S&P Sees Looming Crisis for State OPEB Funding

A 2018 decline in unfunded OPEB liabilities is masking an increased risk in not matching unfunded liabilities in future years, the ratings agency says.

U.S. states continue to severely underfund their other postemployment benefit (OPEB) plans. S&P Global Ratings’ latest survey found that for most states, annual plan contributions do not keep up with growth in liabilities.

Reported total unfunded retiree health care liabilities for U.S. states fell by 7.3% in fiscal 2018 to $628 billion. However, S&P Global Ratings expects that unfunded liabilities will likely escalate in the future if meaningful funding progress or benefit reductions are not implemented. The agency says it believes the reduction mainly corresponds to increases to the discount rate across plans, which reduced reported liabilities.

The agency says most states continue to fund their OPEB liabilities on a pay-as-you-go basis in which annual funding is equal to the benefits distributed. So, assets are not set aside in advance to pay benefits in the future.

The survey found combined annual plan contributions do not cover new benefits earned during the year and interest accrued on the unfunded portion of the liability for 45 of 48 states surveyed. “By not meeting static funding levels, these states will likely report escalating unfunded OPEB liabilities in future years if reform efforts are not implemented,” S&P Global Ratings states.

According to the agency, prudent fiscal plan management, historically, has included pre-funding the liability and/or reducing or capping benefit levels to a level projected to be affordable (within the legal confines of the state). S&P Global Ratings believes state efforts to address OPEB liabilities have been somewhat minimal in recent years.

Most states currently lack concrete plans to address their OPEB liabilities, but the agency believes many will eventually attempt to address these liabilities through a combination of benefit modifications and pre-funding of the liability. It notes that alterations to benefits, however, can be subject to several challenges. These include negotiations with unions, which have resisted reductions to benefits; and the fact that changing the longstanding tradeoff between lower wages and stronger benefits to lower wages and a reduction in benefits could make it more difficult for states to attract and retain skilled workers.

S&P Global Ratings notes that Illinois’ attempt to modify its OPEB obligations was ultimately ruled unconstitutional.