articles Ratings /ratings/en/research/articles/191203-u-s-states-are-slow-to-reform-opebs-as-decline-in-liabilities-masks-increased-risk-11256419 content
Log in to other products

Login to Market Intelligence Platform

 /


Looking for more?

Request a Demo

You're one step closer to unlocking our suite of comprehensive and robust tools.

Fill out the form so we can connect you to the right person.

If your company has a current subscription with S&P Global Market Intelligence, you can register as a new user for access to the platform(s) covered by your license at Market Intelligence platform or S&P Capital IQ.

  • First Name*
  • Last Name*
  • Business Email *
  • Phone *
  • Company Name *
  • City *
  • We generated a verification code for you

  • Enter verification Code here*

* Required

In This List
COMMENTS

U.S. States Are Slow To Reform OPEBs As Decline In Liabilities Masks Increased Risk


U.S. States Are Slow To Reform OPEBs As Decline In Liabilities Masks Increased Risk

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. Given the degree of underfunding, unfunded OPEB liabilities will likely escalate absent meaningful reform.

However, most states have not recently pursued reform efforts. Because the size of these unfunded liabilities varies greatly among states, progress toward reducing them is more pressing for some than others. S&P Global Ratings believes it crucial for states to prudently manage plan fiscal health ahead of a tipping point where rising OPEB costs lead to budgetary stress.

Despite contributions that generally fall short of growth in liabilities, S&P Global Ratings' most recent survey data also indicates that total net OPEB liabilities for states fell by 7.3% in fiscal 2018. This drop occurred primarily due to an increase in the discount rate used to measure OPEB liabilities rather than improved funding or OPEB reforms. Generally, state plans have applied a discount rate based on a municipal bond rate due to a general lack of interest earning assets and Governmental Accounting Standards Board (GASB) methodology.

Our survey results show that, on the whole, states have not taken significant action to keep their unfunded OPEB liabilities from rising as contributions to most OPEB plans fail to cover new benefits earned during the year and interest accrued on the unfunded liability. States are even further away from making progress to reduce these unfunded liabilities. The already poor funded status of OPEBs will decline even more, as unfunded liabilities grow, unless effort is made to pre-fund or reduce these liabilities.

Liabilities Are Likely To Grow As Nearly All States Fail To Meet Even Static Funding Levels

Consistent with years past, most states continue to fund their OPEB liabilities on a pay-as-you-go (paygo) basis in which annual funding is equal to the benefits distributed. In this funding strategy, assets are not set aside in advance to pay benefits in the future.

Our survey found that 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. Kansas and South Dakota do not report liability for retiree health care benefits. By not meeting static funding levels, these states will likely report escalating unfunded OPEB liabilities in future years if reform efforts are not implemented.

Chart 1 illustrates these results by comparing total annual plan contributions to certain costs causing the annual change in the net OPEB liability (NOL). Of the three states that reached static funding levels, only two met our minimum funding progress guideline--a metric we use to evaluate if the most recent year's contributions are adequate for reaching 100% funding within a reasonable time. We believe there is some minimum amount of funding progress if annual plan contributions cover service cost (the value of benefits earned by participants in the year), a portion of the annual total interest cost related to pension liabilities unmatched by plan assets, and 1/30 of the beginning-of-year net plan liability (see Survey Methodology below).

Chart 1

image

Chart 1 shows contributions for three states' combined OPEB plans met static funding and two met minimum funding progress guidelines. These results are in stark contrast to funding for state pension plans where total annual plan contributions for 40% of state plans met static funding and 16% of plans met minimum funding progress. In our view, the strict legal requirements for funding many pension plans, which do not exist for most OPEB plans, are largely responsible for this funding differential.

Meeting static funding might still demonstrate weak funding practices if contributions fail to make measureable progress on reducing the unfunded liability. On the whole, we believe the continued lack of funding OPEBs indicates poor plan management that exposes state governments to rising unfunded liabilities, fixed costs, and budgetary pressure over time.

Funded Ratios Remain Low For Most States Given Sectorwide Underfunding

Although retiree health care benefits are typically paygo, many states have established trusts in an effort to build assets and pre-fund these long-term liabilities. However, many of these trust funds do not hold a significant level of assets compared to plan liabilities.

