Monday, June 5, 2006 | The San Diego City Schools District hired Mary McDonald as a teacher in 1966. While McDonald had a passion for children, the generous health care benefits the district offered its employees also lured her to the job.

Through the Cracks

  • The Issue: Scientists are beginning to better understand the role air pollutants play in contaminating watersheds. But no regulations govern the sources: car tires and brakes.
  • What it Means: No one is sure whose responsibility the pollution prevention should be. Air regulators say it is a water problem. Water regulators say it is a local government problem. Local governments say it is a federal government problem.
  • The Bigger Picture: The state isn’t regulating the sources, but is requiring local governments such as the city of San Diego to reduce the pollution. State officials acknowledge the issue has fallen into a regulatory gap, but haven’t yet fixed it.

“One of the things that attracted me to the district — since generally teachers are paid lower than in the private sector — was that they had good and secure retirement benefits,” said McDonald, who retired in 1991 after teaching at Point Loma High School and working as a counselor at Lincoln High School.

Like most retired government employees, McDonald remained enrolled in the district’s employee health care plan after she retired at age 60. She remained in the health care plan until she turned 65, at which point the coverage expired because she was eligible to enroll in Medicare.

“It was fine coverage. I’ve never had any complaints about my health care, because I’ve always stayed with the same doctors,” McDonald said.

To its benefit, the San Diego City Schools District is no longer on the hook for McDonald’s pricey health care coverage.

While the district didn’t know it back when McDonald’s benefits were approved, a group of seven accountants huddled together two years ago and hurled a snowball down a hill toward school districts like San Diego’s. By the time it gets here, the ball could become a devastating avalanche. This avalanche goes by an innocent name: Government Accounting Standards Board Statement Number 45.

A Leap in Liability

The Government Accounting Standards Board, referred to as GASB (GAZ-bee), is a make suggestions on what information governments need to include within their official financial statements.

GASB’s recommendations are just that — recommendations. But once the group issues a statement, credit rating agencies and bond-buyers expect governments to abide by it if they want to borrow money.

Issued in 2004 and coming into effect this year, GASB 45 requires all governments within the United States — including states, cities, counties, public universities, community colleges, school districts, and infrastructure authorities (like the San Diego County Water Authority) — to report the cost of future retiree health care benefits as present day liabilities.

For example, a state government responsible for a 60-year-old retired employee’s lifetime health care costs is forced to estimate the cost of the retiree’s health care from present day to the estimated year of the employee’s death. Once the cost is determined, the state adds it as a liability to its current balance sheet, which is then reported to credit rating agencies — and credit rating agencies don’t like it when health care liabilities go way up.

In fact, bond rating agencies will lower governments’ bond ratings because of excessive liabilities, which prevent governments from borrowing money at low interest rates.

Before GASB 45, governments were only required to report the present day health care costs of their current and retired employees in a process referred to as the “pay-as-you-go” method.

In other words, even though government agencies know that they owe their employees health care coverage for the next few decades, and they can reasonably estimate how much that will cost, they haven’t been required to before. So rather than put money aside — even invest it in order to ease the future burden — most agencies have simply paid what they needed to each year to keep their retirees insurance up to date.

So, what does this mean to governments big and small?

It means their debts may grow exponentially within the next three years, as GASB 45 is implemented throughout the country. Beginning implementation this year are large governments, including school districts, and the biggest school district loser nationwide is the Los Angeles Unified School District (LAUSD).

LAUSD’s actuary reported recently that the district’s liabilities, stemming only from retiree health care costs to be accrued over the next thirty years, amount to an additional $5 billion to be reported on this year’s financial statement. A $5 billion jump in liability, all within one year.

Yes, GASB 45 is that serious.

The Best Prepared

GASB adopted Statement 45 to thwart the negative effects that skyrocketing health care costs, overly generous public-sector health care benefit packages, and people living longer than ever before are having on government balance sheets.

“What motivated us was the recognition that generous post-retirement benefits were proliferating throughout the country. Promises were being made to attract employees,” said Professor Bill Holder, a member of GASB and the Ernst and Young Professor of Accounting at the University of Southern California’s Leventhal School of Accounting.

