Dealing With Retiree Health Insurance

By: Ron York, President POLICEPAY.NET, Inc.   (http://www.policepay.net)

This is the last in a series of six articles on public safety deferred compensation.  So, I am going to “let it all hang out” and “take no hostages”.  Retiree health insurance is just another defined benefit pension.  The thing different from the traditional defined benefit plan is the formula for calculating the benefit.  It is calculated based on the cost of providing health coverage rather than ending pay.  I shall give you the gospel according to Ron York, but first I must give to you the axioms of the believers – just pretend I am Euclid (remember plain geometry).

Axiom Number One – Only total compensation matters.
Axiom Number Two – Money over time has value.
Axiom Number Three – All forms of compensation are equal.
Axiom Number Four – No form of compensation is obscene.
Axiom Number Five – Market economies really do exist and work.

Any bona fide economist will tell you the same thing, but politicians, journalists, and many of your fellow citizens neither understand nor believe all five of these axioms.  If you are having trouble with the five axioms you just read, go back and read the first five articles. They cover most of the issues.  I will add explanations as we go along.

Retiree health insurance is not inherently bad, but it is very complicated financially.  Traditional defined benefit plans have two major actuarial risks – market (earnings rate) and mortality (how long people live).  Retiree health insurance has one more – benefit (what health insurance will cost in the future).  Sure, there is some risk with what the benefit will be with the traditional pension, but it is much less volatile.

If everyone fully understood that only total compensation matters I could end this article now, but they don’t, so I will continue.  At any given point in time, your total compensation is a zero sum, fixed amount.  Think of total compensation as an apple pie (yum!).  The sum of all of the pieces must equal the total pie – no more or no less.  I am about to serve this pie to six people – base pay, group insurance, pension, retiree insurance, paid time off, and all other compensation and benefits.  What happens if retiree insurance is a glutton and wants more than one-sixth of the pie?  Someone has to receive less than 0ne-sixth.  I am buying the pie for these six people.  Does it cost any more if retiree insurance gets more than an equal share?  No, the more he gets, the less everyone else gets, but I still pay the same and that is all that I care about.

Question, how would you like your pie sliced?  How about this – health insurance, retiree insurance, and pension  combined take 50%.  This leaves base pay, paid time off, and other compensation and benefits to split the other 50%.  You don’t like
that?  Forget about baking a bigger pie.  It cannot be done.  Next year the pie is increasing 4%, but health insurance premiums are going up by 5%.

Okay, the pie is fixed in size, but you want a larger slice for base, what are you going to do?  I am starting to eye-ball the pension and the two insurances and they are starting to look a little pudgy.  Maybe they need to loose some weight, but you truly love these things and do not want to reduce the benefits.  I have it, let’s do something about controlling the cost of our beloved benefits.  Yeah, that’s a great idea.

What could be done to reduce the cost of retiree health insurance?  First, we could integrate it with Social Security so that the benefits are reduced whenever Medicare kicks in.  How about making it hard to qualify for the benefit?  You don’t like that, do you?  Do you think that a person that works for a city for ten or less years should receive retiree health insurance for life?  Have you considered medical savings accounts, coupled with higher co-pays and deductibles?  How about making it a defined contribution plan (the city makes a predetermined contribution each pay period to pay  your premiums when you retire?  Think about it.  I will not require a show of hands.

Pop quiz time – To increase base pay, what needs to be done?

A – make the pie larger
B – make retiree insurance’s slice smaller
C – hunker down and hope for the best

If you answered “A”, please re-read this article.  If you answered “C”, see me after class about repeating the first grade.  If you answered “B”, come on down and get your gold star.

You cannot make the pie larger in the short run.  You can only re-allocate the portions.  Hunkering down just delays and acerbates the problem.  Either deal with the cost issue or don’t cry about low base pay.  Every dollar wasted on one of the six pieces comes out of the others.

Now for the controversy.  There is no need to pre-fund the retiree health insurance plan.  And no, I am not writing this in some airport bar late at night.  The liability will never be paid.  Individual employees will have the liability owed to them liquidated, but they will be replaced by new employees.

Compare this liability to water meter deposits.  Let us assume that a small town has 1,000 homes with water meters.  There is a water meter deposit of $50.  This means that the water meter deposit liability is $50,000.  If the number of meters remains constant, what will the liability be two years from now?  What will it be twenty years from now?  When will the $50,000 become due and payable?  Then why do we need a separate fund to cover the liability?

But the bond ratings companies will pan us if we do not fund this liability.  I find that rather amusing considering that the liability has been reported in the footnotes to the financial statements for years.  The only difference as the result of GASB 45 is that it  must be incorporated into the financial statements presented on the full accrual basis.  There is no sudden  revelation to the rating companies.  What did they know and when did they know it?  They have know all along.  The baloney now being espoused by the rating firms reminds me of the scene in Casablanca where the police chief (Claude Rains) shuts down Rick’s for gambling.  “I’m shocked – shocked that gambling is going on in here,.” He says.  Just then the cashier brings the chief his winnings for the night.

I will probably catch a lot grief for this remark – the three bond rating companies “paint by the numbers” and try to convince you that their product is a Mona Lisa.  The bond rating system we use in this country is in dire need of change.  I have recently worked with cities that have seen revenues go flat.  Although they were implementing draconian budget cuts they were still hell bent on funding the outstanding liability.  Economic conservatism has taken over.

The bottom line?  Forget about the funding of the liability and focus on cash flow.