Funded ratios remain low for most states overall, with notable exceptions. Three states have funded ratios above 75%: Oregon (89.4%), Alaska (88.8%), and Arizona (77.0%). Conversely, 17 states have not accumulated any assets to pre-fund their OPEB liabilities.

We expect funded ratios to continue to remain low in the medium term given the sector's persistent underfunding.

Chart 2

image

Decline In Liabilities Is Not Driven By Improved Plan Fundamentals

Our survey found that aggregate reported retiree health care liabilities dropped slightly across the states. However, we do not believe this decline generally is evidence of fundamental improvement in plan positions. We believe the reduction mainly corresponds to increases to the discount rate across plans, which reduced reported liabilities. S&P Global Ratings believes that in the near term a lower unfunded liability should mean lower annual funding requirements. However, the bond rate might be volatile from year to year and the unfunded liability for many state plans remains large. We view the increase in the discount rate in 2018 as being within reasonable volatility expectations, so we don't consider it to be a fundamental change in the funded status of the plans.

Chart 3

image

In addition, 16 states that reported under GASB 43/45 standards in our previous survey are now reporting under GASB 75 in the current survey. Of these, just over half reported a decline in liabilities and just under half reported an increase in liabilities compared with our previous survey. However, the level of reported declines was 5.1x greater than the reported increases. Driving this scale was a significant decrease to New York's OPEB liabilities since our last survey. The reduction is largely due to adoption of the updated accounting standards and an updated discount rate. While the state set up a trust fund for OPEBs in the fiscal 2018 enacted budget, the trust has not been funded.

Lastly, reported unfunded liabilities for some OPEB plans holding assets could have benefited from strong investment performance through most of 2018, particularly for plans that do not report at the end of the calendar year. However, we believe market effect is slight for most OPEB plans given minimal assets across the sector.

States Report Responsibility For The Majority Of Net Plan Liabilities

More than half the states surveyed participate in at least one cost-sharing, multiple-employer plan, for which GASB 75 requires the disclosure of a state's proportionate share (funding responsibility). For some, this has caused a significant reduction of the reported liability of their largest plans.

Across all state OPEB plans, our survey found aggregate combined state NOL is 16% reduced when accounting for the newly disclosed proportionate share information. Chart 4 illustrates the breakout of responsibility between states and other employers.

Chart 4

image

Understanding Plan Benefit Structure Is Key To Grasping The Credit Story

We believe the structure of state OPEB plans--which benefits are being offered to whom and for how long--is important to understand given their budgetary effects. A typical state OPEB plan:

  • Offers an explicit health care subsidy;
  • Provides coverage to spouses and family alongside employee benefits; and
  • Reduces--but does not eliminate--benefits following Medicare eligibility.

Notably, many retiree medical plans are exposed to escalating health care costs by the way their benefits are structured (for example, many explicit subsidy plans pay for a percentage of insurance premiums), which creates a unique budgetary challenge. Over the past two decades, health care costs have increased by an average of more than 6%, which is approximately 4% faster than inflation. If this trend continues, growth in health care costs will double in 12 years and rise, as a percent of state budgets, by 60% (assuming all else is equal). Some state OPEB plans cap their benefits at a certain dollar level per month; these plans have limited exposure to medical cost growth, though like pensions, risks other risks remain.

In addition, offering spousal and family coverage concurrent to employee benefits effectively doubles the cost of the health benefit paid to the employee.

As budgetary costs creep upward, they will represent an increasing share of state budgets. If a state already faces high fixed costs, these increases could further diminish budgetary flexibility. Because states generally have a legal claim to modify OPEBs, they could have several options to address these rising costs if they become unaffordable. However, waiting until costs become unaffordable to take action is not fiscally prudent, in our view, especially given practical limitations to plan adjustments.

For more information on benefits offered by state OPEB plans, please see "Retiree Medical Benefits Generate Unique Cost Drivers And Risks For U.S. States ," published Sept. 17, 2019.

Lack Of Prudent Fiscal Management Poses The Greatest Risk To State OPEB Plans

Historically, prudent fiscal plan management 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. Some notable exceptions include: Delaware's re-establishment of a retirement benefit study committee to assess options to address the state's unfunded liabilities (although any potential action is currently unknown), North Carolina's budget for fiscal 2018 that eliminated retiree health care for new hires beginning in 2021, and Tennessee's contributions are expected to fully fund actuarial determination.

