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The Fiscal Stress Arising from State and Local Retiree Health Obligations

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  • Byron Lutz
  • Louise Sheiner
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    Abstract

    A major factor weighing down the long-term finances of state and local governments is the obligation to fund retiree benefits. While state and local government pension obligations have been analyzed in great detail, much less attention has been paid to the costs of the other major retiree benefit provided by these governments: retiree health insurance. The first portion of the paper uses the information contained in the annual actuarial reports for public retiree health plans to reverse engineer the cash flows underlying the liabilities given in the report. Obtaining the cash flows allows us to construct liability estimates which are consistent across governments in terms of the discount rate, actuarial method and assumptions concerning medical cost inflation and mortality. We find that the total unfunded accrued liability of state and local governments for the provision of retiree health care exceeds $1 trillion, or about ⅓ of total state and local government revenue. Relative to pension obligations discounted at the same rate, we find that unfunded retiree health care liabilities are ½ the size of unfunded pension obligations. We also find that using assumptions concerning the growth in health care costs that are arguably more realistic than those employed by most states actually reduces the size of the liability in most cases. Pushing in the opposite direction, we find that using plausibly more realistic mortality assumptions increases the size of liability. The second portion of the paper places retiree health care obligations into context by examining the budget pressures associated with retiree health on a continuing, largely pay-as-you go basis. We find that much of the projected increase in retiree health obligations as a share of revenue is the result of health care cost growth. On average, states could put their retiree health obligations into long-run fiscal balance by contributing an additional ¾ percent of total revenue toward the benefit each year. There is, however, wide variation across the states, with the majority of states requiring little in the way of additional financing, but some states requiring a significantly larger increase.

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    Bibliographic Info

    Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 19779.

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    Date of creation: Jan 2014
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    Handle: RePEc:nbr:nberwo:19779

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    1. Robert Novy-Marx & Joshua D. Rauh, 2009. "The Liabilities and Risks of State-Sponsored Pension Plans," Journal of Economic Perspectives, American Economic Association, vol. 23(4), pages 191-210, Fall.
    2. Poterba, James M, 1994. "State Responses to Fiscal Crises: The Effects of Budgetary Institutions and Politics," Journal of Political Economy, University of Chicago Press, vol. 102(4), pages 799-821, August.
    3. James Marton & Stephen A. Woodbury, 2006. "Retiree Health Benefits and Retirement," Upjohn Working Papers and Journal Articles 06-128, W.E. Upjohn Institute for Employment Research.
    4. John B. Shoven & Sita Slavov, 2013. "The Role of Retiree Health Insurance in the Early Retirement of Public Sector Employees," NBER Working Papers 19563, National Bureau of Economic Research, Inc.
    5. Robert L. Clark, 2009. "Will Public Sector Retiree Health Benefit Plans Survive? Economic and Policy Implications of Unfunded Liabilities," American Economic Review, American Economic Association, vol. 99(2), pages 533-37, May.
    6. Clark, Robert L. & Morrill, Melinda Sandler, 2011. "The funding status of retiree health plans in the public sector," Journal of Pension Economics and Finance, Cambridge University Press, vol. 10(02), pages 291-314, April.
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