Mayday, Mayday, Mayday! the County Drifts Ever Closer to the “opeb” Rocks Growing Retiree Health Care Costs Demand

The Contra Costa County Board of Supervisors has the responsibility to resolve the County’s unfunded OPEB liability issues.

In April 2001, an independent actuarial firm report to the County identified the unfunded OPEB liability for County retirees.

The subject of the unfunded OPEB liability has been the topic of three previous Contra Costa County Grand Jury reports: • Report No. 0404, “Take Action Now to Reduce Costs of Retiree Health Insurance” issued in 2004. • Report No. 0508, “Code Blue: County Health Care Costs” issued in 2005. • Report No. 0606, “County Ignores Retiree Health Costs: The Financial Tidal Wave” issued in 2006.

In 2006, an outside consultant hired by the County issued a report that suggested the County set aside $216 million annually for the next 30 years to close the unfunded health care obligation gap.

In April 2007, the Board of Supervisors gave preliminary approval to a fiscal year 2007-08 budget that provides only $33 million (vs. $216 million) to cover the cost of health care benefits for the County’s retirees and their eligible dependents.

The County provides combined medical and dental plan benefits to active employees, qualified retirees, and dependents of both groups. The County subsidizes most of the health care insurance premiums at rates varying from 80% to 98% for the medical plans and from 78% to 98% for the dental plans.

The County provides combined medical and dental plan benefits to approximately 7,800 active employees, 4,200 retirees, 330 surviving spouses of retirees and 16,000 reported dependent spouses, children and domestic partners for active and 3 retired employees. Approximately 28,000 individuals currently rely on the County for employment related health care benefits.

Health care coverage for County retirees is a benefit of employment earned during employment and largely paid for by the County after retirement.

The County does not currently require retirees to secure Medicare Part B medical coverage once they reach Medicare-eligible age, but allows them to continue to rely on the County’s medical and dental health benefit plans available to active employees as their primary coverage.

County deputy sheriffs, firefighters, and their dependents are not covered by the County’s medical and dental plans. These “safety” employees participate in the California Public Employees Retirement System (“CalPERS”) medical and dental plans under the terms of their labor contracts with enrollment conditions set by CalPERS. The County subsidizes the CalPERS insurance premiums at a rate comparable to that paid on behalf of other County employees.

Like many other public employers, the County reports the cost of retiree health benefits in their “Comprehensive Annual Financial Reports” during the employee’s retirement years when the health insurance benefits are received by the retiree (cash basis, also known as “pay-as-you-go” or “PAYGO”), rather than during the employee’s active service when the benefits are earned (accrual basis).

Retiree medical benefit costs, using the PAYGO basis of accounting, have been growing at approximately 15%, compounded annually, for the last five years - growing from $15.9 million in fiscal year 2001-02 to $32.4 million for the current fiscal year 2006-07. This growth is more than double the rate of overall County expenditures and two-and-a-half times faster than revenue growth over the same period.

Governmental Accounting Standards Board Statement Number 45 (“GASB 45”), “Accounting and Financial Reporting by Employers for Post-Employment Benefits Other Than Pensions,” sets an accounting standard analogous to the governmental pension accounting standard. This standard requires the calculation and disclosure of an unfunded liability for government employee retiree health care benefits similar to the method already in place for recognizing the cost of government employee pensions.

GASB 45 accounting standards become effective with the County’s fiscal year 2007-08, which begins July 1, 2007. Under these standards, the County must: • Disclose the unfunded liability for health benefits (and other post- employment benefits other than pensions, that continue to be disclosed separately) that have been earned by all active and retired employees. 4 • To the extent they remain unfunded, increase its annual health care benefit cost to include the normal cost of benefits as they are earned, plus an amount that amortizes (funds over time on a systematic basis) the unfunded liability over a period not to exceed 30 years. • Disclose the County funding policy for medical and dental benefits earned by active and retired employees to date and report this resulting liability.