Some governments, specifically school districts, were smarter than others years ago when they set their benefits.

Like the San Diego City Schools District, the Chula Vista Elementary School District, the second largest school district in the county, withdraws retirees from the district health care plan once they become eligible for Medicare.

Chula Vista, and to a lesser extent San Diego City Schools, goes even further in reducing the size of the district’s health care liabilities.

The Chula Vista District pays no more than $3,800 per year in health care costs per retired employee and caps the amount of health care coverage for current employees at $7,510 per family per year.

“Our overall liability for retirees might only be around $4 million, a very manageable number. We don’t expect our long-term liability to be any more than that. We are one of the districts that doesn’t have anything to worry about,” said Susan Fahle, the Assistant Superintendent of the Chula Vista district.

In San Diego City Schools, just as in Chula Vista, the district’s retirees are enrolled in a defined-contribution health care plan rather than a defined-benefit plan.

The difference between a defined-contribution plan and a defined-benefit plan is critical to understanding the esoteric field of public financial management.

A defined-benefit plan is based upon the blithely made promises a government offers its employees. One common example of a defined-benefit a government might promise is “health care for life” without placing any caps on the amount the government is willing to pay to meet the cost of that benefit and deferring the payment of this benefit to some future date.

A defined-contribution plan limits the amount a government will pay its employees in benefits, by, for example, capping the annual amount a government is willing to pay for an individual retiree’s health care at $5,000 and leaving the rest to the retiree.

For a government, a defined-contribution plan is the way to go.

While the San Diego City School District’s defined contributions are not as narrow as those in Chula Vista, as they vary by job classification and union bargaining unit, they do help protect the district from excessive costs.

“I’ve often said that my predecessors were very wise to establish this kind of a program rather than a defined-benefit program. We believe it limits our exposure to higher liabilities,” said Scott Patterson, the Chief Financial Officer of the San Diego City Schools District.

The Most Vulnerable

While the two biggest school districts in San Diego appear to be safe from the sharpest teeth of GASB 45, at least for now, like the Los Angeles school district, other governments are not so lucky.

Professor Holder, of GASB, cites one city, far north of San Diego and quite a bit colder, as the worst case scenario of a government with runaway health care costs that will leap off a financial statement when reviewed by a bond rating agency — the city of Duluth, Minnesota.

Beginning in 1983, the city of Duluth began offering lifetime health care coverage to any city employee who worked for the city for a minimum of five years, their spouses, and their children until age 26. These benefits came within a defined-benefit program, unrestrained by a financial cap, and not ceasing when employees became eligible for Medicare.

At the time, the city needed to cut a deal with employees and decided providing retirees with health care coverage was a low-cost enticement. The city agreed to the generous health care contributions in exchange for employee unions agreeing to scale back the number of unused sick leave and vacation days that employees could cash in upon retirement.

The city’s actuary completed a report in October 2005 that estimates the cost to the city of providing roughly 1,000 retired employees with health care at more than $280 million — four times the annual operating budget of the city.

Duluth is facing an enormous increase in its liabilities listed on its 2006-2007 financial statement, the first year governments with total revenues of $100 million or more have to abide by GASB 45. Governments with revenues between $10 million and $100 million have to begin reporting in the 2007-2008 fiscal year and governments with less than $10 million in revenues begin reporting in the 2008-2009 fiscal year.

The crisis in Duluth leads to an obvious question for any resident of San Diego who has grown so familiar with the city’s pension crisis — how will the embattled city of San Diego fare with the implementation of GASB 45?

There lies some ambiguity in this answer, but a raw conclusion quickly arises — badly.

“I don’t know if the city is ready to quantify the cost of retiree health care costs. Part of the problem is that it is not at all clear what the city is legally required to pay in terms of post-retirement health care benefits,” said April Boling, an accountant who served as the vice chairwoman of the Blue Ribbon Committee on City Finances.

Boling’s comments echo the conclusions of Penni Takade, a policy and fiscal analyst for the San Diego City Council’s Independent Budget Analyst (IBA). Takade cites the lack of clarity in determining how many retirees are enrolled in the city’s defined-benefit health care plan, which guarantees health care coverage for life to retired city employees.

