Sunday, April 12, 2009 | When the City Council debates new labor contracts Tuesday, a major flashpoint of contention will be a proposal to revamp retiree health care benefits in a way that could leave retired city employees shouldering a larger share of their health insurance.
The plan proposed by Mayor Jerry Sanders also would significantly shrink the city’s future retiree health care obligations, which threaten to wreak havoc with city finances on the scale of the pension problem.
Details about the proposal are scarce because the Mayor’s Office wouldn’t talk about it while labor negotiations are ongoing. But as spelled out in the city’s final offer to the police union, the plan calls for a drastic change from the current plan.
Retirees now receive a guaranteed health care capped this year at $8,880 for each retiree in what’s known as a defined-benefit system. The benefit increases up to 10 percent a year as medical costs rise.
The mayor’s proposal would replace that benefit with what’s known as a defined-contribution system. The city agrees to set aside a certain amount of money every year, and what’s left in the account can be used for a retiree’s health care costs.
But the final amount is not guaranteed. So even if investment losses hit an account hard, the employee only gets what is in the account. By contrast, in a defined-benefit plan, if there’s not enough money socked away, the city is on the hook for the difference.
Since Sanders has formally declared that talks have stalled with all five city unions, the ultimate decision on retiree health care and other contractual issues is up to the City Council, which will hold a hearing on the contracts Tuesday. The council could vote to impose contracts on its employees.
It’s not clear, however, that the retiree health care mandate could be imposed. The unions say the city charter requires a change to the health care benefits to be voted on by all employees. Even Sanders said in an interview last year that retiree health care was an untouchable benefit.
If the City Council does vote to impose a change, it would almost certainly lead to a lawsuit.
But if the plan is adopted, it could swiftly erase hundreds of millions of dollars from the city’s unfunded health care liability, recently estimated at more than $1.2 billion.
April Boling, an accountant and former City Council candidate, said retiree health care looms as “even a bigger problem than the pension plan.”
Part of the problem, she said, is that the city has no idea how much health care costs will rise.
“With the pension plan, you know what the costs are going to be,” Boling said. “With the health care costs, the actual costs are not under our control.”
As of June, the retiree health care trust was only 2 percent funded. The pension system, by contrast, is about 62 percent funded, according to a recent unofficial estimate.
Retiree health care dates back to the early 1980s, when then-Mayor Pete Wilson removed the city from the Social Security system. To get city employees to sign off on the change, Wilson promised employees medical insurance for life.
But the city has never put away enough money to pay for the benefit. Every year, the city pays retirees’ insurance premiums for that year only. But it hasn’t set aside money for future medical costs, as it is required to do with the pension system.
For years, the city siphoned off earnings from the retirement fund and used them to pay for a portion of the retiree health care costs until the practice was found to violate federal regulations.
Retiree health care emerged as a major concern in the early-to-mid 2000s, around the time the pension problems were drawing attention.
“It’s not as though this hasn’t been discussed,” Boling said of retiree health care. “There just hasn’t been the political will to deal with it.”
Nationwide the spotlight was thrown on unfunded retiree health care costs in 2004, when the Government Accounting Standards Board said it would require governments to report to investors their long-term liabilities from health care and other retiree benefits. Some cities, alarmed at the potential effect on their bond ratings, set up separate trusts for retiree health care and started sinking more money into the trusts.
Last year, San Diego set up a trust with the California Public Employees’ Retirement System to manage its retiree health care obligations. Under Sanders, the city has socked away about $25 million a year for the past two years above and beyond what the city must pay annually for those year’s insurance premiums.
But Sanders has backed off an original pledge to set aside much more money for retiree health care. To meet that promise, the city would have to pay an estimated $113 million a year instead of the $50 million it paid this year.
The city’s $1.2 billion unfunded liability reflects the money the city could owe in future years from its current retirees and employees. Because of the rising cost of health care and the potential for employees to live longer, the city’s annual insurance premiums are likely to increase.
