R.I. towns and cities look beyond pension liabilities to an even bigger problem: OPEBs

PROACTIVE APPROACH: Warwick Mayor Scott Avedisian speaks with his press secretary, Courtney Marciano, at his office. Avedisian suggested creating a statewide OPEB trust to help small local plans. / PBN PHOTO/MICHAEL SALERNO
PROACTIVE APPROACH: Warwick Mayor Scott Avedisian speaks with his press secretary, Courtney Marciano, at his office. Avedisian suggested creating a statewide OPEB trust to help small local plans. / PBN PHOTO/MICHAEL SALERNO

Editor’s note: This is the third of a four-part series exploring how well Rhode Island cities and towns are funding municipal pension and benefit plans and the public-policy ramifications.

Leading up to the financial crisis of 2008, cities and towns in Rhode Island and throughout the country enjoyed pre-recession revenue surpluses made available by the bubble-year economies of 2006-07.

Flush with cash, and unaware of the subsequent market crash, municipal leaders were faced with budget options: use the excess money to fund new, short-term projects or pay down old, long-accumulating obligations, such as pension liabilities and other post-employment benefits, known as “OPEBs.”

Rhode Island cities and towns by and large chose the former and allocated excess funds toward new programs, new hires and salary increases. Shortly thereafter, the global economy plummeted, having a trickledown effect on local municipalities that were left to struggle through the worst recession since the Great Depression.

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Budgets tightened, and while earlier choices had not put resources toward those overlooked long-term obligations, now municipalities had no choice. They had no money to put away. And the combination of those earlier choices and the effects of the Great Recession have allowed unfunded OPEB liabilities for 52 locally administered public plans to exceed $3 billion – an amount most likely understated.

“OPEBs are kind of the elephant in the room,” said Mark Higgins, former dean of the College of Business Administration at the University of Rhode Island. “That’s why Rhode Island has a problem with paying for its infrastructure. That’s why it has a problem paying for its education.”

OPEBs are all benefits other than pensions that are given to employees after retirement, but the majority of costs are tied to health care. Like pension liabilities, the cost of funding these OPEB obligations is growing quickly. Unlike pensions, however, the costs among municipalities are much greater than with the state, for which the OPEB liability totaled $778.3 million in fiscal 2015, according to a state fiscal audit. Municipal employees – comprising a greater number of public safety workers – on average retire at an earlier age than state workers, which extends the payment timeline and exacerbates the post-employment liability.

“If you thought the local pension systems were bad news, guess what’s coming next?” Higgins said of OPEBs.

R.I. Department of Revenue director Robert S. Hull told Providence Business News earlier this year that OPEB costs represent an impending crisis because there’s presently no clear answer for how to handle the soaring costs.

New accounting standards that go into effect next year will start giving taxpayers a clearer picture of exactly how much these unfunded amounts are impacting local budgets, which has sparked some public policy action and has municipal leaders worrying about the potential fallout.

“I liken it to sewer construction: It’s under the ground, very few people see it, but it’s a need, and we need an answer,” said Scott Avedisian, Warwick mayor.

THE DANGERS OF UNFUNDED OPEBs

The majority of Rhode Island cities and towns have zero, or next-to-zero, money set aside to pay for these unfunded liabilities, which the state estimates exceeds $3 billion in aggregate and is funded at 1.4 percent, according to the R.I. Division of Municipal Finance.

Because there’s no money set aside, the liabilities – funded on a pay-as-you-go basis each year – eat away at an increasing pace on yearly operating budgets, making it more difficult for municipalities to pay for anything outside of benefit costs.

“That [liability] is increasing each year and that number is significant,” said Kathryn Cannie, senior consultant at the Public Agency Retirement Services, which helps public entities set up OPEB funding programs throughout the country.

The trend is playing out in municipalities throughout the state and country, but its impact is well-demonstrated in Providence, where the unfunded costs are hitting the city especially hard.

The total unfunded OPEB liabilities totaled $1 billion in 2013, according to the most recently available actuarial evaluation done by Segal Consulting, which estimates the unfunded costs could grow 41.8 percent – or $431.5 million – within a decade to total $1.5 billion by 2024. To date the city has set no money aside for those growing liabilities.

