New Jersey’s recently released “Comprehensive Annual Financial Report (CAFR),” which includes the annual audit for fiscal year 2018, contains some bad news about the long-term liabilities of state-supported health benefits for employees and retirees.
Specifically, the report discloses a large increase of $54 billion in the total liability for Other Postemployment Benefits and Active Employee Health Benefits (OPEB), which is separate from pension liabilities. OPEB includes liabilities related to accrued sick time and vacation for current employees, but the dominant component is future costs related to health benefits for active and retired employees.
A very short primer is in order — bear with me.
The state’s balance sheet shows noncurrent liabilities in excess of $235 billion. The two largest liabilities are for state’s pension systems ($99.6 billion) and OPEB ($90.5 billion), principally health benefits. The remaining $45 billion relates to bonded debt and installment obligations.
On the fiscal 2017 CAFR, the net OPEB liabilities were reported as $36.5 billion. So, why the big increase and is it a real problem? In short, the increase is because the Government Accounting Standards Board (GASB) issued new standards (GASB 75) and criteria for how state and local governments must report OPEB liabilities on financial statements. Previously, the standard cost drivers were medical care inflation and changing demographics, but those are now augmented by new GASB 75 requirements.
Does this much bigger number mean the state’s situation has gotten worse, or is it simply a re-calculation of existing data? The answer is “yes” and “no.” Hold on for one more paragraph and I’ll address the issue.
It’s essential to understand that unlike pension systems New Jersey has not set aside any funds for long-term heath costs. These long- term liabilities still exist, however, must be computed, reported, and ultimately paid. Previously these retiree health benefits were funded much like pensions. But in 1995 the governor switched health benefits to a pay-as-you-go scheme and took funds that were accumulating to balance the budget. Not good budgeting or public policy.
The good news is recent cost reductions to some health-benefit plans decreased current and future costs — otherwise the liabilities would have been more.
The bad news is that the new GASB 75 standards require New Jersey and all states to measure liabilities in a different manner — one that GASB argues is more valid and reflects future commitments more accurately.
Without getting too deep in the weeds, let me mention just a few of the reasons for the GASB changes.
Liabilities were previously based on whether the required contribution was funded for the budget year. Now it is based on how large the future liability is projected to be. The discount rate was lowered. The discount rate is critical in computing long-term liabilities, and a lower rate is more realistic. The use of the more conservative “entry age actuarial” cost is now required, rather than the previous “unit credit cost.” Finally, a shorter five-year amortization period must be used; the prior options could be as long as 30 years.
Moreover, the new standards now require the state’s balance sheet to recognize its legal obligation to pay OPEB benefits for qualified local police and firefighter retirees and dependents.
Interestingly, a sensitivity testing of the assumptions must now be computed and reported each year. For example, the fiscal 2018 CAFR reports that a 1 percent decrease in the discount rate would increase liabilities by $17 billion, suggesting possible further increases. The opposite impact would also be true.
To the average reader — and even close followers of government finance — this may appear to be a lot of gobbledygook. Unfortunately, GASB has concluded that these changes are necessary for accuracy and full disclosure.
Further observations and recommendations
As of June 2017 the state provided healthcare benefits for 149,727 retired employees and 349,406 active employees with a liability of $90.5 billion.
The breakdown by level of government is as follows:
|State and College Employees||147,194||$28.1|
The total liability for OPEB, principally health benefits, now rivals the unfunded pension burden of $99.6 billion. True, the rating agencies view health obligations as a more flexible commitment compared with unfunded pension obligations (easier to decrease by statue or negotiation).
However, it is still a very large percentage (15 percent) of the state’s personal income. And when bonded debt is included, the total liabilities of New Jersey are among the highest in the country — not a good harbinger of future stability.
Do the results of these new calculations suggest that the credit rating of New Jersey will be further reduced (it is currently the second lowest of the 50 states)? In the short term I doubt it, since the actual situation of health benefits systems has not changed. Rather, New Jersey must now report such data in a better-structured, better-defined, and more accurate manner reflecting the true scope of the problem.
The new calculations strongly suggest actions must be taken to correct the long-term underfunding of not only OPEB but also the pension systems. There is no logical solution to fund this large problem and other key requirements of the state, including school aid, Medicaid, transportation, higher education, and other legal commitments. It is time to develop a viable solution.
The “Path to Progress” report, prepared by the Legislature’s Economic Policy Committee, contains recommendations to reduce the long-term costs of both systems. Specifically, by altering the pension systems so that new employees and current employees not vested would be enrolled in a 401(k)-type defined contributions system. Further, health benefits for employees and retirees at all levels of government should be changed from a platinum to gold coverage.