month ban on layoffs agreed to contractually by Corzine in exchange for union concessions set to expire next January 1.

Going after retiree health or pension benefits may be another story, because of the legal issues involved. Both the OLS and the Attorney General’s office gave legal opinions in 2006 to a bipartisan legislative committee that a law approved by Gov. Christine Todd Whitman and the GOP-controlled legislature in 1997 had clearly established a “non-forfeitable right” for workers to receive pension benefits at the level promised when becoming vested.

Neither the OLS nor the Attorney General offered an opinion on the topic of post-retirement medical benefits, but a similar law guarantees that retiree healthcare benefits cannot be reduced from the level promised at the time an employee reaches the 25 years of service qualification for free healthcare coverage for life.

Waiting on Other States

While decisions on pension and retiree benefit issues in state and federal courts over the years have upheld the inviolability of promised benefits, Colorado, Minnesota and South Dakota all cut cost-of-living increases for their pensioners, citing state budget crises and unfunded pension liabilities that put their pension funds on the brink of bankruptcy. All three cases are currently in the courts, and Christie, who cited fiscal emergency in assuming unprecedented executive powers to make mid-year budget cuts last spring, may very well be tempted to test New Jersey’s legal limits, especially if those states win their cases.

Changes in retiree health benefits, even if they applied only to current employees who have not reached 25 years of service, could reduce the state’s unfunded liability quicker than changes in the pension system would reduce that $45.6 billion liability.

That’s because while pension payments to retirees grow every year with cost-of-living adjustments until their deaths, the cost of retiree health benefits is front-loaded into the first decade or so after retirement. While the state pays the full cost of health benefits for teachers and state employees with 25 years of service upon their retirement, most retire around the age of 55 or later. Once they hit 65, the state picks up only those costs not covered by Medicare Part B. This budget year’s medical and prescription drug costs for those under age 65 totals $1.3 billion, while Medicare Part B reimbursement for those 65 and older is just $147.8 million.

One reform not likely to be on the table is the creation of a separate prefunding of retiree health benefits to reduce the $68.9 billion obligation. New Jersey was one of the few states to prefund its retiree health care obligation when it did so from 1987 to 1994. Gov. Whitman ended the practice at the same time she enacted the first of a pair of pension refinancing plans enabling the state to take advantage of a booming stock market and stop making regular contributions to the pension system from the state budget — a practice adopted by her Republican and Democratic successors.

Michael E. Morfe, the senior vice president of Aon Consulting and lead actuary on the July 20 report, told the Division of Pension and Benefits three years ago when he delivered his 2007 report that state and local governments could drastically reduce their long-term costs, which are expected to eventually hit $5.8 billion a year, through a prefunding plan that would bring costs down to an average of $3.5 billion a year as the fund earned investment income. But even in pre-recessionary 2007, Gov. Corzine, who was not making the full payment to the state’s existing pension fund, could not consider taking on a new prefunding obligation of that magnitude.

Today, only two states prefund their retiree health benefit programs, and both — Alabama and Alaska — have modest benefit programs compared with New Jersey and larger states.

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