“They’ve kicked the can down the road too far,” Higgins said of Providence. “I don’t think [they] can kick it any further.”

The city – like most other municipalities – has long operated on a pay-as-you-go basis, because for decades health care costs were relatively inexpensive and reporting requirements dictating any need to prefund were nonexistent. But that’s changed, and unless there’s some action to prefund OPEB liabilities, those yearly costs – and future obligations – will continue to grow dramatically. By example, the amount of funds transferred into the city’s retiree medical insurance fund has grown 144.9 percent from $10.3 million in fiscal 2012 to $25.1 million in fiscal 2017, according to the city budget. At the same time, funding put toward the active employee medical insurance fund grew 14.5 percent to $19.3 million in fiscal 2017.

And the city is largely moving in the wrong direction in terms of funding practices.

In 2008, the city contributed 88.2 percent – or $35.6 million – of its $40.4 million actuarially required contribution, or ARC, which is an amount actuaries determine should be paid to cover current and future OPEB liabilities. By 2014, the city was projected to pay 45 percent – or $29.6 million – of the yearly cost, which had grown in the interim to $65.8 million. And that total liability could have been even higher if the city had not shifted retirees to Medicare as part of a reform instituted by former Mayor Angel Taveras.

To break those numbers down further, in 2013, there were 4,688 active employees covered for medical benefits and 4,139 retirees covered for medical benefits. That means the average OPEB liability totaled $147,581 per retiree and $90,027 per active employee, according an analysis done by R.I. Auditor General Dennis E. Hoyle that separated the cost for both groups.

Higgins, now the dean of the John Cook School of Business at Saint Louis University in St. Louis, is a certified public accountant. In 2011, he served on a pension advisory committee for Gov. Gina M. Raimondo, who then served as general treasurer. The committee examined the long-term cost effects of pensions and OPEBs.

The state passed legislation overhauling the state-administered pension system in 2011, but very little was done with regard to local pension systems, which are underfunded by $2.3 billion. Even less has been done to address OPEBs.

Higgins sees a clear correlation between the rising costs and the trend of municipal workers.

“The fact that people live longer and health care is improving, it increases costs,” Higgins said. “The systems are dried up by people being able to stay on the plans and retire at 52 years old, not contributing a whole lot to these plans.”

Municipalities are searching for ways to try to slow these rising costs, asking retirees to pay more and dropping other family members from benefit plans. Most municipalities are now moving retirees over to the Medicare system after they reach the eligible age of 65 to take the cost off the local books.

Other municipalities are waiting for collective bargaining agreements to expire with local unions to see if benefit packages can be renegotiated to alleviate some of the long-term burdens.

But union reps, including Paul A. Doughty, president of Local 799 International Association of Firefighters in Providence, are skeptical about why they should receive less for obligations municipalities promised in the past. Mayor Jorge O. Elorza and city firefighters have been at odds since he took office in 2015 and attempted to lower costs by changing shift schedules from four platoons working on average 42 hours per week to three platoons working on average 56 hours a week. The change has infuriated union members, resulting in a large number of retirements, and the subsequent political fallout doesn’t bode well for future contract negotiations.

“This has consequences in OPEBs,” Doughty said about the current state of affairs in Providence. “You have to have a fairly good relationship to even start this conversation, and that does not even exist. There’s no situation, based on what he’s done to us, where I’d engage in a conversation to fix this.”

There’s been widespread discussions about whether Providence could, or should, be headed for municipal bankruptcy if it doesn’t shore up its finances. Its bond ratings have hovered one level above junk-bond status since 2012 and ballooning long-term liabilities put the city in a precarious position economically. To go into bankruptcy would put a court-ordered receiver in charge and all existing contracts with local union members could be broken, similarly to what happened in Central Falls in 2011. Post-bankruptcy negotiations left the city’s union members receiving much less than what was promised.

Nonetheless, given the current situation in Providence, Doughty says entering into receivership may not be the worst-case scenario for his members.

