California Common Sense released a report this month showing a 45 percent increase in retiree health spending for state employees over the last five years, growth from $1.3 billion in 2008 to an estimated $1.8 billion in 2013. While funding for higher education, K-12, parks, courts, transportation and welfare have all suffered significant cuts, this part of the budget is rare for its consistent increase in funding. This is rapid growth for any budget area, especially when revenue grew only 4.5 percent over that same period.
In the last half-decade, baby boomers have begun to retire en masse, health costs have risen and life spans have increased. Consequently, the costs of the state's retiree health benefits have risen dramatically. In coming years, those costs are expected to rise even faster as more retirees will be receiving health care at higher costs for longer periods of time.
California has a retiree health care liability of $63.9 billion, which represents today's cost of providing future health benefits that employees and retirees have already earned in past years of service. Rather than set aside funds to ensure the security of the promised benefits, the state dips into its operating budget each year to pay only the costs due that year.
By allowing its out-of-pocket benefit costs and unfunded liabilities to grow indefinitely, the state has failed to secure both its future budgets and the benefits it promised its employees. Without substantial reform, future citizens will need to close the gap with tax increases or additional cuts to public services. But now, with many options available, policymakers still have an opportunity to solve this problem. Unfortunately, no option is a painless, quick fix.
For instance, the state could prefund its retiree health benefits just as it does pensions. Under a prefunding scenario, as an employee works, the state would set aside funds in a trust to cover his future retirement health costs. The fund would invest those assets, earn investment returns and pay the employee's benefits from the trust fund when he retires.
If the state began prefunding its retiree health care today, it would start from behind. It would have to continue paying its current out-of-pocket costs ($1.8 billion) and begin setting aside funds for future benefits (an estimated $1.7 billion). Despite the substantial increase in immediate costs, continuing to prefund could reduce the state's long-term costs by as much as a third.
Alternatively, the state could alter benefits for new hires. Currently, state employees who work 20 years are entitled to the state paying 100 percent of their retirement health care premiums. The state could require newly hired employees to begin paying a portion of their retirement health care premiums or increase the number of service years required to qualify for full state coverage.
But only by reforming benefits for current plan participants will the existing debt see any reductions. The state can alter benefits for current employees with respect to years not yet worked, and any benefits an employee has already earned would remain intact. Under all of these options, any benefits an employee has already earned would remain intact.
Conversely, the state could offer workers a lump-sum cash payment in exchange for giving up their promised coverage. If this buyout is conducted responsibly, everyone can win: the state significantly reduces a quickly growing unfunded liability and state workers have the option of accepting a payout. Beverly Hills successfully used buy-outs in 2010 to substantially reduce its growing retiree health care debt.
State leaders, including Gov. Jerry Brown, Senate President Pro Tem Darrell Steinberg, and State Controller John Chiang have acknowledged the state's rising retiree health care costs as a growing problem that the state must address. But acknowledgment has yet to transform into action.
Prefunding, buyouts, and benefit reductions can all successfully reduce the state's retiree health care costs. The solution to this budgetary challenge likely will be a mixture of reforms. But every year California waits before addressing the issue, costs rise and the problem becomes more difficult to solve. Now is the time to channel mere acknowledgment into sustainable reform.
Adam Tatum is a senior research analyst at California Common Sense, and Andrew Crutchfield is a research analyst.