Accounting Rule Could Bust State Budgets

Just when states found some breathing room after years of belt-tightening, a new accounting rule is about to force them to deal with some $500 billion in hidden costs. The new rule, effective later this year, also has state employees worried their benefits soon might be on the chopping block.

Starting in December, states will have to tally up and publicly disclose the cost of health care benefits promised to teachers, police officers and other public sector workers who are retired or will retire in decades to come. Then states have to figure out a way to start putting aside money to cover the liabilities – or risk hurting their states’ credit rating.

“Easily, the number will reach $500 billion,” said Parry Young, a credit analyst at Standard & Poor’s Ratings Services, referring to the amount of money state and local governments may face in unfunded liabilities for retiree health care benefits. That figure exceeds the estimated $300 billion that states will owe in funding retiree pensions, Young said.

Currently, state and local governments use the “pay-as-you-go” approach and set aside money each year for current retiree health care costs. The new rule doesn’t require that states sock away the money needed to cover future retiree health care. But states that don’t are in danger of getting a lower credit rating from Wall Street, making it much more expensive to borrow money at a time when states are borrowing at a record pace.

“The size of this liability [for retiree health benefits] may astonish the public and most government officials,” Paul Maco, a partner of Vinson & Elkins, an international law firm, said in a statement.

The rule, known in government accounting circles as GASB 45 (pronounced GASBEE) for the Governmental Accounting Standards Board that issued it in 2004, also may have huge consequences for public employees. “Some states are trying to trim benefits, and one of the reasons they give is the GASB rule,” said Gary Storrs, a labor economist who specializes in benefits for the American Federation of State, County & Municipal Employees (AFSCME), a union that represents some 500,000 state workers.

While the new accounting measure was published in 2004, some states have only just begun to try to figure it out. “It still hasn’t really hit the radar screen” for some states, said Sujit CanagaRetna, senior fiscal analyst at the Southern Office of The Council of State Governments.

Many states have put off tackling retirees’ pension and health care liabilities because the top priority in recent years has been simply balancing their books. States in mid-2005 began enjoying greater budget stability after weathering the worst economic conditions since the Great Depression earlier this decade. S tates were forced to close $264 billion in budget gaps over five years beginning in 2001 following the terrorist attacks and nationwide recession.

Maryland is among the states that have moved aggressively on this front and was shocked at what it discovered.

Preliminary estimates put the state’s unfunded liability for retiree health care costs between $3 billion and $6 billion, but latest figures put the amount at $20 billion, said Michael Rubenstein, senior policy analyst at Maryland’s Department of Legislative Services.

“No one had a sense that it would be that big or that unmanageable,” he said. The state, which in 2005 created a task force to study the issue, figures it will have to set aside $1.6 billion each year to start covering the costs, a far cry from the $300 million the state currently is paying to cover retirees’ health care expenses, Rubenstein said.

California’s Legislative Analyst Office estimated earlier this year that the state faces between $40 billion and $70 billion in unfunded health care liabilities, but the price tag could be higher when the final numbers come in, said Young of Standard & Poor’s.

Thomas Lowman, chief actuary of the consulting firm of Bolton Partners Inc., said states that promise hefty retiree benefit packages will have a harder time dealing with the rule than states with less generous plans. For instance, he said some local government plans in Maryland cover 80 percent of retire health care costs while counterparts in Virginia pay a flat subsidy, perhaps $200 a month. This means states like Maryland will have to set aside more money.

Storrs of AFSCME concedes that states are in a quandary: They need attractive benefit packages to recruit workers, but the costs of the perks, particularly health care, continue to climb, and states don’t know how to pay for them.

Young of Standard & Poor’s said states either can put more money aside for future retiree benefits or ask public employees to do more, such as contributing higher co-payments, cutting back on family members’ benefits or requiring that public employees work longer before retiree benefits kick in.

But states that have tried to cut benefits for state employees have run into stiff resistance from public sector unions.

Recent attempts to change public pension plans, though not covered by the new GASB rule, show the difficulties. California Gov. Arnold Schwarzenegger (R) was forced to abandon his plan to overhaul the public pension plan after running into fierce opposition from police officers, firefighters and other state employees. Schwarzenegger wanted to move state employees from traditional pension programs with guaranteed payouts to less costly 401(k)-style programs in which the state contributes a set amount to a worker’s investment fund. Republican Govs. Mitt Romney of Massachusetts, Donald Carcieri of Rhode Island and Mark Sanford of South Carolina also last year pitched 401(k)-style programs without success.

Alaska, which puts its unfunded liability for both retiree pension and health care benefits at $7 billion, is one of only two states in the country to adopt a mandatory 401(k) style retirement for all state employees, beginning with those hired after July 1, 2006. Michigan state employees hired since 1997 also have only a defined contribution retirement benefit. But state Rep. Bruce Weyhrauch (R), chairman of the Alaska House Ways and Means Committee, expects Alaska’s new law to be entangled in court challenges. “”It’s a complete mess,” he said.

Weyhrauch said Alaska is among the states that have yet to figure out the GASB rule. “The majority of states couldn’t even tell you what the letters stand for,” he said in a telephone interview from his office in Juneau.

Editor’s note : This story was updated to reflect that Michigan state employees hired since 1997 also have only a defined contribution retirement benefit.