Balancing Dollars and Health Sense - SLGE · Balancing Dollars and Health Sense 1 S tate and local governments in the United States are liable for unfunded post-employment health

Balancing Dollars and Health Sense

June 2008

A Framework for Decision Making on Funding State Retiree Health Care Benefits

State and local governments traditionally used a “pay-as-you-go” method to fund retiree health benefits. Now that they have begun to account for their future costs, it has become clear that many retiree health plans are not adequately

funded. This report is intended to help policy makers better understand the scope of the issues and the options they may want to consider to address these challenges.

Michigan State University’s Institute for Public Policy and Social Research examined several models and recommended that the State of Michigan reach out to all key stakeholders to develop a credible plan to reduce the State’s estimated $22.7 billion of unfunded liabilities in retiree health benefits. Among the report’s recommendations are:

•Establishanonpartisancommissiontodevelopaplanandkeepthepublicandstate employees informed of its progress.

•Createanirrevocable115TrustFundandconsidermultipleapproachestofundit.

•Assurecurrentretireestheywillreceivepromisedbenefits.

•Balancetheneedtocontrolcostswiththeneedtokeeptheplansaffordableforemployees.

•Includeincentivesforemployeewellness.

TheCenterforStateandLocalGovernmentExcellencewasfoundedtoexploreissuesthat are important to attract and retain the talent needed for public service. Offering high quality benefits will remain as important in the future as it has been in the past.

With heightened emphasis on the economic security of future retirees and increasing fiscal pressures, government leaders will need authoritative data to understand the issues. They also will want to identify and adopt promising practices as quickly as practical.

FutureCenterpublicationswillexaminethemythsandrealitiesofthestateandlocalgovernment retiree health care crisis; what states and localities are doing to finance retiree health care; policy alternatives; intergenerational issues; and benchmarking. TheCentergratefullyacknowledgesthefinancialsupportfromtheICMARetirementCorporationtoundertakethisresearchproject.

ElizabethK.KellarExecutiveDirectorCenterforStateandLocalGovernmentExcellence

By Harry Perlstadt, PhD, MPH; AnnMarie Schneider, MS; and Ryan Kevin Kelly, MHRLR

HarryPerlstadt,PhD,MPH,isaprofessorinMichiganStateUniversity’sDepartmentofSociology.

AnnMarieSchneider,MS,isdirectorofProgramPlanningandPolicyEducation,MSULegislativeLeadershipProgram,InstituteforPublicPolicyandSocialResearch, Michigan State University.

RyanKevinKelly,MHRLR,isaresearchassistantwiththeInstituteforPublicPolicyandSocialResearch,SchoolofLaborandIndustrialRelations,MichiganState University.

Balancing Dollars and Health Sense

A Framework for Decision Making on Funding State Retiree Health Care Benefits

iv Balancing Dollars and Health Sense

Contents

Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .1

Research Scope and Methods . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .2

Findings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .3

Gasb-45andOPEBBenefitsBackgroundInformation . . . . . . . . . . . . . . . . . . . . . .3

MeetingFutureObligationsThroughaPre-fundedTrust . . . . . . . . . . . . . . . . . . . .3

RaisingFundsforTheTrust . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .5

ChangingBenefitsandOptionsforCurrentandFutureRetirees . . . . . . . . . . . . . . .6

CoordinatingwithMedicare . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .8

Merging Health Plans, Merging Administration of Health Plans . . . . . . . . . . . . . . .8

OtherStatePracticesConsidered . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .9

Managing Transitions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .9

WhatCanPolicymakersAgreeOnGoingForward? . . . . . . . . . . . . . . . . . . . . . . .10

Recommendations and Conclusions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11

The Policy Process . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11

Summary of Specific Recommendations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11

ConcludingStatement . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .12

References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .13

Other Sources . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .16

Acknowledgements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .18

Appendices

Appendix A: MichiganHouseCommitteeRetireeHealthCare Reforms Timeline . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .20

Appendix B: CommitteeTestimonySummaries . . . . . . . . . . . . . . . . . . . . . . . . .22

Appendix C: StateComparisons . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .29

FundingandAdministrativeStructure . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .29

TheScopeofRetireeHealthCareCoverage . . . . . . . . . . . . . . . . . . . . . . . . . . 31

StateHeathCareCostControlEfforts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .34

RetireeHealthCareCostControl . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .36

RetireeHealthCareFundingMethods . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .38

Balancing Dollars and Health Sense 1

State and local governments in the United States are liable for unfunded post-employmenthealthcarebenefitsestimatedtobebetween$600millionand$1.6trillion(GAO2008:14).Ofthisamount,theStateofMichigancurrentlyhas

unfundedretireehealthcareobligationsestimatedat$22.7billion(ZionandVarshney,2007).Michiganandmostotherstatesfinanceretireehealthobligationsasanoperat-ing expense for that year’s budget costs, a practice commonly referred to as pay-as-you-go.InJuly2007,theMichiganHouseofRepresentativesformedtheCommitteeonRetireeHealthCareReformstodevelopstrategiestoaddressthisunfundedliability.The committee also aims to recommend more efficient health care funding options forretireesofMichigan’scivilservice,publicschools,statepolice,judiciary,andlegislature.

The committee approached the Institute for Public Policy and Social Research (IPPSR)atMichiganStateUniversitytoprovideresearchonthispublicpolicyissue.IPPSRthenreceivedagrantfromtheCenterforState&LocalGovernmentExcellencewhose mission is to help state and local governments become knowledgeable and competitive employers so they can attract and retain talented, committed, well-pre-pared individuals to public service.

The purpose of this study is to gain a better understanding of the complexities sur-rounding the funding of state retiree health benefits, and to identify areas of general agreement and disagreement on what should or should not be done. Additionally, the information collected includes a set of opinions, facts and perceptions that decision makers can consider when exploring alternatives. The focus of this report is primar-ily on state employee retiree health benefits and does not address the more general employee benefits and pensions.

Introduction

2 Balancing Dollars and Health Sense

Inthespringof2008IPPSRinterviewed20stakeholdersfortheirperspectiveonpublicemployee retiree health care funding. The group of stakeholders included government administrators, key policymakers, union leaders, human resources professionals, and research scholars who have some knowledge about the questions Michigan is facing onstateretireehealthbenefits(seeAcknowledgments).Thisisaconveniencesampleand does not include members of the business community, hospital or medical profes-sionals, or the general public. In addition, we reviewed reports from actuarial firms, statessuchasCaliforniaandOhio,researchinstitutesandprofessionalassociationsaswellastestimonypresentedtotheMichiganHouseCommitteeonRetireeHealthCareReforms.

This report begins with a brief background of Michigan’s current situation and then compares and evaluates various options available to Michigan to meet its obli-gations and control future health care costs. It presents practices from other govern-ment entities that Michigan could possibly emulate. It also explores ways to manage a smooth transition from the current pay-as-you-go approach to developing one that will effectively address the unfunded liabilities and rising retiree health care costs over the long-term.Finally,thereportputsforthasetofrecommendationsbaseduponwhatthe stakeholders we interviewed believe policymakers can agree on to move forward.

Research Scope and Methods


Findings

Bondratingagenciesareconcernedwithbothfinan-cial and structural balances and the actions government entities take to attain and maintain both of them. They realizethatstateslikeMichiganhaveaconstitutionalrequirementforayear-endbalancedbudget.Butactionsthat threaten to affect the ability of a state to meet its debt obligations could undermine its perceived credit qualityandleadtobondratingreductions(HackbartandRamsey,2004:197-98).However,thebondratingagencies have indicated that they will be focusing on how state and local governments begin to deal with the largeliabilitiesratherthanonthesizeoftheliability.States that defer action and continue on a pay-as-you-go system may suffer in their bond credit ratings and seetheircostsofborrowingrise.(Bailey2007,D’Angelo2008).

The process for managing Michigan’s retiree health benefits liability can be accomplished through numer-ous scenarios, but most likely will include pre-funding, gradualbenefitreductions,orboth.BecauseMichi-gan did not pre-fund retiree health care, the unfunded liability associated with these future benefits has risen 22percentfrom$6.7billioninFY00to$8.2billioninFY06.Furthermore,generalfundretireehealthspend-ingwillmorethandoublefrom$263millioninFY09to$563millioninFY17(CitizensResearchCouncil,2008).Hence, there is a sense of urgency in addressing the liability since the sooner the liability begins to be paid down, the lower the future liability, the more fiscally responsible the State becomes, and in many views, the more economically viable the State will be.

Meeting Future Obligations through a Pre-Funded TrustState governments, like some large corporations, con-sider employee pensions and retiree health benefits as a way to attract and retain capable workers. Some believe such benefits may offset the lower wages paid in the public sector. In order to continue to do this, interview-ees generally agree that Michigan should end funding its retiree health benefits on a pay-as-you-go basis from each year’s budget. They recommend Michigan con-

GASB-45 and OPEB Benefits Background InformationIn2004theGovernmentAccountingStandardsBoard(GASB)issuedStatementNo.45,Accounting and Finan-cial Reporting by Employers for Postemployment Benefits Other Than Pensions [OPEB].Itrequiresthatstateandlocal governments include the unfunded liabilities asso-ciated with retiree health benefits beginning with their 2007-08financialreports.GASB-45parallelsreportingstandardsestablishedbytheFinancialAccountingStan-dardsBoard’s(FASB106)statementalreadyinplaceforpublicly traded private companies. Specifically, all state governments are required to report the present value of thenext30yearsofretireehealthcareobligations(Gov-ernmentalAccountingStandardsBoard,2005).

Ingeneral,GASB-45encouragespublicentitiestofollow an actuarial approach that entails paying to a pensionorOPEBplananamountthatisexpectedtobesufficient to fully finance the promised benefits when the employee retires. These promises can be an explicit contractual obligation, as with a defined benefit pen-sion that guarantees a specific amount upon retirement or an implicit/implied promise that the government employer will continue to provide a defined contribu-tiontothepensionorOPEBplans.NotethatGASB45doesnotrequireanactuarialapproachinfundingOPEBs,itrequiresonlyachangeinfinancialreportingthataccountsfornon-fundedfutureOPEBobligations.Michigan is fully compliant in this regard.

AccordingtoareportbytheCitizensResearchCouncilofMichigan(2008),healthcarecostshaverisenfasterthanrevenuessince2000andarelikelytoout-pace revenue growth into the foreseeable future as costs continue to increase and the number of retirees swells as thebabyboomgenerationreachesage65.Thisgener-ates a structural budget deficit. Specifically, Michigan spent$364milliononretireehealthbenefitsinFY07.The total long-term obligation of these benefits was valued at $8.2 billion at the end of the fiscal year, but Michiganhadonly$60millioninassetstosatisfytheseobligations.


siderpre-fundingtomeetitsfutureOPEBobligationsby establishing a state trust fund. This trust would be protected and consist of funds set aside for the sole pur-pose of funding future retiree health care benefits. While thetrustdoesnothavetobepre-fundedto100percentof the liability, the flow of funds must not be stopped or interrupted. Several interviewees recall that Michigan public school teachers began pre-funding retiree health carebenefitsinthe1980s,onlytoseetheflowoffundsinto the trust halted when they were redirected for other purposes, and the funds already in the trust depleted as they were used for retiree health care. A protected, irrevocable trust ensures that the contributed funds and the funds’ investment yields cannot be used for other purposes.

A protected trust can take several forms: an IRS 401(h)account,aVEBA,orasection115trust.The401(h)accountsaremedicalbenefitaccountsindefinedbenefit401(a)pensionplansestablishedandmaintainedexclusively for paying medical benefits upon retire-ment for the employee, his/her spouse, dependents, and beneficiaries. Separate accounts can be established for each individual employee or one account for a group ofemployees.Employercontributionsaremadeona tax-free basis, which for state employers means no employment taxes are paid on the amounts contributed. Whether or not employee contributions could be made with pre-tax dollars remains an area of some controversy amongtaxanalysts.Butitappearsthatretireesarenottaxed on payment for medical expenses for themselves oranydependantscoveredundertheplan(Heffelfinger,2000).Fundingofthe401(h)benefitobligationsmustbesubordinate to the funding for retirement plan benefit obligations,althoughthePensionProtectionActof2006generallyallowsthetransferofassetsinexcessof120percent of liabilities to a health benefits account to cover costsforupto10years(Morgan,2006).

AVEBAisaVoluntaryEmployeeBeneficiaryAsso-ciation that creates a trust funded through employer and employee pre-tax contributions but administered by anemployeeassociation.LegislationmayberequiredtoestablishaVEBAforstateandotherpublicemploy-ees(Heffelfinger,2000).VEBAaccountssponsoredbygovernments have no contribution limits and employer contributionstotheVEBAtrustfundwouldbetax-exempt; that is, no employment taxes would be paid ontheamountscontributed(Rush,2006,Heffelfinger,2000).Upontermination,VEBAassetscanbetransferredtoanotherVEBAordistributedtoemployees,solongasitisdoneonanon-discriminatorybasis.VEBAassetscannot be returned to the employer. Several advantages

ofVEBAsarethatemployeesworkingatleasthalf-timemay be allowed to participate; the account may be portable between agencies within state government or school districts; employee groups may choose to par-ticipate; the administration is independent of employer orunions;andcontributionstotheVEBAdonotcountagainstpensionplancontributionlimits(Heffelfinger,2000).Montana(2005)establishedaVEBAandataxexempthealthreimbursementaccount(HRA)toassistemployees, former employees, their dependents, and beneficiaries in the payment of qualified health care expenses.