“For me, I would rather the city go into bankruptcy because I would be able to deal with a more reasonable person in the receiver,” he said. “It’d be more desirable than the situation I’m in now. It’s that bad.”

THE BALANCE SHEET

To try to understand the breadth of the OPEB issue locally, a state-run commission last year completed a study looking at 52 locally administered public plans, including those for 39 cities and towns, nine school zones and four regional school districts.

Fourteen of the 52 local plans had prefunded OPEB at any level, meaning 38 had nothing put away to cover the liabilities. Charlestown had the greatest funded ratio – a tally of assets available to pay liabilities – totaling 33.5 percent. But the prefunded amounts are barely a drop in the proverbial bucket, as the aggregate funded ratio was 1.4 percent, according to the report.

“Most plans are paying for benefits on a pay-as-you-go basis and the liabilities are substantial,” according to the report. “On a national level, many consider this unfunded liability perhaps more critical than pension issues due to the varied nature of the bundle of benefits provided in the plan.”

It’s highly likely that the $3 billion unfunded liability has grown to greater levels since the report was completed, as many of its estimates were gathered from fiscal 2012, when the cost of care for a typical U.S. family of four totaled $20,728 compared with $25,826 in 2016, according to the Milliman Medical Index.

Likewise, the state’s report didn’t include any costs from 26 of the 94 special-purpose districts in Rhode Island that offer OPEBs. Special-purpose districts include fire districts, school districts, housing authorities, water authorities and sewer authorities.

Since the report was completed, a faction of new local entities has begun to put away small amounts in an attempt to prefund OPEB systems. Avedisian is credited with coming up with the idea in 2009 to get out in front of this issue, when he suggested creating a statewide OPEB trust could help small local plans pool assets to try to leverage lower administrative costs and fees. The action could result in funding levels rising at a greater pace.

“The numbers are daunting, but the whole idea is that you’ve got to do something,” Avedisian said. “You have to. I don’t think you can go in and just get rid of the benefits that have been contracted for years.”

In 2012, the General Assembly passed legislation giving the Rhode Island Interlocal Risk Management Trust the authority to create an OPEB funding program, and the intergovernmental insurance risk-sharing pool partnered with the national group, PARS, to launch the project last year. The program’s OPEB trust fund now comprises 18 members with assets totaling about $26 million. According to Interlocal Trust Director of Operations and Member Services Colleen M. Bodziony, it does not know what the total liabilities of participating entities are, both because it is too soon in the project to know and because “it is not relevant for what we do for our members.”

“Some are now starting to understand that it’s so big that they need to start moving toward curtailing some of those benefits a little bit,” said Ian C. Ridlon, president and executive director of the Interlocal Trust.

Other municipalities, such as Middletown, were already working toward funding the long-term obligations. The state’s report says Middletown OPEB unfunded liability totaled $26.1 million with a funded ratio of 11.3 percent. But Marc W. Tanguay, town finance director, says the town has grown that funding level to 17.6 percent last fiscal year compared with 11.3 percent in 2012, which he says has been no easy task.

“We’re proud of the percentages of funding we have because we do work hard at it,” he said. “I think it gives us a lot of credibility with the residents and the employees because they know we take it seriously.”

So why don’t more people start funding OPEB obligations?

“Lack of money,” said Bodziony. “There isn’t anyone who’s opposed to doing this. It’s just a question of where are they going to find the money to fund it?”

Indeed, even in Warwick, where the idea for an intergovernmental trust fund was born, the city is still working toward paying down its unfunded pension liabilities, leaving little money left to put toward another long-term debt payment. There’s also a matter of political will, as Avedisian tried to allocate $100,000 toward its OPEB system last fiscal year, but the proposal was shot down by the City Council. This year, he proposed $50,000, which was approved, but he’s still awaiting approval to set up the trust and without that approval the money will go back into the city’s general fund.

Paying down long-term debts, as Higgins points out, isn’t typically considered as much of a political win as funding other projects in the short term.

“You don’t get elected by focusing on the balance sheet,” he said. “You get elected by focusing on the income statement.” •

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