Retirement Time Bomb
By Milt Freudenheim and Mary Williams Walsh
New York Times
Sunday, December 11, 2005
Since 1983, the city of
Duluth, Minn., has been promising free lifetime health care
to all of its retired workers, their spouses and their
children up to age 26. No one really knew how much it would
cost. Three years ago, the city decided to find out.
It took an actuary about three months to identify all the
past and current city workers who qualified for the
benefits. She tallied their data by age, sex, previous
insurance claims and other factors. Then she estimated how
much it would cost to provide free lifetime care to such a
The total came to about $178 million, or more than double
the city's operating budget. And the bill was growing.
"Then we knew we were looking down the barrel of a pretty
high-caliber weapon," said Gary Meier, Duluth's human
resources manage, who attended the meeting where the actuary
presented her findings.
Mayor Herb Bergson was more direct. "We can't pay for it,"
he said in a recent interview. "The city isn't going to
function because it's just going to be in the health care
Duluth's doleful discovery is about to be repeated across
the country. Thousands of government bodies, including
states, cities, towns, school districts and water
authorities, are in for the same kind of shock in the next
year or so. For years, governments have been promising
generous medical benefits to millions of schoolteachers,
firefighters and other employees when they retire, yet
experts say that virtually none of these governments have
kept track of the mounting price tag. The usual practice is
to budget for health care a year at a time, and to leave the
rest for the future.
Off the government balance sheets -- out of sight and out of
mind -- those obligations have been ballooning as health
care costs have spiraled and as the baby-boom generation has
approached retirement. And now the accounting rulemaker for
the public sector, the Governmental Accounting Standards
Board, says it is time for every government to do what
Duluth has done: to come to grips with the total value of
its promises, and to report it to their taxpayers and
The board has issued a new accounting rule that will take
effect in less than two years. It has not yet drawn much
attention outside specialists' circles, but it threatens to
propel radical cutbacks for government retirees and to open
the way for powerful economic and social repercussions.
Some experts are warning of tax increases, or of an eventual
decline in the quality of public services. States, cities
and agencies that do not move quickly enough may see their
credit ratings fall. In the worst instances, a city might
even be forced into bankruptcy if it could not deliver on
its promises to retirees.
"It's not going to be pretty, and it's not the fault of the
workers," said Mayor Bergson, himself a former police
officer from Duluth's sister city of Superior, Wis. "The
people here who've retired did earn their benefits."
The new accounting rule is to be phased in over three years,
with all 50 states and hundreds of large cities and counties
required to comply first. Those governments are beginning
to do the necessary research to determine the current costs
and the future obligations of their long-standing promises
to help pay for retirees' health care. Local health plans
vary widely and have to be analyzed one by one. No one is
sure what the total will be, only that it will be big.
Stephan T. McElhaney, an actuary and principal at Mercer
Human Resources, a benefits consulting firm that advises
states and local governments, estimated that the national
total could be $1 trillion. "This is a huge liability,"
said Jan Lazar, an independent benefits consultant in
Lansing, Mich. "If anybody understands it, they'll freak
Last spring, the state of Alaska was the scene of a showdown
over retirement benefits that those involved said was a
precursor of fights to come. Conservative lawmakers who
supported scaling back traditional retiree health care and
pension benefits squared off against union lobbyists,
advocates for the elderly and the schools superintendent of
Juneau, the state capital, who defended the current
After saying that Alaska's future combined obligations for
pensions and retiree health care were underfunded by $5.7
billion, Gov. Frank H. Murkowski called a special session of
the Legislature and pushed through changes in pension and
retirement health care benefits for new state employees.
(The state Constitution forbids changing the benefits of
Instead of having comprehensive, subsidized medical
coverage, new public workers will have a high-deductible
plan and health savings accounts. The changes cleared the
State Senate and passed by a one-vote margin in the House.
Even the White House weighed in on the Alaska problem.
Ruben Barrales, President Bush's director of
intergovernmental affairs, lobbied wavering Republican
legislators, arguing in favor or replacing pensions and
traditional retiree health benefits with private savings
accounts for new employees. Mr. Barrales noted that the
president was seeking similar changes in Social Security,
including a plan for private accounts.
The union that represents state employees in Alaska said the
narrower benefits would make it harder to recruit qualified
teachers and government workers. "They keep chiseling away"
at school employees' pay and benefits, said Julia Black, a
single mother and union activist who earns $11 an hour an as
aide in classes for disabled children in Juneau.
Actuaries say that about 5.5 million retired public
employees have health benefits of some find -- and
accountants joke that there are not enough actuaries in the
country to do all the calculations necessary to estimate how
much all these retirees have been promised.
Though it may seem strange after a decade of double-digit
health cost inflation, hardly any public agencies have been
tracking their programs' total costs, which must be paid out
over many years. The promises seemed reasonable when they
were initially made, officials say.
In Duluth, Mayor Bergson said the city actually offered free
retiree health care as a cost-cutting measure back in 1983.