AmajordisadvantageofVEBAstoMichiganisthatthe federal government calculates the trust funds into the per capita income for the State. Therefore, retiree healthcareliabilitiespre-fundedthroughaVEBAcur-rently diminish the federal funds awarded to the state forMedicaidandtheStateChildren’sHealthInsuranceProgram(SCHIP).Policymakersarelookingtofederaladministrators to remedy this situation but no change to the process has occurred to date.

OaklandCounty,Michigan,justnorthofDetroit,hasbeen on the cutting edge of retiree health benefit fund-ingformanyyears(OaklandCounty,2006).Itstartedafull accrual method of funding its retiree health benefits in1987,morethanfiveyearsbeforeitwasrequiredinthe business sector and more than two decades before governmental entities were required to implement it. Thenin2000itcreatedaVEBAtofundhealthcareben-efitsforretirees.Butfacedwithincreasinghealthcarecosts,inJanuary2006,thecounty“closed”itsVEBAto new full-time employees who are now eligible for a RetirementHealthSavings(RHS)Plan.Thisisashiftfrom defined benefits to defined contributions, with the countycontributing$1,300eachyeartoeachemployee’sRHS account and the employees may also elect to con-tribute a portion of their pretax pay, although they are not required. This limits the county’s retiree health care costs and provides ongoing fiscal stability while offering health care benefits to retirees.

Mostgovernmentalentitiesarenotsubjecttofederalincome tax based on the principle of inter-governmental immunity. If an entity is not an “integral part” of the governmental unit, its income is taxed unless it qualifies asatax-exemptentity.Section115oftheInternalRev-enueCodepermitsanirrevocabletrustforthepre-fund-ing and payment of government retiree medical expenses to be exempt from tax on the trust’s income. In addition, contributions to the trust are not taxable to retirees or their eligible dependents, and medical benefits paid fromthetrustwillnotbetaxable(seeBailey,2007).This


hasaflexiblestructureforfundingOPEBs,suchasnorestrictions on funding, no restrictions on benefits, and no limitations on eligibility of participants, and can be setupasatrusttopre-fundfuturebenefits(Zorn,2004).Thesetrustscanbeformedjointlybygroupsofgovern-mental employers to achieve administrative economies of scale and to enlarge the investment pool.

Intervieweesgenerallysupportedasection115trustover the alternatives discussed here. The trust can consist of both a large general trust for all participants andindividualsavingsaccounts.UnlikeaVEBA,a115trust does not require large amounts of funding up front, enabling the state to take incremental steps to fund the trustandaddresstheproblemofunfundedOPEBliabili-ties over the long-term.

Raising Funds for the TrustOur respondents note, however, that state government cannot fund new trusts overnight as the automotive industrydidwhenFord,GeneralMotors,andChrys-lercontributedapproximately$45-$50billiontothreeVEBAs(Bruno,2008).Rather,ourrespondentsproposestarting with a reasonable dollar amount that could slowlygrowoverthenext20to30years.Theynotethatsuch a trust could be launched through several mecha-nisms: bonding, taxation, and selling or leasing state assets.Eachofthesemechanismshasitsadvocatesandcritics.

Tax-exempt bonds are one way for state and local governments to raise money without raising taxes. Althoughthebondmarketinthefirsthalfof2008issuffering from the credit crunch that resulted from the subprime mortgage meltdown, bonding is a long-term possibility.

Two possible bonding strategies are suggested. The first is that bonding should be used to raise money to fund pension benefit obligations, rather than health care benefit obligations. All or part of the future costs could be raised through pension obligation bonds and then the bond proceeds invested in equities earning long-term ratesexceedinginterestratesonthebonds(CitizensResearchCouncilofMichigan,2004).Anythingovertherecommendedreserveinthepensionfundplus15per-cent could be transferred to a retiree health benefit trust. WestVirginiahasreduceditsstateretireehealthliabilitybysuchtransfersfromitsexistingpensionfund.Bond-ing pension benefits is preferred over health care ben-efits because health care costs are unstable and difficult to predict far into the future, while pension benefits are relativelystable.Consequently,itisasaferdebttobond

against if Michigan were to decide bonding is necessary. Thesecondmethodistobondonlyaportion,suchas25percent, of the current unfunded state retiree health care liability. This incremental move helps reduce the risk of bondingwhilegivingthestateajumpstartinpre-fund-ing retiree health care obligations.

Butmanyoftheintervieweesrejectusingbondsasamethodforraisingfunds.Borrowingriskwastheirprimaryconcern.Bondsaredependantonmarketperformance and can do poorly in the long-term if the investmentsdonotperformasexpected.Furthermore,bonds do not solve the underlying problem, but instead replace one type of debt with another. In this way, bonds are merely one method to begin paying down the unfundedOPEBliability.Themainadvantageofbond-ingisthepossibilityofarbitrage.Bondingcanresultin high yields that can reduce Michigan’s debt in the long-term. This lowers the overall long-term debt burden without raising taxes or redirecting funds from other programs. However, the risk involved was perceived is a sufficient reason to not use bonds for future retiree health care funding, even if bonds could result in posi-tive returns through arbitrage.

Although a variety of tax options are proposed to raise funds, interviewees generally agree that increasing the tax burden, especially during the current economic downturn, is not advisable, nor politically feasible. Furthermore,creatingataxspecificallytofundMichiganstate employees’ health care benefits might also face considerable opposition. A suggested alternative is to raise tax revenues not through higher taxes but through increasing the tax base. This could be accomplished by attracting businesses and professionals to Michigan. Emphasisonthiswouldnotonlyincreasetaxrevenuebutalsocreatejobsforthestate.Inthissense,someargue that increasing the tax burden could be counter productive and may actually do more harm than good to the state’s economy and tax revenue.

One possible funding source is a special tax that leaves the rest of the tax structure unchanged. A special tax can take on multiple forms; for example, a one-time addition to the sales tax or income tax. This serves the purpose of pre-funding current state retiree health care obligations but would be removed when pre-funding goals have been met. Other tax suggestions are more permanent in nature, such as increasing the amount and expanding the sources of the sales tax. One idea is to increase the sales tax from its current rate of 6 percent and/or expanding it to include carbonated beverages andbottledwater.Currently,Michigan’ssalestaxislowerthanMinnesota(6.5percent)andIllinois(6.25


percent),butishigherthanOhio(5.5percent)andWis-consin(5percent).Anincreaseinthesalestaxwouldbedirected to pre-funding retiree health care benefits.

A tax on less healthy foods is also a suggested pos-sibility.Fattysnackandhighsugarandsodiumfoodscontribute to unhealthy diets that lead to higher health care costs. A new tax on these types of foods could help fund future health care liabilities and create an incentive for consumers to choose healthier alternatives. Another proposal along this same line would be an additional tax on cigarettes and alcoholic beverages—both of which can contribute to health problems and costs.

Another option is to increase the Medicare payroll taxforstateemployeesfrom1.65percentto2percent.The employee and the employer would both contribute 0.175percentandtheadditional0.35percentwouldgointo the retiree health benefit trust. The advantage is that both the employee and the employer share in the increase and only state employees would be contribut-ing. If the tax were applied to all workers in Michigan, notjuststateemployees,itcouldbeusedtoprovidehealth insurance to more state residents through county health plans. These plans are currently funded by county and state governments to provide some level of basic health care to low income, uninsured individuals who donotqualifyforpubliclyfundedhealthcare(CountyHealthPlans,2005).Thisideaofincludingeveryoneinthe tax is one implemented statewide by Massachusetts andVermontintheireffortstoprovideuniversalhealthinsurance coverage.

Increasing the income tax is yet another possibility. Michigan’scurrentincometaxof4.35percentisrela-tivelylowcomparedwithsomesimilarstates.Further-more,effectiveOctober1,2011,theratewillbereducedby0.1percenteachyearforthenextfouryearsuntilthetaxrateis3.95percent.Itmaybemorefeasibleto delay or stop this tax rollback than to impose new taxes.Wisconsin’sincometaxrangesfrom4.6percentto6.75percent,dependingonincomelevel.Minnesota’sincometaxrangesfrom5.35percentto7.85percentandOhio’sfrom3.89percentto6.56percent.ButMichigan’sincometaxishigherthanIndiana’s(3.4percent)andIllinois’s(3percent).Oneproposalexpandstheincometax to include non-wage income that is currently exempt fromanincometax(suchasincomefromrentalprop-ertyandroyalties)toraisefundstoaddressfutureretireehealth care liabilities.

The selling or leasing of state assets is yet another possiblesourceoffundstodecreaseastate’sOPEBbur-den(Zion,2007).Stategovernmentshavesoldorleasedpark and recreation facilities, buildings, land, prisons,

toll roads and bridges, and state lotteries. Selling or leasing state assets generated little support among the interviewees. It is considered a risky solution that would deplete the state of much needed funding sources over the long-term. In addition, selling or leasing Michigan’s assets could result in the assets being mismanaged and quickly depreciated. With this in mind, interviewees rec-ommend that the state lease rather than sell its assets. The advantage of leasing is that the revenue generated from those assets can fund state employee retiree health care obligations.

Changing Benefits and Options for Current and Future RetireesInterviewees carefully consider the degree to which state employees should be responsible for contributing toward the cost of their health coverage during retirement. They recognizethepossibilityoftransferringhealthcarecostsfrom the state to the retirees by increasing premiums, deductibles, and co-pays to address future health care liabilities. However, interviewees are adamantly against changes to health benefits for current state retirees that would make benefits inferior to what was originally promised in exchange for years of service to the state. Furthermore,currentretireeshavemadeasignificantlifedecision(retirement)andhaveplannedforthatlifedeci-sion based on the expectation that they would receive a promised benefit. Many claim it would be immoral to break that promise, especially if some retirees could not easily afford the transition on their already budgeted fixed income. They also point out that reneging on promised benefits could undermine the credibility of the state in negotiating collective bargaining agreements in the future because present employee benefits are often negotiated with retiree benefits in mind.

Increasing premiums, deductibles, and co-pays for future retirees is seen as a more acceptable means of cost shifting from the state to the employees for several reasons.First,currentemployeescanmoreeasilyadjustto a change in future benefits, both in a dollar sense and in personal health practices. Second, future employees in both the public and private sector will not be promised as generous benefits as offered currently. Third, younger employeeshavemoreopportunitytoutilizethesavingpowerrealizedthroughinvestmentyieldsthatdefinedcontribution plans offer. This can increase the defined contribution plan’s attractiveness for newer employees, who have longer careers ahead of them, while relieving the state of the higher costs of a defined benefits plan.


Butintervieweesdisagreeonthebestwaytoshiftcosts from the state to future retirees. Some interviewees assert that deductibles and co-pays should be increased because it creates an incentive to make retirees more cost conscious. This method controls the growth of health care spending by lowering overall demand for health care services. Participants are encouraged to be more selective and use only those health services that offerarealbenefit.Furthermore,participantswhousehealth care services more often should be expected to pay more. In short, raising co-pays and deductibles translates into more cost benefit per dollar spent on health care than raising premiums.

Other interviewees point out several drawbacks to raising co-pays and deductibles. It may discourage participants from using necessary health care services, which could decrease the retiree’s health and raise long-term costs. Raising co-pays and deductibles can shift the cost burden disproportionately to chronically ill partici-pants, which calls into question the fairness of addi-tional charges on retirees who would already be paying out of pocket Medicare costs.

The advantage of changing the amount that future retirees pay for premiums instead of raising deduct-ibles and co-pays is that it encourages a more equitable dispersionofthecostburden.Byspreadingthecostburden over all participants, the health care premiums per retiree could be more modest than what participants, particularly those with chronic conditions, would pay if deductibles and co-pays were increased.

Unlike many other states, Michigan has already changed the number of years a state employee must work before being fully vested for retiree health benefits. Thestatepays100percentofretirementhealthcarepremiumsforretireeswhowerehiredbefore4/1/97and are Medicare-eligible, but for employees hired after 4/1/97itpays30percentofpremiumcostsafter10yearsof service, increasing by 3 percent for each additional yearofserviceuptoamaximum90percentforthosewhohave30ormoreyearsofstateemployment(Citi-zensResearchCouncilofMichigan,2004).Michiganalso offers a group plan for long-term care insurance for active and retired workers and their family members but it is administered completely through a third party with no state support.