Ultimately, our OPEB risk assessment focuses on the relative level of unfunded OPEB liability compared to other states, the legal and practical flexibility that a state has to adjust these liabilities, and the overall strategy to manage the cost of these benefits, which will affect future contribution rates and budgetary requirements.

While most states currently lack concrete plans to address their OPEB liabilities, we believe many will eventually attempt to address these liabilities through a combination of benefit modifications and pre-funding of the liability. But alterations to benefits are not always straightforward. Adjustments to OPEB benefits can be subject to many challenges such as negotiations with unions, which have resisted reductions to benefits. Other reforms, such as Illinois' attempt to modify its OPEB obligations, were ultimately ruled unconstitutional. Also, state governments have managed a longstanding tradeoff between lower wages than many private sector positions but stronger benefits. Reduction in benefits while maintaining lower wages could make it more difficult for states to attract and retain skilled workers. For these reasons, many states have not taken further action to reduce benefits. For more information on legal flexibility for OPEB plans, see "OPEB Brief: Risks Weigh On Credit Even Where There Is Legal Flexibility ," published May 22, 2019.

S&P Global Ratings believes progress in addressing unfunded OPEB liabilities, by either pre-funding or modifying benefits, could reduce state governments' credit risk. Ultimately, we believe material improvement in funding long-term obligations requires a sustained effort. While changes to benefit offerings and increases in funding could mitigate rising annual OPEB costs, which could challenge future budgets for some states, successful reform comes from continuing commitment from policymakers, potentially over many years.

U.S. States' OPEB Liabilities And Ratios
State Combined plan total OPEB liability (mil. $) Combined plan fiduciary net position (FNP) (mil. $) Combined plan net OPEB liability (NOL) (mil. $) Combined plan NOL per capita State's proportionate share of combined plan NOL (mil $)* State's proportionate share of combined plan NOL per capita Combined plan funded ratio (%) Combined plan total contributions as a % of static funding§ Combined plan total contributions as a % of minimum funding progress†

