Health Care From Pensions Proves Costly
By Mary Williams Walsh
New York Times
Tuesday, December 19, 2006
Many local governments began turning to their pension funds
to help pay for health care for retired public workers in
the 1990s. Some are now regretting it.
When the financial markets were producing soaring returns,
governments sought to use the gains in their pension funds
to help cover rising health costs. Then came years of
investment losses and double-digit increases in health care
Now, in some places, money for retiree health care is
running out, and money for pensions is dwindling fast, too.
Rising medical costs are particularly wreaking havoc on
public pension funds in Chicago; Battle Creek, Mich.; and
the state of Alaska. They threaten longer-term harm in
“The numbers are frightening to anyone who really looks,”
said Laurence Msall, president of the Civic Federation, a
nonpartisan research group in Chicago, where three separate
pension funds for public workers have been paying for health
benefits along with the usual retirement stipends.
The troubles foreshadow broader government problems — not
just in those that combined their pension and retiree
medical accounts — as states and localities that never
estimated the cost of their retirees’ health care move to do
Donald Rueckert Jr., senior vice president and an actuary
with Aon Consulting who has been helping state and local
governments with these calculations, said that when all the
numbers are done, under a new accounting rule, the
governments’ total retiree health bill will probably turn
out to be about $1.1 trillion.
Relieving the strain on government budgets from rising
health care costs will probably mean taking one or more
unwelcome steps: tax increases, union givebacks, sales of
bonds or public assets, mass-transit fare increases, or
increases in the cost of other local services. These
measures are so unappealing that few who understand the
problem are pushing them very hard.
The local troubles also offer a sense of the challenge in
store on a national scale as the obligations of Medicare and
Social Security rise sharply to cover the retirement of the
baby boom generation. While the two federal programs
maintain separate accounts, economists have warned
repeatedly that they have both promised benefits well beyond
what they can reasonably be expected to pay.
For the Chicago Transit Authority’s pension fund, the
problems are real now. A recent study showed that the plan,
which covers nearly 20,000 people, could run out of money
for retiree health care in early 2007 — and that the money
to pay pensions could be gone by 2012.
“There were decisions taken years ago that seemed harmless
at the time, but now they’re very problematic,” said John V.
Kallianis, the plan’s executive director.
One was the decision in 1980 to start paying retiree health
benefits without setting aside enough money to cover the
cost. “Anyone who has embedded their obligation for their
retiree health plan in their pension fund and doesn’t think
it’s going to be a big drain on the assets of that pension
fund is crazy,” said Lynn E. Turner, a former chief
accountant for the Securities and Exchange Commission who is
now managing director of research at Glass, Lewis & Company,
a proxy advisory firm.
But many local governments and their financial advisers did
not see it that way in the 1980s and 1990s. While rules
were established aimed at protecting pension assets, their
investments were doing so well then that there seemed to be
plenty of money to spare. Building a retiree health plan
into a pension fund seemed an efficient way to use the
“excess” and take pressure off the local budget at the same
Battle Creek’s pension fund for police and firefighters has
been paying for retiree health care since 1980, when the
benefits cost about $60,000 a year; now they cost $1.8
million. The pension fund was to run out of money for
retiree health at the end of this year, but officials
obtained an emergency 90-day appropriation from the city
while they seek a longer-term solution.
In Alaska, where the state Constitution guarantees retired
public workers’ health care, towns and school districts have
been watching in amazement as their mandatory pension
contributions doubled this year — even though Alaska tried
to rein in costs by closing the state pension fund to new
employees. The bills are growing to make up for prior
years, when Alaska underestimated the cost of the health
benefits by hundreds of millions of dollars.
Mr. Msall of the Civic Federation said it would be a mistake
for these places to delay action in hopes that big pension
investment returns could solve the problem. “There’s no way
the market is going to keep up with the inflationary
pressures of unmanaged health care costs,” he said.
Like many public pension funds, the Chicago transit plan
receives contributions from both the workers and their
employer. Currently, 3 percent of every worker’s paycheck
goes into the pension fund, while the Chicago Transit
Authority puts in another 6 percent of its payroll.
But the employees have been told that the money going into
the pension fund is not nearly enough to cover the pension
and health payments coming out.