HighDeductibleHealthPlans(HDHPs)arealsoconsidered a possible option for controlling future health carecosts.HDHPscombineahighdeductiblehealthplan with a tax-advantaged savings account, that is, con-tributions are tax deductible from gross income if made by individuals, and they are exempt from both income

andemploymenttaxesifmadebyemployers(LykeandWhittaker,2007).ToqualifyasanHDHP,aplanmusthaveanannualdeductibleofatleast$1000forindividu-alsor$2000forafamily,andanannuallimitof$5000onout-of-pocketexpensesforindividualsand$10,000for a family. Preventive care, such as annual physicals andcolonoscopies,canbesubjecttoalowerdeductibleto prevent conditions that could result in large expenses inthelong-term(Kofman,2004).

SomeintervieweespraiseHDHPsasaninnovativemarket-based approach to health care management that would control rising health care costs by raising partici-pants’ cost awareness and encouraging healthy living toavoidpayingthehigherdeductibles.HDHPsalsooffer tax advantages to encourage savings toward retiree health care—shifting some of the costs away from the state.ItisnotedthatHDHPparticipantshavesimilarhealth records as traditional health plan participants with lower overall demand for health care services. Indi-anaisoneofthefewstatesthatofferHDHPstocurrentemployees.

However,therearereservationsaboutHDHPs.Chronicallyillemployeescouldbesaddledwithunaf-fordable health care costs. Participants may forgo neces-sary medical treatment to save money in the short term, causing deterioration in a participant’s health while significantly increasing long-term costs if the condition becomes catastrophic. Additionally, contributions cannot bemadetoHDHPsuponretirement,furtherdiminish-ingretirees’abilitytoutilizetheHDHPfundstooffsetrising health care costs. State retirees may have difficulty accepting a health care plan that is so different from the planstheycurrentlyhold.Mostimportant,theHDHPisunfeasible for state employees who plan to retire in the near future because they will not have sufficient time to planandsave.Forthesereasons,whenoptionalplansincludinganHDHPareofferedinthecorporatesector,employee enrollment clearly shifts towards more tradi-tional health care plans, like HMOs.

Creatinghealthylivingincentivesisgenerallyrecog-nizedashavingpromiseinreducinglong-termhealthcarecosts.Butoneintervieweefamiliarwithhealthyliving incentives claims to have found no hard evidence thatincentivesactuallyreducehealthcarecosts(alsoseeWarner,2008).Itisalsosuggestedthatstatesareillsuited to effectively implement an incentive program because it is costly to administer and difficult to hold the vast and diverse number of state employees and retir-ees accountable. Allowing individual entities within the state to experiment with their own wellness programs from a public health awareness perspective could be a


more advisable, more manageable initiative. In the end, more research and public education needs to be done before the state commits significant resources to an over-all healthy living program for all state employees.

Coordinating with MedicareMost interviewees agree that Michigan should con-tinuetoutilizeMedicare.Thecostperretireetothestate decreases significantly when a retiree becomes Medicare eligible and enrolls in a coordinated Medicare health plan. The estimated cost savings per retiree was approximately$12,000annually.Inthepast,Michiganhad encouraged early retirement to decrease the state payroll,butthishasnotreducedtheOPEBliability.Oneinterviewee suggests that Michigan increase the age at which state employees are eligible for retirement from age55toage60or65.

WiththeadventofMedicarePartDforprescriptiondrugs, the question is whether to provide supplemental insurance. Several interviewees favor a co-pay system where participants pay a proportion or percentage of prescription drug costs rather than a flat dollar amount, rangingfrom$15to$40.Thiswouldcreateanincen-tive for the participant to be more cost conscious and protects the state against future prescription drug costs increases. A cap on personal out-of-pocket spending can also be put in place to prevent some participants, who need pricier or multiple prescription drugs, from paying too much in any given year. While noting that Medicare may undergo significant changes in the future, interviewees encourage the state to remain focused on addressingitsOPEBunfundedliabilitiesregardlessofhow Medicare might be altered.

Merging Health Plans, Merging Administration of Health PlansThe State of Michigan currently provides retiree health care benefits for five employee groups: civil service, state police, public school teachers, legislators, and judges,eachwithitsownadministrativestructure.Thestate could attempt to obtain recurring savings and efficiencies by merging some or all of the retiree health plans.Butcreatingasingleplanforallemployeegroupsfaces several barriers. These plans are offered by differ-ent government entities and involve separate collective bargaining processes. The plans vary in terms of the benefits offered, the premium costs, and the employ-ees’outofpocketexpenses.Inshort,aone-size-fits-all

health plan for all state employees might not be feasible. Butcreatingasingleadministrativeentityforall

the plans may reduce administrative costs and achieve economies of scale, both of which could significantly lower the cost of providing retiree health care benefits. Giventhedistinctdifferencesintheemployeeplans,onepossibility is to enable each employee group the flex-ibility to tailor its plan to meet constituent needs, while centralizingtheadministrativestructurestoobtaincostsavings. Interviewees caution that a unified administra-tive structure, however, does not solve the problem of rising retiree health care costs and must not become a distraction to the larger issue of addressing future health care liabilities.

Coordinatingtheplanstocreatealargerpurchasingpool is considered to be worth exploring since this could significantly lower the state’s health care costs. A unified purchasing process could achieve stronger buying power to negotiate lower rates among providers. Many states do this to lower Medicaid prescription drug purchases. Michigan currently has some coordination between plans, but broadened coordination can increase leverage to negotiate rates down even further. It is recommended that Michigan start with coordinating prescription drug purchases and then move to other health care purchases.

One interviewee suggests that Michigan go beyond the five plans and seek to broaden the purchasing pool further to build buying leverage. The unfunded liability problemisnotjustonthestatelevel.Someintervieweespointed out that Michigan counties and municipali-ties are also facing unfunded health care liabilities for retirees. The state could work with local governments to develop a comprehensive approach and create larger purchasing leverage. This could not only lower the cost of health care for the state but with adequate oversight and transparency in the process, it would save additional funds for local governments.

In2004,theMunicipalEmployees’RetirementSys-temofMichigan(MERS)createdatrustfundformunici-pal retiree health benefits. This program is voluntary andasofSeptember2007,55localgovernmentalunitswereparticipating.Thefundhasmorethan$95mil-lion available for retiree health care costs. Additionally MERSoffersahealthcaresavingsprogramfromthesame trust fund, which provides tax-favored individual medical savings accounts for tax-free reimbursement of post-employment medical expenses, including health insurancepremiums.Thisprogramhadover75enrolledemployersrepresentingmorethan2,000employeesandabout$10millioninvested(GAO,2007:36).


Other State Practices ConsideredMichigan could learn from the experiences and practices of other states, particularly Ohio. Ohio has been suc-cessful in pre-funding its retiree health benefits through employer contributions. Ohio offers state employees an individual retiree medical account that may be used only to pay qualified health care expenses. The State of Ohio contributes4.5percentofanemployee’spaychecktoa medical savings account; the employee then chooses between a traditional plan or a member-directed plan that allows individuals to make their own investment choices. This model is currently available only for civil service employees; school teachers in Ohio are under a different system and at this time do not have a retiree medical account option. The advantage of this plan is it enables the state to cost shift some of its future retiree health care obligations away from the state while at the same time giving employees a savings vehicle to allevi-ate the cost burden.

Managing Transitions Any change from the current pay-as-you-go approach will require a set of transition steps. While it is diffi-cult to predict what the changes may be, interviewees offer suggestions for managing a smooth transition to a more efficient and cost conscious health care scheme. The process should be inclusive, straightforward, and transparent in order to build trust. The first transition step is to cast a wide net by bringing all key stakehold-ers to the table. This might include representatives from retiree groups, unions, the current retirement plan administrative agencies, and members of the legislative, executive,andjudicialbranches.Healthcarebenefitsarean emotional issue and concerns need to be addressed in a sensitive manner. Including the stakeholders should increase the likelihood that they will envision the change and assist the work needed for a successful transition.

This inclusive group would then need to reach agree-ment that unfunded retiree health care liabilities are a problem that needs to be addressed. Second, they need to develop a set of guiding principles that keeps the work focus on public employee post-employment bene-fits. One example of these guiding principles is provided byaCaliforniaCommission(2008)andreadsasfollows:(a)competitiveaffordablebenefitspackageservesthepublic good by enabling public employers to recruit andretainqualifiedpublicemployees;(b)thecostsofpromised benefits should be fully identified, known and

paid for within the working careers of those receiving the benefit and the process for funding those benefits should be easily understood and actuarially sound; and (c)theprocessthroughwhichbenefitsareadopted,modified and/or paid for needs to be open, transparent, and defensible.

The group would then proceed to collectively decide on good solutions and possible methods for achieving those good solutions. At this point, the key stakeholders should be open to compromise on the details of the solu-tion.Compromisewillbemoreeasilyreachedifevery-one understands that failing to address this problem in a meaningful way will undoubtedly lead to negative consequences for the retirees, the various stakeholders, and the state. Such an understanding will encourage fair compromise on methods for addressing the problem, rather than obstructing the solution.

Associated with the need for compromise is the idea of pacing the solution. Some of the interviewees sug-gest moving incrementally, as opposed to attempting one large and dramatic reform. Incremental reforms will achieve more general acceptance and enable the stake-holders and broader public to digest the changes over a longer period. This is a problem that has been building overthepast50years,anditwouldbeimprudenttoexpect a single broad sweeping and immediate solution.

Once the solution is agreed upon, it is crucial that both the constituents of the stakeholders and the public understand and support it. One interviewee points out that while the larger solution is likely to be multifac-eted, it is extremely important that communication be informative and reinforced by key stakeholders. This communication is most effective through multiple methods because audiences access, receive and interpret messages in different ways. All three modes of commu-nication—written, verbal, and group—should be used. The communication should help employees and retirees understand the reasons for the change and what the state hopes to accomplish with it. It is also absolutely necessary to keep administrative agencies and plan managers well informed of changes and well trained on any new processes or responsibilities. This will ensure greater acceptance of change and a smooth and suc-cessful transition from the current to a newly revised structure.


What Can Policymakers Agree On Going Forward?TheMichiganHouseCommitteeonRetireeHealthCareReforms is in a position to make substantial progress on this issue. Interviewees are generally optimistic that Michigan policymakers can agree on a variety of things. Michigan policymakers can agree that the health care liabilities are a significant problem that needs to be

addressed relatively soon, and that developing some type of pre-funding model is preferable to operating indefinitely on a pay-as-you-go model. Michigan policy-makers can agree, in principle, that a variety of reforms are needed but no single solution can quickly fix or fully resolve the problem. The interviewees believe that Michigan lawmakers can and will agree to solutions that address the costly problem without compromising the current health status of state retirees.


Recommendations and Conclusions

The Policy ProcessThe challenge of a nearly $23 billion liability in state health retiree benefits undoubtedly requires a multi-facetedsolution.TheMichigan’sHouseCommitteeforStateHealthRetireeBenefits,chairedbyStateRepre-sentativeMarkMeadows(D-District69),hasbeguntheprocess by holding hearings and exploring the problem. A timeline summary of its activity is provided in the Appendix.

In order to reduce the state’s liability for public employee retiree health benefits, the legislature and governor need to make revenue and expenditure policy decisions. The logical first step is to form a non-partisan jointlegislative/executivebranchtaskforceorcommis-sion that would accept the information presented here and develop a detailed plan for reducing the state’s unfunded retiree health benefit liabilities. The working group would include key stakeholders and have a small support staff. An agreement on key guiding principles, informed debate, as well as compromise, will be part of the process of addressing the liabilities of state retiree health benefits. In addition, the task force or commis-sion should be committed to a transparent process, one that regularly informs the public and state employees on its progress.

