Public Agencies Face Healthcare-Cost Crisis

Cities, counties, school districts and state agencies across California face rapidly growing bills for retiree health benefits, but most have done little to get ready to pay them.

The future costs, which run into the tens of billions of dollars, are equivalent to a massive mortgage that taxpayers have taken on with little public notice. The required payments threaten to put heavy financial pressure on governments that granted generous benefits in the past and now are beginning to see the bills come due.

“It is a ticking time bomb for many California institutions,” state Supt. of Public Instruction Jack O’Connell said. “It’s clearly a problem.”

The price of retiree benefits has risen quickly in recent years, driven by inflation in healthcare costs and the first retirements of the baby boom generation.

For early retirees, the health benefits cover most doctor and hospital bills until the retiree becomes eligible for Medicare at 65. For those already eligible for Medicare, the plans fill gaps in coverage, particularly the cost of prescription drugs, which has escalated rapidly.

Many government agencies agreed to give unionized workers generous health benefits -- sometimes instead of pay hikes -- in contracts when health costs were relatively low. They handled the bills each year on a pay-as-you-go basis without calculating the long-term bill. But new nationwide accounting rules, which take effect in 2007, have begun to force the agencies to determine the costs.

The numbers are sobering.

The Los Angeles Unified School District, the state’s largest school system, will need to set aside $357 million every year for the next 30 years -- about 6% of its annual budget -- to meet the estimated $4.9-billion cost of retiree benefits over that period, according to a preliminary estimate. District officials say even that figure may be too low and the true cost may be twice as high.

Already, health benefits eat up 13.3 cents of every general fund dollar the school district receives -- up from 8.1 cents eight years ago -- and the number continues to rise.

“There is a day of reckoning, and we just can’t keep putting it off,” said L.A. Unified Supt. Roy Romer. “It is something that has to be cured and corrected, and it has to be done fairly soon because it accumulates each year.”

The Los Angeles district is not the worst off in the state. Elizabeth Hill, the state’s legislative analyst, warned earlier this year that some school districts face bills that may become “so large they potentially threaten the district’s ability to operate in the future.”

For example, Fresno’s financially troubled school district faces a long-term bill that is more than twice its annual budget. The district and its teachers union recently agreed to drop lifetime health benefits for new hires. The Fresno Teachers Assn. also agreed to participate in a joint committee to manage healthcare costs.

Hill warned that financially stressed school districts may eventually seek bailouts from the state. But the state government faces its own heavy costs for retiree benefits. So far, state agencies have barely begun to figure out how expensive retiree healthcare will be.

“We don’t have an estimate that we are comfortable hanging our hat on,” said H.D. Palmer, a deputy director of the state Department of Finance.

In the meantime, the cost to California of providing retiree benefits on a pay-as-you-go basis is soaring. The state spent $457.5 million on retiree health benefits in 2001-02, and that figure is expected to nearly double to $895.2 million this fiscal year.

“It’s expensive, and it’s definitely getting more expensive,” Palmer said.

Some local governments have begun setting aside money to cover the future costs of benefits. The city of Los Angeles began several years ago to deposit money in a reserve account to pay for some retiree benefits. The prepayments cover about 60% of the projected cost of retiree health benefits for most city workers.

“We are in significantly better shape than any other large city in the U.S,” said William T. Fujioka, Los Angeles’ chief administrative officer.

Indeed, the city appears to be an exception to the general pattern.

Los Angeles County government officials also know they face large future costs, but “we don’t have a ballpark figure,” said Sid Kikkawa, a division chief in the county’s chief administrative office. “It will be a large number.”

Like the majority of other government bodies, the nation’s largest county government has not set aside any reserves to pay for those future benefits, Kikkawa said.

Orange County, similarly, has not begun setting money aside to cover future bills for retiree health benefits.

The debate within government agencies over future costs of health coverage lags behind private industry, where many companies have reduced benefits. Two years ago, for example, healthcare was the major issue in the long and bitter labor dispute at major Southern California supermarkets. General Motors officials have estimated that what the company spends on healthcare, including generous benefits for retirees, comes to $1,500 for every car they sell.

Many government agencies, by contrast, have only recently begun to look seriously at the long-term costs. And benefits often are considerably more generous than at most private companies. L.A. Unified, for example, provides fully paid, lifetime health coverage for employees who retire with a certain number of years of service. But the district has only recently begun estimating the long-term cost of those benefits.

Spending on health coverage for current and retired teachers, administrators and staff members in the district has gone from $319 million in 1997-98 to a projected $749 million in the current budget. (During that period, growth in student enrollment led to the hiring of more teachers.)

Any move to cut those costs would require approval from a health benefits committee controlled by union representatives.

“There is a reality that unions are going to have to face that you can’t continue to deliver a benefit that you haven’t paid for or that you haven’t funded,” Romer said. “I think that that fact will cause us all to come to the table and to find a solution.”

A.J. Duffy, president of United Teachers Los Angeles, downplayed the effect of the long-term costs. The new accounting rules driving the debate within government agencies “is a reporting requirement, not a funding requirement,” Duffy said. “It raises issues that need to be looked at and discussed, but you can’t have an overreaction to these amounts.”

Inevitably, any move to set aside money for retiree benefits will compete against demands to fund other government programs. In the case of schools, every additional dollar going to healthcare is one fewer that can be spent in the classroom.

But government finance experts say agencies will have little choice. Government bodies may see their credit ratings go down if they fail to set aside money to pay large future bills, said Ted Hampton, an analyst at Moody’s Investors Service in New York who has been studying the issue.

Finding the money to pay future benefits “will be painful,” said William W. Holder, a USC accounting professor and member of the board that sets accounting standards for government agencies. But deferring a solution will only increase the pain in the long run, he added.

“The sooner you recognize it and begin to manage it,” he said, “the more manageable it is.”