At the time, Duluth was trying to get rid of another
ballooning obligation to city workers: the value of unused
sick leave and vacation days. Public workers then were in
the habit of saving up this time over the course of their
careers and cashing it in for a big payout upon retirement.
Compared with the big obligations the city had to book for
that unused time, substituting free retiree health care
seemed cheap. "Basically, they traded one problem for
another," Mayor Bergson said.
With some exceptions, most states and cities have set aside
no money to pay for retiree medical benefits. Instead, they
use the pay-as-you-go system -- paying for former employees
out of current revenue. Agencies did not have to estimate
the total size of their commitment to retiree health care,
so few did so.
Under the new accounting rule, local governments will still
not have to set aside any money for those promises. But
they will be required to lay out a theoretical framework for
the funding of retiree health plans over the next 30 years,
and to disclose what they are doing about it. If they fail
to put money behind their promises to retirees, they may
feel the unforgiving discipline of the financial markets.
Their credit ratings may go down, making it more expensive
to sell bonds or otherwise borrow money.
Parry Young, a public finance director at Standard & Poor's,
the credit rating agency, said his analysts look at total
liabilities, including pension and now other
"post-employment" obligations. Many governments, he added,
have already been grappling with big deficits in their
employee pension funds.
A few agencies are wrestling with the daunting task of
estimating their total retiree health obligations and coming
up with a way to slice it into a 30-year funding plan. They
are finding that under the new method, the benefit costs for
a particular year can be anywhere from 2 to 20 times the
pay-as-you-go costs they have been showing on their books.
Maryland, for example, now spends about $311 million
annually on retiree health premiums. But when that state
calculated the value of the retirement benefits it has
promised to current employees, the total was $20.4 billion.
And the yearly cost will jump to $1.9 billion under the new
rule, according to an analysis for the state by actuaries at
Aon Consulting, which advises companies on benefits.
That is because Maryland would not be recording just its
insurance premiums as the year's expense, but instead would
report the value of the coverage its employees have earned
in that year as well as a portion of the $20.4 billion they
amassed in the past. After 30 years, the entire $20.4
billion should be accounted for.
Michigan says it has made unfunded promises that are now
valued at $17 billion for teachers, part of a possible $30
billion total for all public agency retirees. Other places
that have done the math include the state of Alabama; the
city of Arlington, Tex., and the Los Angeles Unified School
District. New York City has not yet completed an actuarial
valuation of its many retiree benefit plans. But in its
most recent financial statements, the city said it expected
that the new rule would "result in significant additional
expenses and liabilities being recorded" in the future.
The numbers can vary wildly by locality, depending on how
rich its benefits are, what assumptions its actuary uses
about future demographics and investment earnings, and that
great unknown: the cost of health care 30 years in the
"Fifteen years ago, who would have projected 10 years of
double-digit increases in health care costs?" said Frederick
H. Nesbitt, executive director of the National Conference on
Public Employee Retirement Systems, an advocacy group in
Washington. Mr. Nesbitt pointed out that when the
accounting rulemakers began requiring a similar change in
financial reporting for companies in the 1990's, it was
followed by a sharp decline in the retiree medical benefits
provided by corporate America.
Today, only one is 20 companies still offers retiree
benefits, according to Don Rueckerts Jr., an Aon actuary.
The rate for large companies is less than one in three, down
from more than 40 percent before the private-sector
accounting change, according to Mercer Human Resource
Consulting. General Motors and Ford are among the big
companies that still offer retiree health benefits. But G.M.
recently persuaded the United Automobile Workers union to
accept certain reductions, and Ford is seeking similar cuts.
"We expect the same thing in the public sector, unless we
help employers do the right thing," said John Abraham,
deputy research director for the American Federation of
The Governmental Accounting Standards Board, known by the
acronym GASB (pronounced GAZ-bee), is a nonprofit
organization based in Norwalk, Conn., and a sister to the
Financial Accounting Standards Board that writes accounting
rules for the private sector. Karl Johnson, the project
manager for the retiree-benefits rule, said GASB began
hearing from public employees' unions as soon as it issued a
first draft of its new standard. The unions said that if
governments were forced to disclose the cost of their plans,
they would probably cut or drop them, just as companies have
Mr. Johnson said the accounting board had no interest in
trying to reduce anyone's benefits, and no power to dictate
local policy even if it wanted to. "Accounting is just
trying to hold up a good mirror to what's happening," he
said. "These are very expensive benefits."
Under the new rule -- outlined in the board's Statement No.
45 in June 2004, and known widely as GASB 45 -- large public
government and school boards with large health care
obligations to retirees will have to start reporting their
overall benefits cost in 2007 -- either on Jan. 1 of that
year or, for most big governments, on the start of the
fiscal year beginning June 1, 2007. Smaller governments
will start using the new method in the two years after that.