Summary of Specific Recommendations Firststeps

1.Movetoendfundingretireebenefitsonapay-as-you-go basis from the annual budget as much and as soon as possible. (Page 3)

2.Movetocreateanirrevocable115trustfundforpre-funding and payment of retiree medical expenses. While a protected trust fund could take several forms,thesection115trusthasthemostsupportamong the alternatives. (Page 4)

Buildingtherevenuepool

3.Lookatmultipleapproachesforfundinga115trustincluding bonding, taxation, and leasing state assets. (Page 5)

4.Bondingiscontroversialandmaybeapointofcom-promise in the move toward a solution to pre-funding state retiree health benefits. If bonding were to con-tributetotheprocess,onlybondpartofthedebt(25percent)orusebondingrevenuetohelpfundpen-sion benefit obligations instead, and transfer excess dollarsinthepensionfundtothe115trust. (Page 5)

5.Anumberofsourcesforadditionaltaxrevenueshould be considered, since it is unlikely that increasing the tax base by attracting businesses and professionals to Michigan will be enough to generate specific funds to meet the retiree health care obliga-tions. (Page 5)

6.Leasestateassetstobuildrevenueandpaydownliability.Donotsell. (Page 6)

7. While increasing premiums, deductibles, and co-pays are all seen as acceptable means of cost shifting, it is preferable to raise premiums for future retirees, allowing a more equitable dispersion of the health cost burden. (Page 6)

8.ApproachtheHighDeductibleHealthPlans(HDHP)with caution. (Page 7)

Matter of principle

9. Assure current retirees that their promised benefits from the state will not be compromised. (Page 6)

10.Keepthesolutionfocusedonfindinganappropriatebalance between controlling rising health care costs and assuring that participants obtain the health care services they need at affordable prices. (Page 8)

11.Creatingoneormorehealthylivingincentivesisagood idea to consider among revisions to health care funding, but cannot be relied on to lessen the health care cost burden. (Page 7)

Administrative considerations

12.RetireesshouldcontinuetouseMedicareastheirpri-mary health insurance, but the state should address itsOPEBunfundedliabilitiesregardlessofhowMedicare might change in the future. (Page 8)

13.Considerasupplementalinsurancethatrequiresco-pays on a percentage of prescription drug costs with


a cap on annual, personal out-of-pocket spending rather than the current flat dollar amount. (Page 8)

14.MergeadministrationofplansmanagedbytheState through a single entity to unify the purchas-ing process and increase bargaining power, but keep employee group plans separate. (Page 8)

15.Investigatetheadvantagestoinvitinglocalgovern-mentstoparticipateinajointventuretocreatealarger investment and purchasing pool. (Page 8)

Ideas for transitioning

16.Maketheprocessofreviewandrevisioninclusive,straightforward, and transparent. (Page 9)

17.Reachanagreementonthedefinitionanddegreeofthe problem. (Page 9)

18.Understandthatthebestsolutionismultifacetedandincrementally applied. (Page 9)

19.Lookforwaystocompromisewhenaddressingtheproblem. (Page 9)

20.Communicationwithallstakeholdersshouldberegular and use all three modes—written, verbal, and group. (Page 9)

21.Keepcommunicationclearandinformativeonthepresent and future outlook. (Page 9)

The Policy Process

22.Formajointlegislative/executivetaskforcetodevelop a plan that considers the information pro-vided in this report and acts on the basis of these recommendations. (Page 11)

23.Committoatransparentprocessthatregularlyinforms the public and state employees on the progress being made to reduce the state’s liability for retiree health care benefits. (Page 11)

Concluding StatementIt is important to relay a message that was consistently noted during this research. The message is one of cau-tion to change agents involved in addressing the cost of state retiree health benefits. While the state needs to develop methods for achieving greater cost control among its participants and lowering overall health care costs,thiscannotberealizedattheexpenseofdecreas-ing the health status or health care of participants. The state needs to keep its eye on finding an appropriate balance between controlling rising health care costs and assuring that retirees obtain the health care services they need at affordable prices.

ThesizeofMichigan’sunfundedhealthcareliabili-ties is a problem that has been developing over time, but it is one that can no longer be ignored. It has no easy or single solution, and will require sustained effort, com-promise, and predictably, a multifaceted solution. This is an opportunity for the state to assure that current and future state retirees will receive the health care benefits that have been promised, and to improve the state’s long-term fiscal standing by reducing the structural budget deficit. The state must balance dollars and health sense. In the end, the wisest solution will benefit current and future state retirees, as well as all state residents.


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Gibson,V.,Mausolf,J.,&Moquin,M.(2007,October).MERS and Retiree Health Care Pooling Options. Pre-sentedtotheMichiganHouseCommitteeonRetireeHealthCareReforms.http://www.house.mi.gov/ SessionDocs/2007-2008/Testimony/Commit-tee90-10-17-2007.pdf

Gotimer,T.,Lantzy-Talpos,D.,&Leleszi,J.(2007,September).A Bolder Retiree Vision for the State of Michigan.PresentedtotheMichiganHouseCom-mitteeonRetireeHealthCareReforms.http://www.house.mi.gov/SessionDocs/2007-2008/Testimony/Committee90-9-6-2007.pdf

Hoekstra,Ellen.(2007,November).Comments Regard-ing Retiree Health Care on Behalf of the Retirement Coordinating Council. Presented to the Michigan HouseCommitteeonRetireeHealthCareReforms.http://www.house.mi.gov/SessionDocs/2007-2008/Testimony/Committee90-11-1-2007-9.pdf

Kopasz,R.,Marlan,D.&Whitefield,A.(2008,January).MichiganStateEmployeesRetirementAssociation’sCouncilPresentationtotheHouseRetireeHealth


CareReformsCommittee.http://www.house.mi.gov/SessionDocs/2007-2008/Testimony/Committee90-1-17-2008.pdf

Ladenheim,Kala.(2005,March).Health Savings Accounts. (Legisbrief,Vol.13,No.17).Washington,DC:NationalConferenceofStateLegislatures.

Lennon,LesterG.(2006,December).OPEBPanelPresentation at the NAST Treasury Management Conference.http://www.nast.net/2006tzmgt/presentations/opeb.lennon.ppt#307

MichiganAssociationofRetiredSchoolPersonnel.(2007,November).Points for Consideration Regarding Retiree Health Care or Pension Reform. Presented totheMichiganHouseCommitteeonRetireeHealthCareReforms.http://www.house.mi.gov/SessionDocs/2007-2008/Testimony/Committee90-11-1-2007-5.pdf

MichiganDepartmentofCivilService.(2007,July).State Retiree Health Plan Benefits. Presented totheMichiganHouseCommitteeonRetireeHealthCareReforms.http://www.house.mi.gov/SessionDocs/2007-2008/Testimony/Committee90-7-19-2007-3.pdf

Murphy,Brian&Zorn,Paul.(2006,March).Methods for Stabilizing Public Retirement Plan Contribution Rates. ResearchMemorandumpublishedbyGabriel,Roeder,Smith&Co.,ActuariesandConsultants.

PublicEmployeePost-EmploymentBenefitsCommis-sion(2008)Funding Pensions & Retiree Health Care

for Public Employees.Sacramento,CA:DepartmentofGeneralServices,OfficeofStatePublishing,StateofCalifornia.http://www.pebc.ca.gov/images/files/final/080107_PEBCReport2007.pdf

TaxFoundation.(2008,February)State Individual Income Tax Rates.Washington,DC:Author.http://www.taxfoundation.org/taxdata/show/228.html

UBS(2007,August).State of Michigan: House Committee on Retiree Health Care Reforms. Presented to the MichiganHouseCommitteeonRetireeHealthCareReforms.http://www.house.mi.gov/SessionDocs/ 2007-2008/Testimony/Committee90-8-16-2007-1.pdf

Vitale,MaryAnn&Zorn,Paul.(2003,July).Phased Retirement Arrangements and Deferred Retirement Option Plans. Chicago:Gabriel,Roeder,Smith&Co.,ActuariesandConsultants.

Whitefield,Alvin.(2007,December).Michigan State Employees Retiree Association Council’s Presentation to the House Retiree Health Care Reforms Committee. PresentedtotheMichiganHouseCommitteeonRetireeHealthCareReforms.http://www.house.mi.gov/SessionDocs/2007-2008/Testimony/Committee90-1-17-2008.pdf

Young,Parry.(2005,December).FundingOPEBLiabili-ties:Whatareyouroptions?.Government Finance Review.p.11-15.

Zorn,Paul.(2004,May).Methods for Stabilizing Public Retirement Plan Contribution Rates. Chicago:Gabriel,Roeder,Smith&Co.,ActuariesandConsultants.


Acknowledgements

The Institute for Public Policy and Social Research at Michigan State University would like to thank the following individuals in addition to our funding orga-nization,theCenterforStateandLocalGovernmentExcellence(slge.org).

The grant process opened doors for conversations and ideas about solutions that may have not happened had it not been for this research initiative. Special thanks areextendedtoJoshuaFranzelatCSLGEforhisencour-agement and trust.

Theprojectleaderswouldliketoespeciallyacknowl-edgeMs.LindaPivarnikforintroducingthisgrantopportunity to them and laying the foundation for a successfulproject.AdditionalthanksareforwardedtoIPPSRdirector,DouglasB.Robertsforhisguidanceandconfidence,aswellashisnotingtheprojectasanimme-diate priority.

The thoughtful input from the individuals listed here madethisprojectpossible.

Members of the House Committee for Retiree Health Reforms, State of MichiganThe Honorable Mark Meadows, ChairStateRepresentative,(D)District69

The Honorable Chuck Moss, Minority Vice ChairStateRepresentative,(R)District40

The Honorable Brian CalleyStateRepresentative,(R)District87

IntervieweesChuck AgerstrandRetireeBenefitsConsultantMichiganEducationAssociation

Nick CiaramitaroLegislationandPublicPolicyAFSCMECouncil25

John CoganSeniorFellowatHooverInstitutionStanford University

Roderick CraneDirector,InstitutionalClientRelationsTIAA-CREF

George DascouliasDirector,HealthandGroupPlansKodak

Chris DeRoseChiefExecutiveOfficerOhioPublicEmployeesRetirementSystem

Karen EastDirector,ResearchServicesLegislativeServiceBureauMichigan House of Representatives

Teresa GhilarducciSchwartzChairinEconomicPolicyNew School for Social Research

Cynthia IrwinExecutiveDirectorMESSA

Jim MillsteinManagingDirectorLazardFrères&Co.,LLC

Brian PackAssistantDirector,HealthCareOhioPublicEmployeesRetirementSystem

Leslie PapkeProfessorofEconomicsMichigan State University

Melissa PatalonaHRBusinessPartnerJohnson&Johnson

Linda PivarnikFormerResearchAssistantMichigan House of Representatives

Douglas B. RobertsDirector,InstituteforPublicPolicyandSocialResearchMichigan State University


Lawrence A. RoehrigSecretary-TreasurerAFSCMECouncil25

William Saint-AmourDirectorofSurveyResearchMunicipalEmployeesRetirementSystem

Phil StoddardDirectorMichigan Office of Retirement Services

Sheila TaylorLegislativeServiceBureauMichigan House of Representatives

Fred TimpnerExecutiveDirectorMichigan Association of Police

Richard WardAssistantVicePresidentTIAA-CREF

Ann WagnerChiefExecutiveOfficerMunicipalEmployeesRetirementSystem

Paper ReviewersRichard T. ColeChairpersonandProfessorDepartmentofPublicRelations,Advertising and RetailingCollegeofCommunicationArtsandSciencesMichigan State University

Karen EastDirector,ResearchServicesLegislativeServiceBureauMichigan House of Representatives

Denise HolmesAssociateDeanCollegeofHumanMedicineMichigan State University

Susan P. SerotaPartnerPillsburyWinthrop,ShawPittmanLLP


July 19, 2007–TheMichiganHouseCommitteeonRetireeHealthCareReformshelditsfirstmeeting.TheCommitteetooktestimonyfromJaneWinters,representingtheCivilServiceCommission,PhilStod-dard,DirectoroftheOfficeofRetirementServices,andChristineHammond,DirectoroftheOfficeofLegislativeRetirement.

August 2, 2007–TheCommitteeheardtestimonyfromCreditSuisse,aninvestmentbankingandfinancialser-vices company.

August 16, 2007–TheCommitteeheardtestimonyfromUBSInvestmentBankMunicipalSecuritiesGroup.

September 6, 2007 – Three additional representatives joinedthecommittee,increasingthesizefromsevenmembersto10.ThenewmemberswereRepresentativesMaryValentine,ChuckMoss,andAlmaSmith.

ThecommitteeheardtestimonyfromAETNA,ahealthinsurancecompany,andTIAA-CREF.

September 13, 2007–TheCommitteeheardtesti-monyfromRobertDaddow,theOaklandCountyDeputyCountyExecutive,andLaurieVanPelt,theOaklandCountyDepartmentofManagementandBudgetDirector.

September 27, 2007–TheCommitteeheardtestimonyfromDavidEilser,thePresidentofFerrisStateUniver-sity,ontheMichiganPublicSchoolEmployeeRetire-ment System.

October 17, 2007–TheCommitteeheardtestimonyfromtheMunicipalEmployeesRetirementSystem.

October 25, 2007–TheCommitteeheardtestimonyfromhealthinsuranceproviderBlueCrossBlueShield.TheCommitteealsoheardtestimonyfromTimothyNel-son,presidentofNorthwesternMichiganCollege,andDr.DavidMatthews,presidentofSouthwesternMichi-ganCollege,regardingretirementoptionsatMichigan’scommunity colleges.

November 1, 2007–TheCommitteeheardtestimonyfrom the Michigan Association of Retired School Per-sonnel,theRetirementCoordinatingCouncil,andthe

MichiganAssociationofPublicEmployees’RetirementSystems.

November 29, 2007–TheCommitteeconsideredbillsHB4451,HB5465,andHB5466.TheCommitteeadoptedHB4451andreportedthebillwithrecom-mendation.TheCommitteealsovotedtoreportHB5465withrecommendationandtoreportHB5466withrecommendation.

December 13, 2007–TheCommitteeconsideredHouseBills5545and5546andheardtestimonyonthebills.TheCommitteeadoptedsubstitute(H-1)toHouseBills5545and5546.TheCommitteevotedtorecommendHouseBill5545,withrecommendation,asSubstitute(H-1)andHouseBill5546,withrecommendation,asSubstitute(H-1).

