CHICAGO - Illinois faces an estimated $24 billion unfunded liability for retiree health care benefits, a figure that - though far lower than the number a business group had previously estimated - adds significantly to the state's financial challenges as it grapples with a $42 billion unfunded pension liability, a $750 million budget shortfall, and tardy Medicaid bills.
The preliminary number represents the state's actuarally accrued cost for providing health care benefits to current and future retirees, a number the Segal Group was hired to compile and accounting consultant Deloitte reviewed and validated, as the state seeks to comply with the Governmental Accounting Standard Board's new reporting rules on the other post-employment benefits, largely health care, that governments provide.
The state's top fiscal officer, chief operating officer John Filan, portrayed the number as manageable given the figures other states have released. It's also far less than the $43 billion the Civic Committee of the Commercial Club of Chicago had estimated in an assessment of the state's debt. The committee warned in its report in late 2006 that the state was "headed toward financial implosion" given its pension, general obligation, and unpaid Medicaid bills.
Though substantial, the OPEB liability is more manageable than the state's whopping pension fund liability, Filan said because the GASB accounting rules require only that governments report OPEB liabilities. It does not require that they fund them. The state has flexibility in addressing how the liability is eventually funded and in controlling the size. "The difference is pensions are constitutionally guaranteed," he said.
The state shared the figure with rating agency analysts in discussions on an upcoming general obligation debt sale this week. Ratings reports were not yet released by press time. Fitch Ratings and Standard & Poor's both rate the state's $20 billion of GOs AA, although Fitch assigns the credit a negative outlook due in large part due to the state's pension funding woes. Moody's Investors Service rates the state Aa3.
Standard & Poor's John Kenward said the number itself would not contribute to any rating action. "It should be manageable," he said. "It's a large dollar amount, but what's more important is how it will impact future budgets and whether the state will move to prefund it with a trust."
The Civic Federation of Chicago, a business-funded government watchdog group that annually reviews the pension liabilities of local and state governments, said the figure only adds to its concerns over the state's fiscal house.
"The Civic Federation has not seen the actual OPEB but if it is in the magnitude of $25 billion, it is a dramatic increase in the stated liabilities of the state," president Laurence Msall said. "The Civic Federation remains very concerned. The state needs to reform both its funding of pensions and reform its generous benefits."
Filan said the state intends to bring the issue up as a subject in labor negotiations. "This is a combined liability [of both employer and employee] and we will work on it in collective bargaining," he said.
Illinois provides health, dental, vision, and life insurance benefits for retirees and their dependents. The cost of providing those benefits on a pay-as-you-basis in fiscal 2006 was $578 million or 2.2% of state general fund expenditures, according to Standard & Poor's.
In an interview late last month at The Bond Buyer's annual OPEB conference, Filan said he views issuing debt to pre-fund the state's OPEB liability more skeptically than debt to fund pensions because of the legal and statutory distinctions between the pension and OPEB liabilities.
Filan considers the pension liability a "hard" obligation because pension benefits are guaranteed by the state constitution. Rating agencies have countered that position to some extent, as they believe pension obligations represent a soft liability while debt service is a hard liability with little flexibility.
In contrast, he believes OPEBs to be a "soft" liability as they are governed by collective bargaining agreements that are subject to revision. The benefits can be negotiated, and costs brought down by increasing deductibles and premiums. The state also must weigh the trade-offs of funding its OPEBs. For example, if funds are diverted from construction projects to better fund the OPEB liability, Illinois would face increased inflationary construction costs.
"There's a lot of moving parts. OPEB is a very different animal," he said.
Roughly 40 states have completed OPEB valuations, totaling $400 billion, according to Robert Smith 3d, president of Sage Advisory Services. The average state OPEB liability is between $9 billion and $10 billion, but there's a big range between states. For example, North Dakota's projected OPEB is $52 million, while New Jersey's is $58 billion. California liability is $47.9 billion, New York's is $47 billion, and Michigan's is $7 billion.
The state released the number on the same day Filan spoke at a City Club of Chicago luncheon to the city's business and civic community, seeking their help in winning legislative approval for a $16 billion pension obligation bond issue and a partial lease of the Illinois Lottery to raise $7 billion towards a $25 billion capital program.
Filan reiterated his long-standing mantra that it is the state's $42 billion unfunded pension liability that poses the "single largest challenge" to the state's long-term health and pushed for support for Gov. Rod Blagojevich's proposal to sell $16 billion of pension bonds.
Under the proposed borrowing plan, the state would also restructure its amortization schedule, increasing its annual payments by nearly $300 million. The infusion of bond proceeds would boost the pension system's funded ratio to 75% and put the state on track to reach a 90% funded ratio by 2033, 12 years earlier than now anticipated.
The state issued $10 billion of pension bonds in 2003 to improve the funded ratio to a current level of 63% from 48%. The new borrowing proposal and reforms would help cut $34 billion off state contributions overall.
Filan also pushed for support for a proposed lottery lease as the best method to finance a multi-year capital program because it would hold down the state's need to borrow in a difficult market. The state expects to raise at least $10 billion by seeking bidders to operate the lottery system for a minimum 50-year term. The state would retain a 20% ownership stake in the lottery over the lease term.
About $7 billion from a lottery lease would go to fund a proposed capital budget, while the remaining funds would go into a trust. The state would also funnel nearly $300 million it would expect to collect from its remaining 20% ownership share into that trust so that it would generate the $600 million needed to replace current lottery profits that fund education.
Legislative concerns over how the state would replace that money for education helped kill a lottery lease proposal last year. The capital budget relies on $3.8 billion of state borrowing with the remainder coming from local and federal matching funds.