“Medical costs are shooting way out of control,” said Jim
Collins, a city bus driver, “and nobody is giving a
With the assets draining away, the transit authority and the
Amalgamated Transit Union have been trying to negotiate a
package of higher contributions or benefit cuts that could
stop the bleeding. But the talks have stalled. The state
legislature passed a law requiring the plan to be correctly
funded starting in 2009 but did not make clear how this
Mr. Collins has been driving for 24 years and will qualify
to retire next year, when he turns 55. He said he was tired
of traffic jams, predawn shifts and workplace politics. By
next year he will have earned a pension of about $2,800 a
But planning his retirement is impossible, he said, with the
retiree health plan teetering on the brink. If he retired
on schedule and the health plan failed, he could be left
with no insurance for 10 years, until he turns 65 and
qualifies for Medicare.
Transit workers are not the only ones in Chicago in this
predicament. The pension plan for Cook County’s roughly
40,000 government workers and retirees has been paying for
retiree health care since 1991, at a cost currently running
at about $37 million a year.
Cook County’s chief financial officer, Thomas J. Glaser,
said that the county never authorized this diversion — the
pension trustees did it unilaterally, he contended. The
nine-member pension board is dominated by locally
influential people who represent the county’s workers and
retirees, and they can easily outvote the two trustees who
represent the county.
Since the county never agreed to the provision, Mr. Glaser
said, it was disavowing any obligation for retiree health.
“No one can impose a liability on the county without the
county’s approval,” he said.
If Cook County succeeds in bowing out, its 26,000 active
government workers will be liable for their retired former
co-workers’ health care. Their contributions to the pension
fund, now 8.5 percent of each paycheck, would have to rise.
Employees have not yet been told of this possibility, but
Mr. Glaser said he expected it to become apparent in the
next few months when the county board debates next year’s
Elsewhere, plans have been tripped up by misreading
actuarial projections and thinking there was “extra” pension
money when there was not. One common error has been to
spend investment income before it has been earned.
Another is to underestimate the rate of health cost
inflation. Estimates typically assume the rate will taper
off to 5 percent in the next few years, even though health
inflation has been running at almost double that, with
little sign of slowing.
The Internal Reveune Service permits pension money to be
spent on health care only if certain rules are followed, to
keep health payments from bleeding the pension assets. In
recent years, governments have thought they could comply by
creating a separate account for health benefits inside their
pension funds and limiting their contributions to the health
account to no more than 25 percent of the total.
But with gray areas in the tax law and the accounting rules
for pensions, those steps may not have been enough to
Some cities have also promised comprehensive health coverage
to all retirees, even those who retire in their 40s. Cities
and states that offer narrower benefits, or do not permit
such early retirement, are less likely to find themselves
New York City never dipped into its pension fund to pay
retiree health benefits but, like many places, it did not
set aside any money to pay retiree health care obligations.
Instead, it has used the pay-as-you-go method, taking money
from each year’s budget to pay current health bills.
Now that the new accounting rule has forced New York, along
with other state and local governments, to look ahead, the
city has just published the total estimated future cost of
its retirees’ health care: $53.5 billion in today’s dollars.
Mayor Michael R. Bloomberg has said that the city will set
up a new trust fund, separate from the pension fund, and
prime it with $2.2 billion from the city’s current surplus.
While the down payment is small relative to what is owed,
credit analysts expressed approval that New York, unlike
most other places, was at least starting with a plan.
Still, not every government is in trouble. Alameda County,
Calif., which includes Oakland, says it has kept its plans
responsibly funded even though it uses pension money for
retirees’ health care. Still, the fund’s executive director
called the situation unusual.
Other places that have tried to set aside ample resources
are running into problems anyway. The pension fund in
Cincinnati, for one, shows an unusually large amount of
money available to pay for promised pensions and health
The trouble is, those rosy numbers have recently encouraged
the city to withhold contributions — effectively borrowing
from the pension fund — to shift money to neighborhood
development projects even as it is accelerating retirement
benefits coming due. Cincinnati is downsizing its municipal
work force and offering early retirees and their dependents
health care at little or no cost.
“It’s like musical chairs,” said Christopher Smitherman, a
former Cincinnati City Council member. “Whose lap is this
whole problem going to fall into?”
Local officials dispute Mr. Smitherman’s contention, saying
they are trying to strike a balance between the pension fund
and other pressing needs, like hiring more police. When he
issued his budget proposals last month, Mayor Mark Mallory
said that he remained “committed to fully funding the
The Chicago Transit Authority’s problems are beyond
dispute. The president of the union local representing its
railway workers, Rick Harris, said that the workers could
double their pension contributions — and the retirees could
chip in for their health care — and it would still not be
“We’re putting a Band-Aid on a bullet wound,” Mr. Harris