January 10, 2008–TheCommitteeheardtestimonyfromtheMichiganEducationAssociation,theMichiganAssociation of Public School Academies and the Michi-ganCouncilofCharterSchoolAuthoritiesregardingMichigan’s retiree health care for schools.

January 17, 2008–TheCommitteeheardtestimonyfromtheStateEmployeesRetireeAssociation,theMichi-ganOfficeofRetirementServicesandGabriel,Roeder,SmithandCompany,anactuarialfirm,regardingfund-ing Michigan retiree health care obligations.

January 31, 2008–TheCommitteeconsideredlegisla-tionHR243andHCR62.TheCommitteeamendedHCR62andreportedHCR62asamendedwithrecommenda-tion.TheCommitteeamendedHR243andreportedHR243asamendedwithrecommendation.

February 21, 2008–TheCommitteeheardtestimonyfromW.AlanWilkofDykemaGossett,PLLC,alawfirm,regarding115Trustsandpossiblealternatives.

March 13, 2008–TheCommitteeannounceditwouldreview a draft of proposed legislation that would estab-lishaSection115Trust.TheCommitteeheardadditionaltestimonyfromW.AlanWilkofDykemaGossett,PLLC,regardingPublicEmployeeRetirementHealthCareFund-ing Act.

Appendix ATimeline of the Michigan House Committee on Retiree Health Care Reforms


March 20, 2008–TheCommitteeadoptedHB5913(H-1).Thiswillcreatearetirementhealthcaretrustforthe purpose of funding retiree health care benefits for qualified state retirees.

May 15, 2008 –TheCommitteeheardtestimonyfromEllenHoekstraofCapitalServicesInc.,onbehalfoftheRetirementCoordinatingCouncil,onproposedchangesandquestionsregardingHB5913(H-2).


Appendix BSummary of Testimonies Presented to the Michigan House Committee On Retiree Health Care Reforms

The following are summaries of testimonies that were presentedtotheMichiganHouseCommitteeonRetireeHealthCareReforms.ThisincludesmosttestimoniesuptoMarch13,2008.Forafulllistoftestimoniestothecommittee, please visit the committee’s home page at:http://house.michigan.gov/committeeinfo.asp?lstcommittees=Retireepercent20Healthpercent20Carepercent20Reforms

To view the complete contents of a particular testi-mony, please visit the website listed at the end of the relevant testimony summary.

OverviewsCredit Suisse Presentation—You Dropped a Bomb on Me, GASB

Presented by David Zion on August 2, 2007

This article focuses on some general methods for reducingthegapbetweenOPEB(OtherPostEmploy-mentBenefits)andcurrentlyavailablefunds.Itfocusesonpre-funding,increasedborrowing(throughissuingbonds),andsellingassets.

•GASB(newaccountingrule)haschangedOPEBfrom a pay as you go basis to an accrual basis. This significantly increases the visibility of legacy obligationsforstates—over$1.5trillionofOPEBobligations that were previously hidden are now open. It has not created these obligations, it only forces states to include them on their balance sheets and to account for them. Previous politicians created these obligations by putting off costs to future generations.

•Thereareavarietyofwaysstatescanmanagethesecosts. Some are transferring costs to retirees, raising taxes, cutting other services, pre-funding retiree obligations, and/or selling assets.

1. Passing the Buck: This method forces retirees to shoulder a larger burden of the cost through changes in benefits administration, such as

increased retiree contributions to premiums, higher co-payments, higher deductibles, caps on the healthcare plan, closing the plan to new employees,freezingtheplan,settingupadefinedcontribution plan, etc. Some states have already started this to help pay for future obligations.

2. Raising Taxes: This will increase taxes to the rest of the state’s residents. However, increased taxes can lower disposable income, hurting purchas-ingpowerand(consequently)economicperfor-mance. This will also likely be unpopular with voters.

3. Pre-Funding the Plan: The states have an oppor-tunitytobeamajornewinvestor.Pre-fundedplans have a significantly higher discount rate than pay-as-you-go plans. Higher discount rates result in significant savings over the long-term for anystatethatchoosestopre-funditsplan.Forexample,ifthestateofNewYorkdecidestopre-fund its entire planitwillreduceOPEBobliga-tions by $27 billion.

4. Increased Borrowing: This is done in the form ofissuingbondstofundOPEBliabilities.Thiscan reduce the debt burden significantly if the OPEBfundsachieveagreaterrateofreturnthanthe interest yielded from the bonds. However, if the investments go bad, the debt burden will greatly increase in the long-term and leave tax payers with the bill. This strategy carries a certain amount of risk that needs to be accounted for.

5. Selling Assets: This is a possible source of funds to decrease a state’s debt burden. It includes the selling/leasing of various public assets by priva-tizingtollroads,statelotterysystems,etc.Uptonow, this has been given relatively little consid-eration. However, it has worked well for govern-ments around the globe and could work well for US state governments.

Source:http://www.house.mi.gov/SessionDocs/2007-2008/Testimony/Committee90-8-2-2007.pdf


Presented by UBS Securities LLC to the House Committee on August 2, 2007

Thisarticleemphasizestheimportanceofpre-fundingOPEB(OtherPostEmploymentBenefits)torealizefuturesavings. While this may increase cost in the short-term, it will significantly increase the long-term economic health of the state over the currently practiced “pay-as-you-go” model.

•OPEBliabilitiesmayapproximate20-25timesthecurrently practiced pay-as-you-go payment benefits inthefuture.(Pay-as-you-gomeansthestatepaysretiree healthcare benefits as those benefits are demanded,notatthetimetheyarepromised.)

•NotfundedlegacycostsmayincludebothOPEBand notfundedpensionliabilities.GASB43/45forOPEBandGASB25/27forpensionliabilitiesmandatethatemployersreportandprovideamortizationschedulesnot to exceed thirty years.

•OPEB/pensionfundingbondscanhelppublicemployeesrealizethefollowingbenefitsbyarbitraging(i.e.,issuingdebt,placingdebtproceedsin an irrevocable trust, and investing the proceeds pursuanttoadiversifiedinvestmentsstrategy).Thisis because of the difference between the bond rate andthetrustfundestimatedearningsrate(couldbeashighas5-6percent).Thebenefitsofthisare:

1. Lower net payments: Cash-flowsavingsreduceeffective employer contributions.

2. Present value savings: Savings can range between15percentand30percentofthetotalOPEBliability.

3. Financial flexibility: Ability to delay payments in earlyyearstoallowtimetobudgetandadjusttounforeseen increased costs.

•Anticipatedbenefitshavebeenestimatedbaseduponthe experience of pension obligation bonds.

Source:http://www.house.mi.gov/SessionDocs/2007-2008/Testimony/Committee90-8-16-2007-1.pdf

TIAA-CREF Presentation to the Committee on September 6, 2007

James Leleszi, Deborah Lantzy-Talpos, and Teresa Gotimer, AETNA

Topics discussed were funding strategies to avoid; the effect of a substantial reduction in retiree health costs; allocationofsavings;keyelementsofanOPEBmitiga-tion strategy; cost containment strategies; retiree contri-

butionstrategies;theOhioPublicEmployeesRetirementSystem and funding structure; investing in health equity; reducingcarecosts;MedicareAdvantagePlans;AETNA’sholistic integrated medical management approach; dem-onstrated savings through Medicare Advantage plans; healthoptimization;AETNA’sHealthyRoadsProgram;innovations in care delivery; preventative services; and CareEngine.

Rod Crane, the Director of Institutional Business Development for TIAA/CREF

Mr.CraneprovidedanoverviewofTIAA-CREF;anational perspective of public sector retiree health care liabilities and retiree health environmental factors; a 2006reporton21stcenturychallengesandretirementinsecurity; strategy of four public sector multiple stake-holders and influencers; options for dealing with retiree health funding issues; attributes of an ideal retiree health trust funding vehicle; designing health funding solutions; defined contribution approaches; and a case studyoftheStateofMinnesotaHealthCareSavingsPlan.

A Bolder Retiree Health Vision for the State of Michigan

Presented by Aetna on September 6, 2007

This presentation begins by stressing that incremental stepsarenotsufficientformeetingtheOPEBobliga-tions—it has to be a broad and comprehensive strategy. The reason for this is:

•Healthcarecostscontinuetooutpaceoverallinflation and growth in the Michigan economy.

•Healthcostshaveasignificanteffectontaxes,thecompetitiveness of the State, and the competitiveness of the State’s industry.

•HealthcostsareamajorconcernoftheState’sretirees as well as active state employees planning for retirement.

•Slowingorevenstoppingtheincreaseindirecthealth costs will not be sufficient to address these concerns.

The presentation also mentioned strategies to avoid:

•Adramaticcostshifttotheretirees/employeesorasignificant reduction in benefits.

•Dramaticallycurtailingeligibilityforemployees/retirees(althoughsomemaybenecessary,thisshouldbelimited).


•Carerationingforemployees/retirees,whichiscounter to the US value system of choice and access.

•Pricesettingofhealthcareservices,whichcouldconstrain innovation and encourage a two class system for those that could afford to pay privately.

•Reducethecarequalityandaccess,whichcouldsignificantly increase cost in the long-term and counter to the previously mentioned US value system of choice and access.

The strategies for controlling cost recommended by Aetna are:

•Increaseplanparticipantresponsibility(modestcostshiftingtotheparticipant).

•Createmorereadilyavailablesavingsvehiclesandbegin to transition from a defined benefit model to a defined contribution model.

•Roll-overotherbenefitpayouts,suchasunusedvacation pay or sick pay.

•Createfinancialincentivesforhealthylifestylechoices and better chronic disease management.

According to the presentation, these methods should all beutilizedtohelpmeetMichigan’sOPEBobligations.Source:http://house.michigan.gov/SessionDocs/2007-2008/Testimony/Committee90-9-6-2007.pdf

OPEB—Bonding for Retirees’ Healthcare

Presented by Robert Daddow and Laurie Van Pelt on September 13, 2007

OaklandCountyfirsttookstepstodealwithOPEBobli-gations several decades before states were mandated by GASP45todoso.In1985,OaklandCountyfirstpre-pared an annual retiree health care actuarial valuations report. The report was the first step in switching from a pay-as-you-go approach to a pre-funded approach. In 1987,theCountyadoptedapolicytofundtheOPEBliabilities and continually monitor how these liabilities affecttheCounty’sfiscalposition.ThishasenabledtheCountytomeetitspresentOPEBobligationswithrela-tive fiscal constancy.

OaklandCountymadechangestoitshealthcareretirement policies and structure beginning in the mid 1980s.In1985,theCountyincreasedtheyearsofservicerequiredtovestforretireehealthcareservice.Cur-rently,employeesare60percentvestedafterachieving15yearsofservice,withincrementsof4percenteachyearthereafteruntilfullyvestedat25yearsofservice.In2000,thecountyalsocreatedaVEBATrust,whichprovidedtheCountytheflexibilityneededtoofferanew

taxexemptinvestmentplan.Finally,in2005,OaklandCountyadoptedaRetirementHealthSavings(RHS)PlanforallemployeeshiredonorafterJanuary1,2006.Thisis a change from a defined benefit plan to a defined con-tributionplan.UnderthisplantheCountycontributes$1300eachyeartoeachemployee’sRHSaccountandthe employees may also elect to contribute a portion of theirpretaxpay(althoughtheyarenotrequired).WhilethisdoesnotchangetheCounty’svestingrequirements,itdoeslimittheretireehealthcarecoststhattheCountycontributes to and provides ongoing fiscal stability while continuing to offer reasonable health care benefits to retirees.

This could be a possible model for what the state can do to help control retiree health care cost and pre-fund theOPEBobligations.

Source:http://house.michigan.gov/SessionDocs/2007-2008/Testimony/Committee90-9-13-2007.pdf

The Michigan Public School Employee Retirement System and Its Impact on Michigan Public Universities

Presented by David Eisler on September 27, 2007

This article gives a brief testimony on the develop-ment of the Michigan Public Schools Retirement System (MPSERS).Itdiscussesreasonsforthecurrentfundingshortfalls of some of Michigan’s public universities. The un-fundedOPEBliabilitieshaveincreasedfrom$3.6millionto$15.8milliondollarsinthepastthreeyears(anincreaseof335percent).Someofthepossiblecon-sequences of this are increases in student tuition rates and decreases in funds used for educational purposes (decreasingthequalityofMichigan’suniversities).

The recommended solutions to help finance these OPEBobligationsare:

•HaveMPSERSuniversitiespayafixedpercentageannuallyintoMPSERSandtiethistothesamepercentageasK-12districtspay.

•Eliminatetheun-fundedliabilitychargetotheMPSERSuniversities.Thiscostisthestate’sresponsibility.

•DirectfundMPSERScostfromtheStateratherthansending these dollars to the universities and then back to the State. Under this approach university obligationforMPSERSpaymentswouldnotbereduced by budget cuts from the State.