A defined-contribution plan like the one Sanders is seeking to set up would vaporize hundreds of millions of the unfunded liability by taking the city off the hook for those future costs.
A change wouldn’t erase the entire amount because the new plan wouldn’t apply to employees who are already retired and those who are nearing retirement, though Sanders is seeking to cap their costs so the city wouldn’t pay more if medical costs escalate. New hires already don’t receive a defined-benefit medical plan.
The city’s blue-collar union has expressed an openness to the idea “in concept,” said Joan Raymond, the president of the local chapter of the American Federation of State, County and Municipal Employees. However, it hasn’t come to any agreement yet.
The openness may reflect in part the union’s desire to avoid wage cuts. Raymond said last week that while employees prefer a defined-benefit plan, they realize the city’s is only 2 percent funded.
“We just think it’s a huge reform that is going to really benefit the city by erasing that whopping $1.3 billion liability from its balance sheet,” Raymond said.
Other union officials say the proposed overhaul of retiree health care was dropped on them at the last minute, too late to cobble together a workable plan. They say the details are too sketchy for them to sign off on the plan, which would go into effect in 2010.
“Without it being fully fleshed out, there’s no way we can agree to a plan that’s basically been presented to us as a conceptual framework,” said Joan McNamara, president of the Deputy City Attorneys Association.
Brian Marvel, president of the Police Officers Association, said the union wants to have its own experts verify the city’s numbers on the unfunded health care costs. “We’re willing to discuss it,” he said of the idea of a defined-contribution plan, “but we’re not going to take whatever the city says as gospel.”
Under the defined-benefit plan, employees know the health care benefit they are entitled to on the day they are hired. Moving to a defined-contribution plan would transform the city’s retiree health care payments into matters that are negotiated with each contract, like salary.
That raises the fear among employees that the city will only pay a share of retiree health care costs for a few years, then stop paying altogether. At the very least, they worry that the city won’t increase its payments as medical costs rise, leaving retirees on a fixed income to shoulder skyrocketing medical costs.
One potential difficulty of pushing through changes to retiree health care now is that it comes as the city is also seeking other concessions from employees, such as furloughs, in order to bridge a $60 million budget gap for the financial year starting July 1. Revamping retiree health care won’t shrink next year’s $60 million shortfall.
The city didn’t push changes to retiree health care, for instance, when it gave police raises in 2007 and 2008. Without a carrot, unions may be unwilling to sign on.
“The timing couldn’t be more difficult for that conversation,” said Pat Shea, a former mayoral candidate. “That’s a conversation that everyone needed to have a decade ago.”
Shea said there are several problems with tackling the crisis now: The recent investment losses mean the city’s annual pension payments will take a bigger bite out of the city’s budget. The recession has decreased the city’s tax revenues. And the financial crisis has decimated 401(k)-style accounts, making them look less attractive to employees than the city’s current defined-benefit plans.
A switch to a defined-contribution plan doesn’t solve anything by itself, Shea said. He said the city’s health care plan is troubled not because it produces a defined benefit, but because it’s been mismanaged.
“The problem is that we game the system,” Shea said.
One argument for an overhaul this year is that there’s no easy time to make a change to the retiree health care plans.
When revenues are increasing, Boling said, “the unions will say why are you asking us for concessions when you have more money coming in, even though what you probably should be doing with that money is putting it against the previous liability.”
Some City Council members have stressed the need for the city to address its retiree medical costs, without discussing specific changes.
“I don’t see any way currently that we can sustain the promise of lifetime health care benefits to retirees,” Councilman Tony Young said, “especially right now since we don’t have a vehicle and a way to actually pay for it.”
Councilman Kevin Faulconer said this is a pivotal time to take on the crisis, with four new council members unsaddled with the baggage of the past pension scandal and all five unions at the bargaining table.
“This is it,” Faulconer said. “This is the year, and if we don’t deal with it this year, it’s only going to get worse.”