“The health care benefits of retired city employees are very complex. There is a question as to when people vested into the system. The city is falling on the side of assuming employees are vested,” said Takade, who added that the city’s actuary recently estimated the city’s health care liabilities to be around $1 billion.

Combined with the city’s $1 billion pension deficit and an estimated $1 billion infrastructure deficit, $1 billion in additional liabilities in this fiscal year is a Herculean slap to the city’s books.

To help begin paying off the liabilities, Takade said that the IBA supports a proposal by Mayor Jerry Sanders to place $5 million into an interest-bearing special trust fund to begin paying for retiree health care costs exclusively. Sanders’ proposal will be voted on by the City Council in the upcoming weeks.

Assuming Sanders’ proposal is adopted by the City Council, and there is no guarantee of this, that new trust fund is only a $5 million down payment on a $1 billion liability — a solution similar to trying to hydrate Death Valley by pouring a beaker of water onto the dry desert floor.

While the city of San Diego has some serious problems emanating from GASB 45, school districts all over the state face their own GASB liabilities.

“School districts considered offering retiree health care a relatively low-impact decision, and now the promises are coming home to roost. We estimate that about half the districts in the state offer post retirement non-pension benefits. These benefits are relatively modest, including health care until age 65. It is a handful of the largest districts that put together health care packages till death that have the biggest problem,” said Scott Plotkin, the Executive Director of the Sacramento-based California School Boards Association.

What School Districts are Doing

San Diego County School Districts are preparing for GASB 45 in a variety of ways.

“I think GASB 45 will have a dramatic effect on school districts and I anticipate that in the future it will have to be funded,” said Lora Duzyk, Assistant Superintendent for Business Services for the San Diego County Office of Education, which advises the 42 school districts within San Diego County on how to abide by state and federal education requirements.

Duzyk is currently visiting with San Diego school district financial officers and explaining how best to follow GASB 45. She tells districts to select an independent actuarial firm to perform a liabilities analysis and she makes sure districts know their GASB 45 implementation dates.

Some districts know more than others.

“We have no idea what our liabilities could be. Our external auditor is writing an opinion right now,” said San Diego City Schools’ Patterson.

Patterson said that San Diego City Schools’ labor contracts run out on June 30 and reducing the contributions the district makes into current employees’ health care plans to limit GASB 45 liabilities “is in the universe of possibilities” of the various strategies the district might use during labor negotiations.

Marilyn Jones, the vice president and chief actuary for the Epler Company, a San Diego-based actuarial consulting firm for employers, is currently working for about a dozen San Diego County school districts, including the Chula Vista Elementary School District, to estimate their GASB 45 liabilities.

Jones said that aside from beginning to pay down the costs of health care liabilities, districts have limited options in dealing with GASB 45.

“Districts can do some prefunding, but a significant factor against this is budget constraints. Some districts have begun to put money aside to pay for benefits in the future, or they are limiting benefits because they don’t have the budget to start paying for them now. Some districts are reducing promises to new and future employees and some districts are taking the wait-and-see attitude,” Jones said.

How widespread are defined-benefit plans that offer lifetime health care coverage to school district employees? Jones estimates that around 50 percent of the districts within the state do so, which predicts a steep financial hurdle to such districts.

Funding the Liabilities: The Next Step?

Patterson and Duzyk agree that GASB 45 is merely a step toward a more dramatic future financial hurdle — not just the reporting of health care liabilities, but the actual funding of such liabilities.

“This could be the first step toward something much bigger. Districts would have to use instructional money to pay the future health care liabilities of future retirees. This is a widely held belief,” said Patterson.

For his part, GASB’s Professor Holder eschews any mention of GASB issuing a statement requiring the funding of future retiree health care costs.

“We are not in some huge rush to make a benefit formula change, or to start funding (health care costs) in any meaningful way,” Holder said.

Whether GASB ends up requesting the funding of these liabilities or not, merely reporting them is going to be a monumental challenge to governments over the next three years.

It won’t be easy.

Ramsey Green, a native San Diegan, is currently a graduate student concentrating in public finance at the Fels Institute of Government at the University of Pennsylvania in Philadelphia. Reach him at ramseyjgreen@yahoo.com. Or write a letter to the editor.

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