MERS and Retiree Health Care Pooling Options

Presented by Michael Moquin, Virginia Gibson and Jennifer Mausolf, October 17, 2007

MERS(MunicipalEmployees’RetirementSystem)isavoluntary municipal employee pension plan, created by thelegislaturein1945andisthefirststatewidemunici-palpool.ItisoperatedbytheMERSRetirementBoard,which is the trustee and the fiduciary. Participation is voluntaryandMERSbecameanon-profitpubliccorpo-rationin1996.In2001,attherequestofMERSmembersthe board began a feasibility study of pooled health care programs,whichbeganashiftfromMERSasonlyapen-sionplantoMERSasalsoaproviderofpooledemployeebenefit program for municipalities.

MERSrecommendssomeconditionsforsuccessfullypooling resources. These are:

•Acomprehensiveviewofretirement—coordinatingpension and health care benefits.

•Affordableandsustainablebenefitdesigns—soretirees have lifetime access to income and health care.

•Equitablecostsharing,whichincludesspreadingcostfairlywithoutjeopardizingaccesstocare.

•Encouragedincreasedemployeeretirementsavingsthrough tax deferred contributions and other incentives.

•Stabilizegrowthinhealthcarecostswhileensuringquality of care.

•Maximizegrowthinprofessionallyinvestedtrustassets by federal and state tax exemption on all investment earnings.


Presented by Timothy Nelson, Dr. David Mathews and Brendan Ringlever, October 25, 2007

Currently,Michigan’sCommunityCollegeshavetwoavailableoptions.ThefirstisthroughMPSERSandisavailable to all full-time and part-time employees. The secondisORP(OptionalRetirementPlan)andisavail-abletofull-timeprofessionalstaffandfaculty.MPSERSisadefinedbenefitplanandvestswith10servicecred-its(5servicecreditsforemployeesage55orhigher).Employeescontributeanaverageof6.4percentoftheircompensationandofferslifetimeretireeHealthCareif fully vested. The ORP rate is set by individual col-legesNMCat11.5percentwithanaverage4percent

required employee match and vesting periods vary by college. This is a defined contribution plan and the employer does not offer health care upon retirement, but the employee can use the funds contributed by both employer and employee to pay for retiree health care.

Rising health care costs for current employees is put-ting increased pressure on community colleges’ budgets. The current pay-as-you-go approach does not address theunfundedliabilityinMPSERSplan.IncreasingMPS-ERSratesareoutsidethecontrolofthecollegesandareunsustainable.Furthermore,onequarterofstudenttuitionfeesgotowardslegacycosts(pensionsandhealthinsurance).Thisproblemisonlygettingworse.MPSERSrecommends fixing the problem through stopping new entrantsintoMSPERSandleavecollegesasmembersforvoiceontheboard.MPSERSwouldliketheHouseCommitteetonotdiscouragecommunitycolleges’abilityto hire retirees, particularly retired faculty as part-time faculty.

Source:http://house.michigan.gov/SessionDocs/2007-2008/Testimony/Committee90-10-25-2007-1.pdf

Managing the Rising Costs of Retiree Health Care

Presented by Paul Austin of Blue Cross Blue Shield Michigan on October 25, 2007

This testimony presented three of the most common methods for reducing retiree health care costs. These are:

•BenefitPlanChangesthroughincreasingdeductiblesand co-pays, increased annual out-of-pocket maximum, and a more tightly managed benefit plan.

•Employeepremiumsharingthroughofferinglessexpensiveplans(suchasHSAs)andcreatingincentivesforbetterbehavior(suchasnon-smokingorbetterdiseasemanagement)

•Changingemployeeeligibilitythroughrequiringlonger tenure to become eligible and requiring new hires to pay more towards health care costs.

The testimony also stressed the impact Medicare can have on health care costs. A non-Medicare employee costbetween2.5and3timesthecostofanactiveemployee.



Funding for Retiree Health Care Benefits

Presented on behalf of MAPERS by Michael VanOverbeke of VanOverbeke, Michaud & Timmony, P.C., on November 1, 2007

MAPERS(MichiganAssociationofPublicEmployeeRetirementSystems)comprises129publicemployeeretirement and health care plans in Michigan represent-ingmorethan250,000retireesand500,000employ-eeswithover$60billiondollarsinassets.MAPERSrequestedthattheCommitteeshouldreviewandmakerecommendationstoamendPA149to1)protectassetsfromtheclaimsofcreditors,2)provideapplicabilitytoallretireehealthcaretrustsfunds,and3)requireclari-ficationoftheretireehealthcarepromise.MAPERSalsoput forth an amendment initiative that enabled plans to pursue investment strategies with greater protection from market volatility and further diversify the retire-ment system’s portfolio.

MAPERSsoughttodefineandprotectMichigan’shealth care promise to state employees through four mainpoints:1)Retireehealthcarebenefitsshouldremainalocalissue;2)Retireehealthcarepromisesshouldbedefinedinwriting;3)Ifapromiseismade,itshould be a contractual benefit that is afforded appropri-atelegalprotection;and4)Lackoflegislativeguidancewill result in significant legal costs to the public sector plans.MAPERSalsorecommendsthecommitteeexpandthe protections of the Public Employee Retirement Benefit Protection Act,PublicAct100of2002,tocoverretireehealth care accounts and that the committee seek clari-ficationandguidancefromtheAGand/ortheIRSastotheauthorityanduseofPublicAct28of1966.Source:http://house.michigan.gov/SessionDocs/2007-2008/Testimony/Committee90-11-1-2007-10.pdf

Comments Regarding Retiree Health Care on Behalf of the Retirement Coordinating Council

Presented by Ellen Hoekstra of Capital Services, Inc., on November 1, 2007

TheRetirementCoordinatingCouncil(RCC)isacoali-tion of both active and retired school and state employ-ees. They conveyed four main points. The first is that theRCChasactionsthathavealreadytakenplace,suchastheMedicarePrescriptionDrugPlanforanestimated$80millionsavingsandtheMedicareAdvantagewith$40millionestimatedsavings.Thesecondisthatretir-ees have had several cost increases in their health care plans in the interest of greater cost sharing. The third is

that there is a difference between reducing retiree health care cost and shifting cost increases to retirees, and careful consideration should be taken that retirees do not shoulder too significant a burden. The fourth point is that Michigan policymakers can take steps to both diminish the potential impact of the new accounting standards and control health care costs. This includes moving toward a pre-funding model so that investment returns can help finance retiree health care and consider administrative efficiencies to reduce health care costs. Furthermore,thecommitteeshouldseekinputfromhealth care economists that are familiar with innovative state solutions and review the investment strategies of other large retirement systems. Source:http://house.michigan.gov/SessionDocs/2007-2008/Testimony/Committee90-11-1-2007-9.pdf

Presented by the Michigan Association of Retired School Personnel, November 1, 2007

In this presentation, the Michigan Association of Retired SchoolPersonnel(MARSP)asserteditssupportforpre-funding retiree health care obligations through a trust fund specifically for this purpose. MARSP also states the following statements in regards to pre-funding health care obligations.

•“Webelieveinconstitutionallyprotectedadvancefunding for health benefits with active members contributing a portion of the actuarial cost, if contributions can be considered IRS tax exempt, placed in individual accounts, and refundable if the employee is not eligible for pension/health benefits.”

•Webelievethatemployersshouldcontributetothisfund in at least the same proportion as the active members.”

•“WebelievethatthefundmustbeprotectedfromState government use for anything other than pre-funding of health benefits, and that the investment earnings of the fund must have the same protection.”

Overall, MARSP is supportive of pre-funding through a trust and prudently investing the funds to achieve above average returns.



How are Michigan Charter Public Schools Providing for Teacher Retirement?

Presented by MCCSA and MAPSA on January 10, 2008

Therearecurrently230charterpublicschoolsthatenroll100,000studentsacrossMichigan,whilereceiv-ing per pupil funding of $2,289 on average less than traditionalpublicschools.Compensationperteacherisalso significantly less than traditional public schools. Michigan charter public schools have saved significant fundsthroughofferingcompetitiveandportable401(k)retirement packages instead of traditional defined ben-efit pensions. However, many Michigan charter public schoolsaremembersofMPSERSandareinterestedinsolutionstoMPSERSpossiblefundingshortfallsforretiree benefits, as charter schools will have to make up forunfundedpensionliabilitiesbyMPSERS.However,charter public schools have flexibility in offering creative solutions that are good for teachers and efficiently use taxpayer funds while maintaining academic excellence.

Source:http://house.michigan.gov/SessionDocs/2007-2008/Testimony/Committee90-1-10-2008-2.pdf

Presentation on behalf of the Michigan Education Association

By Charles Agerstrand and Don Noble of MEA on January 10, 2008

MPSERS(MichiganPublicSchoolEmployeesRetirementSystem)currentlyhasinexcessof305,000membersandapproximately161,882retireesandbeneficiarieswhoareentitled to receive benefits provided by the retirement board.MPSERSconsistsofallpublicschoolsdistricts,intermediate school districts, public school academies, communityandjuniorcolleges,andsevenuniversities.

Traditionally, benefits have been an important tool for attracting and retaining school teachers. As health care costs have increased, so have the costs of offering thesepromisedretireehealthcarebenefits.Beginningin1982,MPSERSstartedtakingactionstoreduceretireehealth care liabilities and began requiring its participants to pay more toward retiree health care benefits. How-ever, care must be taken that retirees do not have to pay too much of the costs in rising health care costs. If this happens, retirees have an incentive to forgo medical care that is necessary for their health.

The presenters recommend three actions of the MichiganLegislatures.First,theLegislatureshouldstop

funding retiree health care benefits by shifting costs to retirees,suchaswasthecasein1995,1997,1999,2000,2001,2005,and2008.Second,theLegislatureshouldfreezeco-paysanddeductiblesatcurrentlevels.Third,there must be some kind of effort to pre-fund the health care benefits. This will help ensure the future of the benefits and that investments and earnings from that pre-funding effort will help finance the benefits and help offset inflation and health care cost increases.


Michigan State Employees Retirees Association Council Presentation

January 17, 2008

ThisistheStateEmployeeRetirementAssociation’s(SERA)testimonyofwhichthepurposeistoaddressconcernsregardingmorerecentCommitteeactionsandpronouncements.

•Thefirstportionofthetestimonystatedthatretireeshave currently endured significant cut backs to their pension benefits and many retirees are already under financial strain. The implication is that a further reduction in retirement health care benefits will be perceived extremely negatively by retirees.

•ThesecondportionofthetestimonytouchedonconcernbySERAforrapidintroductionofthelegislation.PastexperiencehasindicatedtoSERAthat legislation introduced and reported out of committee so fast may have ulterior motives and warrants closer scrutiny.

•ThethirdpointisthatSERAstressedtheirabilityto assist in changes in retiree benefits. They can be consulted in the process and be used to communicateadjustmentstoretireesandachievetheiracceptance.SERAanditsmembersarenotafraid of change, but would like to be involved in the process so that the association can look after the interest of their constituents.

In conclusion, the testimony questioned the overall sup-port of the legislation and stated that the process needs to slow down so that other options can be addressed. Morespecifically,SERAquestionedhowaconsolidatedplan with both state employees and public school employeescanachievecostsavings.Also,SERAwantedto know why legislation that created a pre-funding trust in2001forretireebenefitsshouldnotbeusedinsteadofcreatinganewaccount.Overall,SERAwouldlikemore


dialogue and greater understanding on the issue before a hasty decision is made.


Retiree Health Care Funding Vehicles in a GASB World: Sorting Out the Acronyms, Exploring the Options, and Finding a Solution

Presented by W. Alan Wilk of Dykema Law Firm, February 21, 2008 and March 13, 2008

W.AlanWilk,memberoftheDykemalawfirm,addressedtheCommitteetodeterminethemostappro-priatetrust.Thefocuswason401(h),VEBA,Section115and HRAs.

•Asection115oftheIRSisasourceoftaxexemptstatus for government entities to perform an essential government function and is a tool government entities can use to help pay for retiree health benefits. There are no restrictions on state funding, but because funds need to be composed only of governmental contributions there may be some restrictions on employee funds. A participant’s remaining funds after all medical expenses have been paid(bothparticipantandparticipant’sdependents)mustbereturnedtotheemployer.Section115trustcan also be funded by multiple government entities.

•A401(h)isasub-accountwithinapensionplanforthepurposeoffundingretireehealthbenefits.401(h)accounts allow for both employer and employee contributions,butaresubjecttoanIRCfundingratioinwhichheathcarecontributionsarelimitedto25percent of the pension contributions.

•AVEBA(VoluntaryEmployeeBeneficiaryAssociation)isataxexempttrust.ReasonsfornotchoosingaVEBAarehighadministrativecomplexityand there is no option for pre-tax employee money.

•HRAs(HealthReimbursementAccounts)areindividual health care savings accounts to which tax advantaged contributions can be made to pay a retiree’s health care expenses. HRAs can limit the extent of an employer’s financial exposure to rises in benefit costs to a defined dollar amount. Contributionscanberestrictedtoonlyhealthcareexpenses.Thiscanbedoneinconjunctionwitha115trust.

Mr. Wilk concluded with stating that whatever option theCommitteechoosesitwillhavetoobtainIRSapproval before it is officially adopted.



