CHICAGO - State and local governments - grappling with how to address the unfunded accrued liability of their other post-employment benefits - face another looming fiscal burden in the coming decade as the federal government is pressured to deal with the skyrocketing shortfall of funding Medicare.

The risk to local and state governments currently in the midst of reporting their unfunded health care liabilities to retirees and future retirees on an accrued basis is that the federal government will shift more of the funding burden to a local level by reducing benefits to the elderly significantly, said Thomas R. Saving, whose seven-year tenure as a member of the Social Security Administration and Medicare Trust Funds ended at the start of 2008.

In 12 years, the federal government will need a 10% income tax increase to cover projected shortfalls and keep Medicare solvent, that rises to 45% in 2050. The funding shortfall will eat up 22.4% of income taxes in 2020, 52% in 2040 and 76% in 2080.

If seniors were left to cover the shortfall, the cost of their premiums would skyrocket with payments for Medicare supplements absorbing all of the average retiree's Social Security benefits in 75 years. Even with current taxpayers and retirees sharing the burden, the need for higher premiums, increased payroll taxes and general taxes would still prove unaffordable and do little to curtail the escalating costs.

"You have a big stake ... it is going to make your jobs doubly difficult," Saving said, in his keynote address addressing his comments to government finance officers attending The Bond Buyer's OPEB conference here. "The feds are going to try to put it back on you."

Saving predicted that little will occur in the way of benefit cuts over the next four years, but action is looming within the next decade "The budgetary pressure will be so big, they will have to do something," he said. "We are talking about things happening very fast."

The looming crisis is fast approaching as the baby boom generation begins retiring and claiming benefits. The 2007 Social Security Trustees Report estimates that the current generation is owed $28.5 trillion, based on a closed-group present-value estimate. That is in addition to $16.5 billion in Social Security benefits.

Proposed reforms include raising the age at which Medicare benefits kick in to coincide with the increase in eligibility for Social Security benefits, fixing the benefits at a certain level, implementing a deductible for benefits, and requiring more affluent seniors to pay more or scaling back on their benefits. Each would result in just limited savings overall and not solve the Medicare funding crisis. More dramatic cuts may be needed, prompting Saving's warnings that it is local and state governments that may be forced to absorb greater costs.

The potential burden faced by local and state governments would come as those same governments are addressing how to deal with the unfunded accrued liability of their OPEBs, which in most cases are health care benefits offered to their retirees.

The Governmental Accounting Standards Board's deadlines for reporting OPEB liabilities on an accrual basis, like traditional pension costs have long been counted, are being phased in. Most governments have reported and covered OPEB costs on an annual pay-as-you-go basis for current retirees.

Using the accrual method, governments must also take into account the cost of paying for benefits for future retirees and the annual required contribution or ARC that is needed to amortize the liability over 30 years. Governments must report the difference between their current funding level and the ARC.

Governments with revenues of more than $100 million must report their actuarial accrued liability in the fiscal years that end after Dec. 15, 2006. By the end of 2009, all states and localities are expected to adhere to the new reporting standards. More than 40 states have reported OPEB liabilities totaling $400 billion and health care costs are expected to increase by 10% over the next five years, then tail off in single digit increases.

While GASB 45 doesn't require governments to come up with a plan to address OPEB liabilities, governments will be looking to trim costs as they begin shifting from the more expensive pay-as-you-go funding of the accrued liability to an ARC to achieve a solid funded ratio in the coming decades.

In one panel, Jim Kelly of JPMorgan said he doesn't expect a significant increase in the near term of OPEB bond issues, a move a handful of issuers have taken to fund newly established irrevocable trusts to fund their OPEBs.

"People aren't running out to issue bonds ... it's too early," Kelly said.

Most issuers are still digesting their actuarial reports, looking at ways to trim costs and at the difference between their current payments and the ARC. Most OPEB borrowing to date has been done by issuers who have for years contemplated funding their OPEB as a means to relieve budgetary pressures. As governments grapple with how to meet the ARC, Kelly predicted that more might consider borrowing but he doesn't see a rush to market at least through 2008.

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