Alabama

12,737 1,613 11,124 2,276 5,391 1,103 12.7 35.9 25.5

Alaska

11,837 10,512 1,325 1,796 514 697 88.8 11.2 10.7

Arizona

3,016 2,322 694 97 694 97 77.0 31.4 28.9

Arkansas

2,184 0 2,184 725 2,184 725 0.0 40.0 27.2

California

88,269 1,090 87,179 2,204 87,179 2,204 1.2 35.5 25.4

Colorado

1,640 279 1,361 239 459 81 17.0 65.6 48.8

Connecticut

21,445 606 20,838 5,833 20,838 5,833 2.8 49.6 35.4

Delaware

8,592 382 8,210 8,489 7,422 7,674 4.4 36.5 25.3

Florida

21,628 232 12,197 573 9,445 443 1.1 60.5 48.0

Georgia

17,829 2,775 15,055 1,431 2,227 212 15.6 74.0 54.0

Hawaii

10,194 880 9,314 6,557 9,314 6,557 8.6 74.0 54.9

Idaho

100 0 100 57 100 57 0.0 90.3 61.6

Illinois

41,324 0 41,324 3,243 41,324 3,243 0.0 11.1 7.5

Indiana

640 183 456 68 456 68 28.6 78.2 58.7

Iowa

186 0 186 59 186 59 0.0 47.2 35.8

Kansas

N/A N/A N/A N/A N/A N/A N/A N/A N/A

Kentucky

8,783 2,913 5,871 1,314 3,933 880 33.2 63.3 50.5

Louisiana

8,639 0 8,639 1,854 8,639 1,854 0.0 57.9 36.4

Maine

2,639 328 2,311 1,727 2,084 1,557 12.4 60.9 43.3

Maryland

10,901 329 10,571 1,749 10,571 1,749 3.0 78.4 52.6

Massachusetts

16,100 1,191 14,909 2,160 14,909 2,160 7.4 36.6 27.4

Michigan

12,553 2,223 10,330 1,033 10,330 1,033 17.7 79.1 58.8

Minnesota

621 0 621 111 621 111 0.0 46.7 36.0

Mississippi

775 1 774 259 186 62 0.1 70.0 45.5

Missouri

3,164 130 3,034 495 3,026 494 4.1 62.9 43.8

Montana

86 0 86 81 86 81 0.0 32.8 23.5

Nebraska

14 0 14 8 14 8 0.0 82.3 62.1

Nevada

1,303 1 1,301 429 799 263 0.1 38.5 26.8

New Hampshire

2,725 37 2,687 1,981 2,198 1,620 1.4 40.7 29.3

New Jersey

90,487 0 90,487 10,157 90,487 10,157 0.0 29.2 20.3

New Mexico

5,006 658 4,348 2,075 1,049 501 13.1 76.4 55.6

New York

65,058 0 65,058 3,329 63,391 3,244 0.0 38.7 27.0

North Carolina

30,157 1,699 28,458 2,741 5,475 527 5.6 34.1 26.0

North Dakota

211 128 83 109 5 6 60.6 74.9 65.4

Ohio

30,181 15,522 14,659 1,254 3,203 274 51.4 16.5 13.8

Oklahoma

156 0 156 40 156 40 0.0 120.8 81.3

Oregon

684 612 72 17 158 38 89.4 117.6 106.4

Pennsylvania

22,709 0 22,279 1,740 22,279 1,740 0.0 46.8 32.9

Rhode Island

845 228 616 583 508 480 27.0 92.4 69.6

South Carolina

15,426 1,253 14,174 2,788 3,035 597 8.1 54.6 37.7

South Dakota

N/A N/A N/A N/A N/A N/A N/A N/A N/A

Tennessee

1,283 0 1,283 190 1,050 155 0.0 69.4 54.8

Texas

99,159 1,179 97,980 3,414 75,527 2,631 1.2 29.8 21.9

Utah

367 265 102 32 102 32 72.3 157.6 134.5

Vermont

2,168 (5) 2,173 3,469 2,152 3,436 (0.2) 37.8 26.3

Virginia

5,955 2,119 3,836 450 2,243 263 35.6 66.9 8.5

Washington

5,826 0 5,826 773 5,826 773 0.0 16.3 12.2

West Virginia

3,109 963 2,145 1,188 1,781 986 31.0 76.0 60.0

Wisconsin

719 0 719 124 719 124 0.0 40.1 32.1

Wyoming

805 0 805 1,394 308 533 0.0 20.2 15.5
Total 690,232 52,648 627,955 82,713 524,584 67,463 - - -
Median 4,085 230 2,860 1,221 2,191 530 2.9 52.1 35.9
Average 14,380 1,097 13,082 1,723 10,929 1,405 15.3 56.4 41.4
OPEB--Other postemployment benefits. N/A--Not applicable. *Each state's proportionate share of the combined plan NOL is weighted per plan and summed. §Static Funding is calculated as service costs plus unfunded interest costs. †Minimum funding progress is calculated as static funding plus 1/30 of the unfunded liability. We have excluded several minor OPEB plans that do not offer medical benefits. Kansas and South Dakota do not report liabilitiy for retiree health care benefits. Arizona's Public Safety Personnel Retirement System and Corrections Officer Retirement Plan plans plans are excluded from our calculation of static funding and minimum funding progress because a schedule of changes to the NOL was not publically available; both plans are overfunded. California's Trial Courts plan is excluded from our calculation of static funding and minimum funding progress because the state does not disclose schedules of changes to the NOL for the 58 trial courts reported as a part of the primary government in its comprehensive annual financial report.

Related Research

  • Retiree Medical Benefits Generate Unique Cost Drivers And Risks For U.S. States, Sept. 17, 2019
  • OPEB Brief: Risks Weigh On Credit Even Where There Is Legal Flexibility , May 22, 2019
  • U.S. State Rating Methodology, Oct. 17, 2016

This report does not constitute a rating action.