Appendix C

StateHow are Retiree Healthcare Benefits Currently Funded Administrative Structure

Michigan Funded on a pay-as-you go basis. Michigan currently monitors retiree health care obligations and estimated costs, but there is no plan for pre-funding the health care obligations.

Decentralized structure in which retirement benefits for civil service retirees, state police, teachers, legislative, and judges are administered separately.

Illinois Funded on a pay-as-you go basis. Retiree health care obligations are recognized on state financial balance sheets but no funds have been set aside to finance the health care obligations when they become due. Total unfunded non-pension obligations are estimated at $48 billion.

Decentralized structure in which the Illinois Department of Central Management Services oversees the state employees’ retirement benefits and the teachers’ retirement benefits. However, the Teachers’ Retirement System administers the teachers’ health care plans, while the Illinois Benefits Bureau of the Department of Central Management administers the state retirees’ benefits.

Ohio Pre-funded through employer contributions (4.3% of covered payroll for Ohio Public Employees Retirement System and 4.75% for State Highway Patrol Retirement System, as of 2001. Currently, Ohio has $11 billion out of $32 billion set aside to fund future retiree health care obligations.

Decentralized structure in which the civil service employees’ and teachers’ retirement benefits are administered through different organizations. State employees’ retiree health care benefits are administered through Ohio Public Employees Retirement System, while the teachers’ health care benefits are administered through the School Employees Retirement System.

Indiana Pre-funded through contributions to an employee’s individual health reimbursement account annually. This is a defined contribution plan and the state has no more responsibility for the employee when the funds are exhausted. As a result, the state does not have significant unfunded retiree health care obligations.

Outsourced retiree health care benefits to a private provider that administers the plans for all state employees.

Wisconsin Pre-funded through the Department of Employee Trust Fund. Currently, non-pension (health care) retiree benefits are 99% funded. The state contributes to a health savings account for each employee based on unused sick time. This is used to fund future retiree health care obligations.

The Wisconsin Retirement System is responsible for administering retiree benefits for Wisconsin state employees, teachers and university professors. The Department of Employee Trust Funds, which finances Wisconsin state employees’ benefits, manages the funds and all retirees are on the same plan as current employees.

Minnesota Funded on a pay-as-you go basis. However, the state does not fund state retirees health care, so un-funded health care obligations are minimal. State employees can maintain membership in the state’s group plan, but have to pay full membership cost. As a result, the state has little unfunded health care obligations.

Decentralized structure in which the Minnesota Teacher’s Retirement Association administers Minnesota teachers’ and college and university professors’ retiree benefits and the civil service employees are covered under the Minnesota Department of Employee Relations.

Matrix 1: Funding and Administrative Structure

State Comparisons


StateHow are Retiree Healthcare Benefits Currently Funded Administrative Structure

Vermont As of January 2007, Vermont operated on a pay-as-you go model and no funds have been set aside to finance future retiree health care obligations. However, there is currently a recognized need to switch from a pay-as-you-go model to a pre-funded model and the State Treasurer hoped to have a pre-funding model in place by the end of 2007. Currently, the state has an estimated $552 million in unfunded non-pension obligations, of which health care is the largest portion.

A mixed system in which the State Treasurer’s Office administers three statutory pension plans—Vermont State Retirement System, Vermont Teachers Retirement System, and Vermont Municipal Employees Retirement System. A Board of Trustees for each system is vested with the general administration of the system, as well as the responsibility for formulating administrative policy and procedures for its members and their beneficiaries. The day-to-day retirement operations and pension investment functions are administered through the State Treasurer’s Office. The State Treasurer is a member of each Board of Trustees.

Hawaii Funded on a pay-as-you-go basis through the Hawaii Employer-Union Health Benefits Trust Fund. The state currently has an estimated $6.8 billion in unfunded non-pension obligations, of which health care is the largest portion.

Centralized structure in which both state and county employees receive benefits from the Hawaii Employer-Union Health Benefits Fund. The trust is administered as a wing of the Department of Budget and Finance for all participating employees.

Massachusetts Funded on a pay-as-you go basis and no funds are currently set aside to finance future retiree health care obligations. The un-funded amount is currently estimated at $13.3 billion. However, in 2008 Massachusetts fully funded its retiree health care obligations for the current year, putting aside an estimated $1.1 billion, and hopes to do more in the future.

Centralized structure in which a Group Insurance Commission (GIC), a quasi-independent state agency governed by an 11-member Commission appointed by the Governor, provides health insurance to the Commonwealth’s employees and retirees. The GIC also covers housing and redevelopment authorities’ personnel, and some municipalities, retired municipal employees and teachers in certain governmental units.

Matrix 1: Funding and Administrative Structure (cont.)


Matrix 2: The Scope of Retiree Health Care Coverage

StateYears of Service Relative to Coverage

Health Care Coverage When Retiree Becomes Medicare Eligible Prescription Coverage

Michigan State subsidizes health care premiums for employees hired after March 31, 1997, at 30% after 10 years of service and an additional 3% for each additional year of service up to a maximum of 90% after 30 years of service. Retirees hired before 1997 are fully vested after 10 years of service and the state subsidizes 95% of the retirees’ health care coverage.

Health care coverage becomes supplemental to Medicare when a retiree enrolls in Medicare Part A and Part B. In addition, the retiree no longer pays a monthly premium for health care coverage—the state pays the entire monthly premium for health care coverage.

Retirees are not required to enroll in Medicare Part D because Michigan’s prescription drug coverage for retirees is at least as good as Part D’s, and the state does not offer prescription drug coverage for retirees enrolled in Medicare Part D.

Illinois The state subsidizes 5% of health care premiums for every year of service, reaching 100% at 20 years of service.

The state retiree pays a percentage of Medicare Part B coverage cost contingent on years of service (typically about half the non-Medicare rate for the same coverage). For 20+ years of service the state pays 100% of coverage regardless if the person is enrolled in Medicare.

Illinois’s prescription drug coverage is split into three categories—generic, preferred, and non-preferred. Generic drugs have the lowest co-pay, preferred brand drugs have a slightly higher co-pay, and non-preferred brand drugs have the highest co-pay. The state discourages members from enrolling in Medicare Part D unless the retirees qualify for low income/extra help assistance under the Social Security Administration.

Ohio A retiree qualifies for an Ohio Public Employees Retirement System (OPERS) plan upon accumulating 10 years of service with the state. Some additional restrictions may apply for additional purchased years.

Health care coverage becomes supplemental to Medicare and is offered at a reduced rate. This is contingent on the retiree enrolling in both Medicare Part A and Part B.

Ohio’s prescription drug coverage is split into two categories—preferred (lower co-pay) and non-preferred (higher co-pay). Enrolling in Medicare Part D is not recommended because Ohio’s group plan has better prescription drug benefits for participants.

Indiana Indiana has a retirement health care reimbursement account that employees can use to pay for health care expenses upon retirement. The contributions are based on age ($500 for employees under age 30; $800 for employees aged 30-39; $1100 for ages 40-49; and $1400 for employees aged 50 and older) and are contributed annually. Contributions are based on an employee’s age, not years of service.

Retirees become eligible for a supplemental plan upon enrolling in Medicare Part A and Part B. Health care is then offered at a reduced rate.

Indiana’s prescription drug plans are split into three categories. Generic preferred prescription drugs have the lowest co-pay, formulary preferred prescription drugs have a slightly higher co-pay, and non-preferred prescription drugs have the highest co-pay. Retirees are encouraged to enroll in Medicare part D through the outsourced provider for prescription drug benefits and receive a reduced premium for doing so.




Wisconsin An employee’s unused sick time is credited into an account upon retirement. This account can then be used toward health care expenses. Age does not affect this in any way. Years of service indirectly affects it, because an employee with more years of service has more opportunity to accumulate sick leave credit to pay for health care coverage upon retiring.

Upon becoming eligible, retirees must enroll in Medicare Part A and Part B to continue to be part of the state’s group health care plan. The plan becomes supplemental to Medicare and coverage through the plan is offered at a reduced rate.

The state has three levels of pre-scription drug coverage. Level 1 (lowest co-pay) consists of formu-lary generic drugs and certain low-cost brand drugs. Level 2 (slightly higher co-pay) consists of formu-lary brand name drugs and certain formulary high cost generic drugs. Level 3 (highest co-pay) consists of covered non-formulary prescrip-tion drugs. The state recommends against enrolling in Medicare Part D because employees already have coverage through the state’s plan that is as good as or better than Medicare Part D’s coverage.

Minnesota Retirees are eligible for retirement health care benefits upon completing five years of allowable pension service or are age 50 with 15 years of state service. Retirees may continue on the state’s group plan, but they pay the full cost of health care coverage for themselves and their families.

Retirees become eligible for a supplemental plan upon enrolling in Medicare Part A and Part B. Health care is then offered at a reduced rate.

Minnesota’s prescription drug plans offer generic prescription drugs for a lower co-pay and preferred brand drugs for a higher co-pay. Retirees are encouraged to enroll in Medicare Part D through the state-provided carrier for prescription drug benefits.

Vermont The state will pay 20% toward the health care plan premium for any employee who qualifies for retiree health care coverage. An employee qualifies either by reaching 30 years of service, regardless of age, or turning 62, whichever comes first.

State retirees must apply for Medicare Part A and Part B upon becoming eligible (typically at age 65). At this time, the Vermont-sponsored health plan becomes supplemental to Medicare and the retiree pays a lower premium.

The program is administered by Express Scripts, Inc., a private provider contracted by the state to administer prescription drug benefits.

Hawaii For state retirees hired after July 1, 2001: with 10-14 years of service the state pays 50% of the retiree’s health care premium; 15-24 years of service the state pays 75% of the retiree’s premium; and at 25+ years of service the state pays 100% of the retiree’s healthcare premiums.

Retirees in Hawaii’s state plan must enroll in Medicare Part B, but are reimbursed for the premium. Retirees are automatically enrolled in Medicare Part A.

Retirees enroll in Medicare Part D and are reimbursed by the Employer-Union Health Benefits Trust Fund for their premium. Retirees are covered under Medicare Part D and are subject to Part D’s co-pays and deductibles.

Matrix 2: The Scope of Retiree Health Care Coverage (cont.)




Massachusetts Before a state retiree is eligible for Medicare s/he will pay a higher premium. However, there is no indication that years of service affect retiree health care coverage.

The state offers a variety of plans for both Medicare-eligible retirees and retirees who opt out of Medicare coverage. Retirees enrolled in Medicare plans tend to pay a reduced premium. Teachers can participate in these plans, as well.

There are a total of 15 different plans offered, and the typical plan is divided into three tiers. Tier 1 (generics) has the lowest co-pay; tier 2 (preferred brand name) has a slightly higher co-pay; and tier 3 (non-preferred brand name) has the highest co-pay. The state recommends against enrolling in Medicare Part D because retirees have prescription drug coverage through the state-sponsored plan that is better than Medicare Part D’s coverage.

Matrix 2: The Scope of Retiree Health Care Coverage (cont.)


Matrix 3: State Heath Care Cost Control Efforts

State HDHP combined with a HSA* Opt-out IncentiveWellness Programs/Preventive Care Coverage

Michigan No HDHP combined with a HSA account offered.

Current state employees are paid an opt-out incentive if they decline state coverage for enrollment in a non-state plan. Current retirees are not offered the same incentive.

Michigan’s plan offers no tobacco cessation incentive, but does offer free tobacco cessation programs for participants. Michigan has an employee health and wellness campaign that offers discounts for certain gyms as well as healthy recipes and other promotions to encourage healthy living. Under the state health care plan all procedures classified as preventive care, such as routine physicals, are typically covered 100%.

Illinois No HDHP combined with a HSA account offered.

Illinois offers an opt-out incentive to state employees who are non-Medicare retirees, eligible for retiree health care coverage through the state’s plan, and have adequate coverage elsewhere (such as through a spouse or previous employer). The opt-out incentive is $150 for each month the retiree opts out of the state’s health care coverage.

The state’s health care plan offers a lower premium for employees who meet the requirements of the tobacco cessation incentive (designed to help eliminate tobacco use). In addition, all procedures classified as preventive care are typically covered 100% by the state’s health insurance plan.

Ohio No HDHP combined with a HSA account offered.

No opt-out incentive offered. Offers a lower plan premium for employees who meet the tobacco cessation incentive requirements. Eligible retirees can obtain a $100 incentive for completing a goal-oriented coaching program under the Aetna Medicare plan. A new health and wellness program will be initiated in 2008 aimed at encouraging healthier living among all participants. Procedures that are classified as preventive care are covered 100% by the state’s health care plan.

* HDHP (High Deductible Health Plan) are health plans that are intended to be consumer directed and are combined with an HSA (Health Savings Account). This operates similar to a 401k, but for health care expenses. The account can be rolled over to the following years (unlike a flex-account in which participants lose funds at the end of the year). It must be combined with an HDHP with an annual deductible of at least $1000 for individuals and $2000 for families. However, maximum out-of-pocket expenses per year are $5000 for individuals and $10,000 for families (as of 2007). Maximum allowable annual contributions are $2600 for an individual and $5150 for a family.