The change comes at a rough time for state and local
governments. Spending on Medicaid and education has been
spiraling and Congress continues to cut federal taxes and
shift burdens of governing away from Washington. In some
areas, including parts of Michigan, governments are also
suffering from the financial difficulties of important local
industries. Max B. Sawicky, an economist at the Economic
Policy Institute, a liberal research group in Washington,
called the new requirement "another straw on the camel's
back" for state and local governments already straining
under their budget burdens.
Mr. Johnson said the accounting board had tried to issue the
retiree health care rule 10 years ago, when the economic
picture was rosier. It did succeed then in issuing an
accounting standard for government pension plans, but before
it could turn to the related issue of retiree health care,
other urgent accounting issues crowded onto its agenda. The
board finally cleared it decks and voted to address retiree
benefits in 1999. Coming up with the new methodology took
Now that it is here, "the general sense in the marketplace
is that GASB 45 is going to lead to a watershed in
public-sector health benefits," said Dallas L. Salisbury,
president of the Employee Benefit Research Institute, a
nonpartisan research center in Washington.
Indeed, the handful of states and cities that have already
calculated their obligations to retirees have concluded they
must also rein in the costs. Michigan, for example, with
its possible $30 billion in largely unfunded health care
promises, is already considering legislation that would
shift "a considerable amount of the cost for health
insurance to the retiree," said Charles Agerstrand, a
retirement consultant for the Michigan Education
Association, a teachers union. The legislation would
require teachers retiring after 20 years to pay 40 percent
of their insurance premiums, as well as co-payments and
deductibles, he said.
The pressure is greatest in places like Detroit, Flint and
Lansing, where school systems offered especially rich
benefits during the heyday of the auto plants, aiming to
keep teachers from going to work in them. Away from those
cities, retiree costs may be easier to manage. In the city
of Cadillac, 100 miles north of Grand Rapids, government
officials said they felt no urgent need to cut benefits
because they promised very little to begin with. Instead,
Cadillac has started putting money aside to take care of
future retirement benefits for its 85 employees, said Dale
M. Walker, the city finance director.
Ohio is one of a few states to set aside significant
amounts. Its public employee retirement system has been
building a health care trust fund for years, so it has money
today to cover at least part of its promises. With active
workers contributing 4 percent of their salary, the trust
fund has $12 billion. Investment income from the fund pays
most current retiree health costs, said Scott Streator,
health care director of the Ohio Public Employee Retirement
System. "It doesn't mean we can just rest," he said. "It
is our belief that almost every state across the country is
underfunded." He said his system plans to begin increasing
the employee contributions next year.
In Duluth, Mayor Bergson grew quiet for a moment at the
thought of a robust trust fund. "There was not a nickel set
aside" in Duluth, he said. "The reason was, if you set
money aside, you'd do less 'pretty projects.' Less bricks
and mortar. Fewer streets. Fewer parks. So no one set the
money aside. "If the city had set $1 million aside every
year for those 22 years" since the promise was made, he
added, "we'd be in really good shape right now."
Mayor Bergson said his city intends to start setting aside
money for the first time in 2006, but he is also trying to
rein in the growth of new obligations. He raised to 20 from
3 the number of years that an employee must work for the
city in order to qualify for retirement benefits.
He also imposed a hiring freeze and pledged not to lift it
until Duluth could hire employees without promising them
free lifetime health care. As the city has lost police
officers, firefighters, an operator of its huge aerial lift
bridge and other workers, the remaining employees have
racked up more than $2 million in overtime. But Mayor
Bergson says that this is still cheaper than dealing with
free retirement health care once the new accounting rule
Most recently, he reached out for what may prove a political
third rail: he took issue with the idea that once a public
employee has retired, his benefits can never be reduced.
This idea, as applied to pensions, is rooted in the
constitutions of about 20 states, and unions argue that it
also protects retiree health care.
Active employees in Duluth have had to start paying more for
their health care under the city plan, Mayor Bergson said.
If active workers must make concessions, he said, retired
workers should make concessions, too. Otherwise, in
relative terms, they are pulling ahead of the active work
"That's not a popular thing to say," Mayor Bergson said.
"I'm getting kicked hard by retirees. I'm getting beat up
by active employees. The people who are kicking me are the
ones I'm trying to protect."
Attemps to balance the competing interests of retirees,
active workers and taxpayers are building tension. Ross
Eisenbrey, a former Clinton administration official who is
now at the Economic Policy Institute, said that "when
taxpayers wake up to these obligations, their first
inclination is often to escape them or reduce them."
The problem is that people have counted on those benefits,
and many have accepted lower salaries in exchange for better
retirement benefits, said Teresa Ghilarducci, an economics
professor at the University of Notre Dame. If they are
close to retirement, said William R. Pryor, a firefighters'
union official who is an elected board member of the Los
Angeles County Employees Retirement Association, it may well
be too late for them to make up for the loss with their own
The clock is ticking. In Duluth, a city official approached
the actuary who made the city's estimate in 2002 and asked
her to refine and update her numbers because economic
conditions had changed and the new accounting rule had been
announced. This time the obligations worked out to $280
million, a 57 percent increase in less than three years.