Primary Credit Analysts:Jillian Legnos, Hartford (1) 617-530-8243;
jillian.legnos@spglobal.com
Todd D Kanaster, ASA, FCA, MAAA, Centennial + 1 (303) 721 4490;
Todd.Kanaster@spglobal.com
Secondary Contacts:Timothy W Little, New York + 1 (212) 438 7999;
timothy.little@spglobal.com
Carol H Spain, Chicago (1) 312-233-7095;
carol.spain@spglobal.com

No content (including ratings, credit-related analyses and data, valuations, model, software or other application or output therefrom) or any part thereof (Content) may be modified, reverse engineered, reproduced or distributed in any form by any means, or stored in a database or retrieval system, without the prior written permission of Standard & Poor’s Financial Services LLC or its affiliates (collectively, S&P). The Content shall not be used for any unlawful or unauthorized purposes. S&P and any third-party providers, as well as their directors, officers, shareholders, employees or agents (collectively S&P Parties) do not guarantee the accuracy, completeness, timeliness or availability of the Content. S&P Parties are not responsible for any errors or omissions (negligent or otherwise), regardless of the cause, for the results obtained from the use of the Content, or for the security or maintenance of any data input by the user. The Content is provided on an “as is” basis. S&P PARTIES DISCLAIM ANY AND ALL EXPRESS OR IMPLIED WARRANTIES, INCLUDING, BUT NOT LIMITED TO, ANY WARRANTIES OF MERCHANTABILITY OR FITNESS FOR A PARTICULAR PURPOSE OR USE, FREEDOM FROM BUGS, SOFTWARE ERRORS OR DEFECTS, THAT THE CONTENT’S FUNCTIONING WILL BE UNINTERRUPTED OR THAT THE CONTENT WILL OPERATE WITH ANY SOFTWARE OR HARDWARE CONFIGURATION. In no event shall S&P Parties be liable to any party for any direct, indirect, incidental, exemplary, compensatory, punitive, special or consequential damages, costs, expenses, legal fees, or losses (including, without limitation, lost income or lost profits and opportunity costs or losses caused by negligence) in connection with any use of the Content even if advised of the possibility of such damages.

Credit-related and other analyses, including ratings, and statements in the Content are statements of opinion as of the date they are expressed and not statements of fact. S&P’s opinions, analyses and rating acknowledgment decisions (described below) are not recommendations to purchase, hold, or sell any securities or to make any investment decisions, and do not address the suitability of any security. S&P assumes no obligation to update the Content following publication in any form or format. The Content should not be relied on and is not a substitute for the skill, judgment and experience of the user, its management, employees, advisors and/or clients when making investment and other business decisions. S&P does not act as a fiduciary or an investment advisor except where registered as such. While S&P has obtained information from sources it believes to be reliable, S&P does not perform an audit and undertakes no duty of due diligence or independent verification of any information it receives. Rating-related publications may be published for a variety of reasons that are not necessarily dependent on action by rating committees, including, but not limited to, the publication of a periodic update on a credit rating and related analyses.

To the extent that regulatory authorities allow a rating agency to acknowledge in one jurisdiction a rating issued in another jurisdiction for certain regulatory purposes, S&P reserves the right to assign, withdraw or suspend such acknowledgment at any time and in its sole discretion. S&P Parties disclaim any duty whatsoever arising out of the assignment, withdrawal or suspension of an acknowledgment as well as any liability for any damage alleged to have been suffered on account thereof.

S&P keeps certain activities of its business units separate from each other in order to preserve the independence and objectivity of their respective activities. As a result, certain business units of S&P may have information that is not available to other S&P business units. S&P has established policies and procedures to maintain the confidentiality of certain non-public information received in connection with each analytical process.

S&P may receive compensation for its ratings and certain analyses, normally from issuers or underwriters of securities or from obligors. S&P reserves the right to disseminate its opinions and analyses. S&P's public ratings and analyses are made available on its Web sites, www.standardandpoors.com (free of charge), and www.ratingsdirect.com and www.globalcreditportal.com (subscription), and may be distributed through other means, including via S&P publications and third-party redistributors. Additional information about our ratings fees is available at www.standardandpoors.com/usratingsfees.

Any Passwords/user IDs issued by S&P to users are single user-dedicated and may ONLY be used by the individual to whom they have been assigned. No sharing of passwords/user IDs and no simultaneous access via the same password/user ID is permitted. To reprint, translate, or use the data or information other than as provided herein, contact S&P Global Ratings, Client Services, 55 Water Street, New York, NY 10041; (1) 212-438-7280 or by e-mail to: research_request@spglobal.com.


Register with S&P Global Ratings

Register now to access exclusive content, events, tools, and more.

Go Back