State HDHP combined with a HSA* Opt-out IncentiveWellness Programs/Preventive Care Coverage

Indiana Offers a HDHP combined with an HSA for current state employees. The state contributes funds to the account. The amount is depen-dant on the employee’s plan and whether the plan is individual cov-erage or family coverage. Unused funds can roll over to subsequent years and can be used for retiree health care expenses.

No opt-out incentive offered. Indiana offers a lower health care plan premium for employees that meet a tobacco cessation incentive requirement as part of the state’s sponsored health care plan. All procedures listed as preventive care are typically covered 100% by the state’s group health care plan.

Wisconsin No HDHP combined with a HSA account offered.

No opt-out incentive offered. Wisconsin offers a tobacco cessation incentive to lower tobacco use among state employees. Procedures classified as preventive care are 100% covered by the state’s group insurance plan.

Minnesota No HDHP combined with a HSA account offered.

No opt-out incentive for retirees. But if a retiree’s spouse works for the state of Minnesota, the retiree cannot claim the spouse as a dependant and both retiree and spouse must be covered individually.

Minnesota has no specific wellness program or policies currently listed to encourage healthier living among participants. Preventive care procedures are typically covered 100% by the state’s group health insurance plan.

Hawaii No HDHP combined with a HSA account offered.

No opt-out incentive offered. The U.S. Department of Health and Human Services awarded Hawaii an innovation in prevention award in November 2007 for promoting physical activity and nutrition at work. The state health department has outlined these ideas in an online Worksite Wellness Toolkit that it has made available so that other employers can start similar programs.

Massachusetts No HDHP combined with a HSA account offered.

Retiree can elect to “buy out” the healthcare coverage. The incentive for doing so is 12 monthly checks of 25% of the premium. If the retiree “buys out” his/her health care coverage, s/he will no longer be eligible for retiree health benefits through the state’s plan.

Operations classified as preventive care are typically 100% covered by the state-sponsored health insurance plan after a small fee of $5-10 per visit. The Massa-chusetts Health Care Quality and Cost Council works to promote safe, effective, timely, efficient, equitable, and patient centered care through consumer education, encouraging transparency, issuing quality standards, and other initia-tives.

Matrix 3: State Heath Care Cost Control Efforts (cont.)


Cost Savings Methods Description Advantages Disadvantages

Electronic Health Information Exchange

This is the use of electronic health care records. The goal is to put current patient information in the hands of practitioners at the point of patient care through electronic exchange (as opposed to hard copy exchange). This can result in quicker and more accurate transfer of health care records.

The aim is more efficient transfer of health care records, which will result in quicker diagnostic time and more efficient use of administrative resources, possibly cutting overall administrative costs in health care significantly. According to a PricewaterhouseCoopers study, administrative costs account for an estimated 11% of health care premiums.

There could be difficulty in implementing electronic health records and the initial training may incur significant upfront costs. There are also concerns of patient privacy being violated through third parties having access (either legally or illegally) to confidential patient information.

Evidence-Based Medicine

The use of medical treatments that have been proven to work through careful research and analysis and are cost effective for the consumers and insurance providers. The focus of this approach is both on increasing the quality of treatment and controlling overall costs.

Health care systems can achieve the best possible patient outcomes by eliminating costly, ineffective, and dated treatments that have been shown to be unsafe, not to work well, or have been replaced with treatments that are offered at a lower price (such as generic drugs). Participants are encouraged to use these cost effective procedures, often through financial incentives, such as lower co-pays.

This could limit consumer choice among employees because health providers will have increased say in what kind of treatment an employee receives.

Chronic Disease Management

The improved management and possible prevention of chronic diseases, such as Type II diabetes or cardiovascular disease.

Ten percent of the sickest patients account for about 70 percent of total health care costs. Many diseases can be better managed and, in some cases, prevented. This will significantly reduce health care cost in the long-term if participants take initiative in controlling or preventing chronic diseases.

There are initial upfront costs that may not achieve the expected benefits because the benefits depend largely on the participants’ willingness to commit to more health-conscious decisions.

Wellness Programs/Healthy Living Incentives

This consists of various initiatives to educate employees on the benefits of healthy living and create incentives for participants to achieve a healthier lifestyle.

If implemented effectively, it controls the demand for medical services, decreasing overall health care costs without raising premiums. This increased savings can then be passed on to the employer, the retiree, or both.

The benefits depend on the pro-gram’s ability to motivate employ-ees to improve their overall health. If employees are not motivated to achieve healthier lifestyles (whether through ineffective incen-tives or poor communication), the benefits of the program will likely not outweigh the costs of imple-menting and administering it.

Matrix 4: Retiree Health Care Cost Control


Cost Savings Methods Description Advantages Disadvantages

Create a Two-Tier System

The two-tier system would be similar to the recently negotiated agreement between the United Auto Workers and General Motors. New employees would pay significantly higher rates with equal or less coverage, while current employees and retirees would maintain their existing benefit levels.

This can lower the costs without affecting the morale of current employees. Michigan also avoids the perception that it is reneging on its previous promises to current employees. The assumption is that new employees will not have as strong a sense of entitlement to retiree health care benefits, minimizing the negative effect on their morale.

This approach can create resentment from employees hired under the new tier, which could undermine morale and solidarity in the workplace. This approach could also undermine Michigan’s ability to attract and retain new talent necessary for the effective functioning of the state.

Reduce Retiree Benefits for All Employees

This is a simple approach to controlling costs in which retiree health care benefits are reduced (through higher co-pays and annual deductibles) for all employees.

This will lower retiree health care liabilities and carries little or no financial risk. It also encourages the perception that Michigan is acting fairly by treating all employees equally.

This will most likely decrease workforce morale, which could lower employees’ performance and increase turnover. This could also decrease Michigan’s ability to attract and retain talented employees. State employees often view competitive benefits as part of the value proposition of working for the state.

Offer an Opt-Out Incentive

Sometimes employees are covered under two plans, either from another employer or their spouse/partner. The state can offer a retiree who qualifies for a non-state plan the option to opt-out for a financial incentive. This financial incentive covers a portion of the retiree’s health care coverage costs, but not all of them.

An employee who opts-out of health care coverage can be paid less than the total costs to the state of covering the employee if the employee maintained membership in the alternative health care plan, saving the state a proportion of that individual’s health care costs. Illinois offers participants $150 to opt-out of the state’s health care plan, provided they have adequate coverage elsewhere.

The medical benefits of the alternative health care plan may not be as good as the state’s health care plan, affecting the retiree’s access to health care. Problems can also arise if the retired employee loses the benefits based on an unforeseen event (such as a company filing for bankruptcy, etc.).

Health Care Savings Account combined with a High Deductible Health Plan (HDHP)

This operates similar to a 401k, but for health care expenses. The account can be rolled over to the following years, unlike a flex-account in which participants lose funds at the end of the year. It must be combined with an HDHP, which has an annual deductible of at least $1000 for individuals and $2000 for families. Some preventive care can be covered by the insurance provider before the deductible has been met.

This enables greater acceptance of reducing rates by offering employees a more affordable alter-native to financing rising health care costs. This type of plan saves an employer an estimated $1673 annually per plan (relative to a pre-ferred provider plan), according to an article in Business Week. HSAs also encourage savings for future health care expenses because savings can be rolled over to sub-sequent years, which encourages employees to make more cost conscious health care decisions.

Overall, shifts the burden of health care expenses from the state to the employees. The benefits from the account depend on whether an employee takes advantage of the account. HDHPs could also increase inequality as an employee’s available contribution often depends on total salary earned. A lack of consumer education can result in bad choices that will increase long-term health care costs, such as forgoing necessary treatments to save money.

Matrix 4: Retiree Health Care Cost Control (cont.)


Matrix 5: Retiree Health Care Funding MethodsFunding Methods Description Advantages Disadvantages

Raising Retiree Contribution Rates

Raising the rates, such as monthly premiums, of retirees who are covered under the state’s current health care plan.

This is a simple and immediate way to raise funds to cover gaps between funding and future health care liabilities. This will spread the insurance premium increase over all retirees and not an isolated group.

This does not necessarily reduce health care costs, but only shifts costs from the state to the retired state employees. Although it can create an incentive for retirees to reduce medical expenses through healthier living, it does not resolve the long-term health care debt but is only a temporary fix.

Pre-fund Retiree Health Care Obligations

Pre-funding future retiree health care obligations at the time they are promised, instead of the current pay-as-you-go system under which funds are paid at the time they are demanded by retirees, not when they are promised.

Pre-funding health care obligations will result in greater future savings for Michigan. While pre-funding may increase upfront costs, it will also significantly increase the long-term economic health of the state and result in significant future savings.

This will significantly increase upfront costs. Most states can commit only a limited amount to pre-funding health care obligations. It is often necessary to borrow additional funds, decrease funding in other areas (possibly hurting beneficial public service programs), or raise taxes (something that could be politically unpopular). Another problem is that long-term medical costs are uncertain, so states often do not know how much it will take to adequately pre-fund their long-term health care obligations.

Issue bonds to finance Retiree Health Care Obligations

Pre-funding retiree health care obligations by raising funds through issuing bonds to the general public. Bonds are a method for borrowing funds with the promise of repaying those in the future, along with an agreed upon interest rate. Issuing bonds will raise the funds needed to finance future health care liabilities.

Funding through bonds can help states realize benefits by placing the debt proceeds in an irrevocable trust and investing the proceeds under a diversified investments strategy. If the trust fund earnings through the investments are higher than the bond interest rate, the state can achieve financial gains from this strategy.

Issuing bonds carries a certain amount of risk depending on the performance of the state’s investment portfolio. Market fluctuations can result in a lower rate of return relative to the bond rate, resulting in increased costs in the long-term for the state.

Progressive monthly rates or premiums based on employee salary or family reported income level

As an employee’s salary or overall family income increases, the employee will pay progressively more for the same health care coverage. For example, employees whose income is $30,000 and below may pay $60 per month in health care premiums. Employees who make $75,000 and above may pay $75 a month in health care premiums. The state of Illinois has a current policy in place.

This transfers some of the increased health care costs to higher-income employees who (in theory) should be the most able to shoulder the burden.

This could create resentment from employees in a higher income bracket (similar to a two-tiered system, but probably not as divisive). This could also create a disincentive for employees to work hard and be promoted within the state, undermining both employee motivation and commitment.


Funding Methods Description Advantages Disadvantages

Internal Revenue Code 401(h) Account

A separate account within a 401(a) pension trust that is established and maintained exclusively for paying medical benefits upon retirement. Employer (and possibly pre-tax and post-tax employee) contributions are credited to the account. Separate accounts can be established for each employee or one account for a group of employees. Employer contributions and investment income are not taxable.

A tax advantageous account in which retirees are not taxed on payment for medical expenses for themselves and any dependants covered under the plan. An additional advantage for the employer is that any funds left over upon death of retiree and after all medical expenses have been accounted for must be returned to the employer.

Disadvantages of a 401(h) account are that funds cannot be transferred to a VEBA or other retirement trust/account. Furthermore, as a result of the subordination limit (total contributions to a 401(h) account may not exceed 25% of total contributions to a 401(a) pension trust) funds may not be sufficient to cover all retiree health care expenses.

Internal Revenue Code 115 Trusts

A section 115 organization provides tax exemption for the provision of a particular and necessary government function, such as administering health care benefits for state retirees by creating a trust to finance future health care expenses.

This has a flexible structure for funding health care benefits, such as no restrictions on funding, no restrictions on benefits, and no limitations on eligibility of participants (can have been full-time, part-time, or even contracted employees).

Similar disadvantage to a VEBA account, in which the burden of risk shifts from the employer to the employee. If the 115 Trust fails, the employer is not held accountable and the participants (typically the employees and retirees) must account for the losses through increased contributions.

VEBA (Voluntary Employee Benefits Association) Accounts

VEBAs are set up as a trust in which employees share a common association, which can be a broad association, such as contracting, part-time, and full-time employees. VEBAs are funded through employer and employee pre-tax contributions and can be used to pay current and future health care costs.

VEBAs allow flexibility in who can become a member of the association and protect employees from the employer defaulting on payments because the funds are separate from the employer. The funds can be invested to cover future retiree health care costs, one possible method of pre-funding the benefits. Often the employer will offer a large lump sum contribution at the VEBAs creation.

VEBAs shift risk from the employer to the employee. This is especially important if the VEBA fails. VEBAs have failed in the past, which greatly increases the burden on employees and retirees, since the employer is often divulged of responsibility as a result of the VEBAs creation and initial contribution. An additional disadvantage of a VEBA is that retiree health care liabilities pre-funded through a VEBA diminish the federal funds awarded to the state for Medicaid and the State Children’s Health Insurance Program (SCHIP).

Matrix 5: Retiree Health Care Funding Methods (cont.)

Documents

Balancing Dollars and Health Sense - SLGE · Balancing Dollars and Health Sense 1 S tate and local governments in the United States are liable for unfunded post-employment health