An independent actuarial firm hired by the County analyzed the County’s OPEB unfunded liability as of January 1, 2006 using two discount rate assumptions: (1) 4.5%, which relates to the current PAYGO method and (2) 7.9% which reflects the economics of a funded trust plan based on GASB 45. The results follow: Contra Costa County Retiree Health Care Costs (Dollars in Millions) Annual Required Contribution3 Discount Unfunded Liability Normal Total Rate1 Liability2 Amortization4 Cost5 Contribution6 4.5 % $2,571 $86 $130 $216 7.9 % 1,425 48 55 103 Notes: 1) Discount rate is the annual rate by which future payments are adjusted to reflect the current value of the obligation; 2) Unfunded liability refers to the total current value of a stream of future payments for which money has not been set aside; 3) Annual Required Contribution consists of the Normal Cost plus a portion of the total unfunded accrued actuarial liability amortization for the year; 4) Liability Amortization is the annual payment necessary to pay off a specific liability over a fixed period of time, in this case 30 years; 5) Normal cost is amount necessary to meet the current expense of the benefit earned during the period regardless of when the amount will be paid; and 6) Total Contribution consists of the Liability Amortization and Normal Costs.

Options to address the OPEB liability discussed to date by the County’s consultant and County staff in public meetings include: • Continue the current PAYGO funding method that will minimize the short-term budget impact but will have long-term budget implications as deferred health care benefit costs continue to accelerate and current costs, earned by active employees, are added to the liability. • Modify the existing medical and dental benefit plans by changing eligibility requirements, coverage amounts, deductibles, co-pays, co- insurance, changing the amount the County contributes towards coverage and the separation of the health care costs incurred by the active employees and retired participants. • Establish and partially pre-fund an irrevocable trust that will enable the County to reduce reported liability and Annual Required Contribution by 5 allowing the County to use a higher discount rate. (An irrevocable trust is a separate legal entity created to hold assets dedicated to meeting the obligations to the entitled beneficiaries of the trust.) • Combining options by modifying the current health care plans and conditions of retirement coverage plus partially pre-funding the existing liability using an irrevocable trust.

Creating an irrevocable trust to secure the pre-funded assets against other uses, and funding it annually, would minimize the reported liability and reduce the required minimum annual amortization amount.

The County does not currently have a separate irrevocable trust for paying retiree health benefits.

According to the “Comprehensive Annual Financial Report” as of June 30, 2006, the County’s debt limit (five percent of valuations subject to taxation) was $6.6 billion. The total amount of debt applicable to the debt limit was $0.7 billion, net of assets in the debt service funds and other deductions allowed by law. This would enable the County to issue an additional $5.9 billion of debt.

The County has issued pension obligation bonds to lock in interest rates significantly below the discount rate used by the Contra Costa County Employees Retirement Association Trust, thereby reducing the annual payment due from the County. As of June 30, 2006, $667 million of pension obligation bonds were still outstanding. The history of previous successful pension obligation bond issues follows: • In 1994, the County issued $337 million in taxable pension obligation bonds. • In 2001, the County restructured these bonds with a new issue in the amount of $107 million. • In April 2003, the County issued $323 million in taxable pension obligation bonds. • In July 2005, the Contra Costa County Fire Protection District issued $130 million in taxable pension obligation bonds.

Federal and state reimbursements for mandated services (e.g., health and social) provided by the County account for approximately 55% of the County’s total operating budget. Federal and state guidelines that establish the principles and standards for allowable reimbursements include some pre-funding costs. However, the extent to which pre-funded health benefit costs are reimbursable by the federal and state governments has not yet been formalized.

Credit rating agencies have indicated that management of the retiree health care liability will influence credit ratings for public agencies. Contra Costa County, 6 like other counties, cities and special districts, and even states, are likewise required to report unfunded OPEB liability, if they follow GASB 45.

An outside consultant hired by the County has advised that the credit rating agencies will look favorably on public agencies that develop mitigation plans and demonstrate progress in implementing those plans to address the OPEB liability.

County employees, other than safety employees (deputy sheriffs and firefighters), employed on or after January 1, 2007, must have worked for the County for 15 years, and have retired directly from the County, to receive retiree health care benefits.

The County does not segregate the costs of medical and dental plan coverage for active employees and retirees. Instead, it combines or “pools” the costs for both groups and calculates a common or “blended” premium rate that is applied to all eligible parties. This has the effect of masking the higher health care costs for retirees and means the active employees, with their relatively lower health care requirements, subsidize a portion of the higher cost of providing benefits to retirees.

When Medicare Part B medical benefits are assigned to the County’s insurance carriers, Medicare becomes the primary provider, leaving the County responsible only as a secondary provider. Retirees covered by Medicare are given credit for Medicare Part B premiums they pay directly to Social Security. Medicare health benefits are not uniformly assigned to the County’s health plan carriers to help pay for the participants’ medical care. The current coverage rules result in higher costs being absorbed by the County.