State and Local Governments Might Be Able Use Federal Funds to Reduce Other Post-Employment Benefits Debt

As state and local leaders begin allocating federal COVID-19 stimulus and aid, they should consider using the federal funds to improve their long-term financial balance sheets rather than creating new programs that would require ongoing taxpayer funding.

Although recently published Treasury Department guidance restricts the ability of grantees to pay down their pension liabilities, the regulations do not specifically prohibit the application of federal assistance to other post-employment benefits (OPEB) liabilities.

Other post-employment benefits are most often health care benefits provided to retirees, but can also include distributions of insurance or disability benefits.

A recent Reason Foundation analysis of government financial disclosures found that state and local governments have a total of $1.2 trillion in OPEB liabilities. This is a significant amount of debt weighing on state and local entities—and taxpayers.

There are at least three ways state and local governments can use a one-time inflow of federal funds to help reduce their other post-employment benefits liabilities:

1. Invest the proceeds into a dedicated fund to pay future benefit obligations as they come due;
2. Pay an insurance company to assume the obligation;
3. Fund retiree health care savings accounts as a replacement for the defined retiree health benefit.

Let’s consider each in turn.

As with public pensions, governments can prefund other post-employment benefits by contributing to a dedicated fund and then investing the proceeds. Unfortunately, most governments have minimal or no OPEB assets saved for the benefits they owe retirees. As a result, General Account Board Standards (GASB) rules require them to discount their future expected OPEB payments at a low municipal bond interest rate.

By contrast, governments that have a plan to fully prefund OPEBs can use a higher discount rate akin to the one they use for pension liabilities. So earmarking funds for an OPEB plan may produce a much larger liability reduction than the amount invested. This approach to paying down OPEB liabilities requires not only a one-time application of federal funds but an ongoing commitment to making OPEB contributions in subsequent years.

Another alternative to paying for other post-employment benefits costs is to contract with an insurance company to take on OPEB payment obligations. In exchange for a one-time premium, the insurance provider would agree to make a stream of payments to the contracting government each year (a “buy-in” arrangement) or to simply pay employee claims directly (a “buy out”). Although there are multiple examples of insurance companies entering into such arrangements with private sector entities to reduce pension obligations, it is important to note that this approach has yet to be applied to public sector OPEB liabilities.

By implementing either of these alternatives, the government employer increases the likelihood that it will be able to service OPEB liabilities as they come due. While reducing risk for its employees by paying down outstanding debt, the employer might also consider ways to “right-size” its OPEB package, which may have become quite costly after decades of health care cost inflation. Among the changes that might be considered— capping insurance premium reimbursements at the cost of an Affordable Care Act bronze plan, tightening eligibility requirements (especially for spouses and dependents), and re-evaluating whether dental, vision, and/or life insurance should be included in these benefits.

The third alternative for using federal stimulus funds to reduce OPEB liabilities is to transition some or all employees to a defined contribution retiree health plan. The government employer could use federal funds to make initial deposits to a retiree health care savings account which could then be later augmented by some combination of employer and employee contributions as well as asset growth. Employee contributions are tax-deferred, and the accounts are portable, which is beneficial for employees who leave prior to vesting in a defined benefit plan.

Governments should seek third-party expertise when considering any of these strategies to ensure that they are implemented in a way that does not run afoul of Treasury Department guidance and protects taxpayers from potentially hidden costs. But if state and local government can legally use the federal funds to tackle their significant other post-employment benefits debt, public agencies could greatly improve their long-term fiscal sustainability.

Using one-time federal COVID-19 pandemic stimulus and relief funds to pay down long-term OPEB liabilities would be a better way of spending federal taxpayers’ money than starting new programs that would surely come with recurring costs to taxpayers.

The post State and Local Governments Might Be Able Use Federal Funds to Reduce Other Post-Employment Benefits Debt appeared first on Reason Foundation.