GAO Reports Serious Retiree Health Plan Underfunding

February 28, 2008 ( - While most state and local government pension plans have enough invested resources set aside to keep up with the benefits they are scheduled to pay over the next several decades, governments offering retiree health benefits generally have large unfunded liabilities, according to a new report from the Government Accountability Office (GAO).

According to the report, for retiree health benefits, studies estimate that the total unfunded actuarial accrued liability for state and local governments lies between $600 billion and $1.6 trillion in present value terms. Unfunded liabilities for retiree health benefits are high because, unlike pension plans, nearly all state and local government retiree health benefits have been financed on a pay-as-you-go basis, the GAO noted.

However, current annual payments for retiree health benefits are considerably lower than for pensions. According to the GAO’s analysis presented in another recent report, in 2006 the aggregate state and local contribution rate for pensions was about 9% of salaries, and the pay-as-you-go expense for retiree health benefits was about 2% of salaries. The GAO warned though that the pay-as-you-go amount is estimated to more than double to 5% of salaries by 2050 to keep up with the growth in health costs.

The GAO warned that pay-as-you-go financing leaves less budgetary flexibility because state and local governments must pay the full costs of each year’s benefits even during bad fiscal years. With pre-funding of benefits, government contributions could be reduced when fiscal pressures are great.

Under the pay-as-you-go financing model and with increasing health care costs and new reporting requirements, governments may face even greater pressure to reduce benefits or shift the costs of benefits to beneficiaries by restricting eligibility, reducing coverage, or increasing premiums, the GAO said.

As for pension benefits, most public pension plans report having sufficient assets to pay for retiree benefits over the next several decades. The GAO’s analysis of the Public Fund Survey data on 65 self-reported state and local government pension plans showed that 38 (58%) had a funded ratio of 80% or more, while 27 had a funded ratio of less than 80%. In fiscal year 2006, the aggregate funded ratio was about 86%.

However, the GAO warned that some pension plan sponsors do not contribute enough to improve their funded percent. In fiscal year 2006, the sponsors of 46% of the 70 plans in its data set contributed less than 100% of the annual required contribution, including 39% that contributed less than 90% of the ARC.

The GAO report is here .