CHICAGO — Cities and towns across Michigan face a combined $13.5 billion in non-pension, other post-employment benefit obligations, with Detroit accounting for at least 40% of the debt, according to a new report from Michigan State University.
Other post-employment benefits, or OPEBs, represent the single largest debt for are many Michigan municipalities, and in some cases total more than their pension and bond debts combined, the report found.
The annual required contributions for OPEBs average 20% of cities and towns’ general fund revenues.
“For municipalities experiencing severe fiscal stress, the magnitude of this liability has heightened the tension between providing services to current residents while upholding past commitments,” the report says. “For units with the most proactive financial management, OPEB continues to be a pressing budgetary issue.”
Retiree health care obligations and other so-called legacy costs, including pensions and long-term debts, are increasingly considered key measures of financial health for governments by rating analysts and public finance pros.
How governments deal with the debt will prove important to overall credit strength, experts say.
The report, “Funding the Legacy: The Cost of Municipal Workers’ Retirement Benefits to Michigan Communities,” marks the first breakdown of OPEB liabilities by city, village and township.
A 2012 report by an independent Michigan research group examined OPEB debts owed by counties, and found a total liability of $4 billion, $3 billion of which is unfunded.
The MSU report was released the same week that Gov. Rick Snyder formally took over the city of Detroit, and named Jones Day LLP bankruptcy attorney Kevyn Orr as its emergency financial manager.
Snyder and Orr have said a top priority is bringing down the city’s massive $14.9 billion long-term debt liability. OPEBs make up the biggest chunk of that debt — and the least secured — accounting for $5.7 billion, according to the state.
How Orr and the state handle Detroit’s OPEB liability will be closely watched by struggling local governments across Michigan.
“Detroit is absolutely a test case for other municipalities,” said Eric Scorsone, a local government expert at Michigan State University and a co-author, with Nicolette Bateson, of the report.
“Legacy costs are the big bomb that everybody sees,” said Scorsone, who is a member of Detroit Mayor Dave Bing’s restructuring team.
“If you can reduce OPEBs and the current premium, that’s more cops on the street right now — and that’s critical in Detroit. How do you fix this problem without laying a lot of people off?” he said. “This is the way you do it: you go to OPEBs and you cut the cost per employee and per retiree, and now you’re able to keep people on the job and provide services and get your budget back to some sort of structural balance.”
In Michigan, most cities face an OPEB tab that they wouldn’t be able to pay even if they were able to double local property tax rates, according to Scorsone.
The state capital of Lansing, for example, already pays $20 million out of a $150 million budget for its OPEB costs. It would need to double its 20-mill property tax rate to fulfill their annual required contributions.
Cities with populations between 30,000 and 200,000 would need to levy an additional 3.52 mills to cover their OPEB annual required contributions, or ARC, the report said.
Detroit, the most extreme case, would need to levy an additional 36 mills to cover its ARC.
“You can’t legally do it and would never get voter approval,” Scorsone said. “So this is where it comes down to unions and employers saying, ‘What can we reasonably negotiate?’ ”
The OPEB liability is especially large in Michigan’s older urban cities, most of which are located in the southeast region of the state, where the automobile sector is concentrated, the report indicates.
Almost $11 billion, or 86%, of the $13.5 billion liability comes from local governments in southeast Michigan. Detroit accounts for at least 40% of that.
“The core old cities in Michigan — they don’t have the tax base anymore,” Scorsone said. “This should signal to the investor community that these are going to be very tough political issues.”
Michael Brown, the former emergency manager of Flint, said he faced an $862 million unfunded OPEB liability when he took over in December 2011.
“We looked at all six of our union contracts and we rewrote those contracts and made fundamental changes in health care insurance,” said Brown, who is now Pontiac’s city administrator. “The goal was not to eliminate retiree health care altogether, but to try to keep the system going. No way we were ever going to be able to address an $862 million unfunded liability.”
The unilateral contract changes brought the liability down to roughly $360 million, Brown said.
The changes also sparked a lawsuit from a coalition of retirees, who sued for breach of contract. The lawsuit is now in federal court in downtown Detroit, with no hearing dates yet set.
“It will have a major impact, so we’ve got to pay close attention,” Brown said of the outcome of the lawsuit. “The OPEB liability affects every municipality in Michigan. It’s not just the Flints and the Detroits on this one — there are small communities with major unfunded liabilities.”
The emergency manager in Pontiac, Louis “Bud” Schimmel, has said the city’s OPEB liability is the final item on his to-do list before he exits the city. He recently tried to raise property taxes to dedicate solely to paying down the debt. Voters rejected the measure.
He is now considering privatizing Pontiac’s overfunded pension plan and using the money for the OPEB liability, he said in a recent interview with The Bond Buyer.
Of the state’s 1,773 cities, towns and villages, 311 provide other post-employment benefits, according to the report. Those 311 governments represent 67% of Michigan’s population.
Of the municipalities that provide retiree health care benefits, 52% do not require employee or retiree contributions to the plans, according to the report.
The report examined 284 governments out of the 311 that had complete financial data from fiscal 2011.
Their OPEB liability totaled $13.5 billion, with a funding level of 6%. In contrast, unfunded pension liabilities totaled $3.1 billion as of the end of fiscal 2011, and governmental activities debt, including bonds, totaled $4.7 billion.
Of the 284 units included in the report, 138 have started prefunding their OPEB debt.
For cities with populations between 30,000 and 200,000, the OPEB liability totaled $5.52 billion, with a 19% funded status.
The average OPEB liability per citizen in those cities totaled $1,360, and OPEB costs averaged 17.2% of general fund revenue.
Detroit, which is Michigan’s only city with more than 200,000 residents, had a $4.9 billion net OPEB liability as of the end of fiscal 2009, with none of it funded. The state recently put the figure at $5.7 billion.
That translates into $6,965 per resident and just under 27% of general fund revenue. The OPEB cost makes up 20% of government-wide revenue, according to the report. The city’s annual required contribution totaled $324.4 million. It made a payment of $166.2 million in 2009.
Detroit’s total legacy costs, including pensions and debt, accounted for nearly 36% of general fund revenue as of 2009 and 27% of government-wide revenue, the report said. The debt is equal to a dramatic 87% of the city’s taxable value, the analysis reads. “Despite the fact that a large city such as Detroit has other significant revenue sources, this ratio clearly indicates that long-term commitments are not sustainable.”
Scorsone, who testified last week about the report’s findings before the House Committee on Financial Liabilities, said the state needs to give municipalities more tools to manage the debt.
Michigan last year created a hard cap on local government contributions for health care, which was beneficial for municipalities, he said.
Other tools would be creating regional governmental pools to offer benefits at lower costs, or directing pre-Medicare retirees to the state-based insurance exchange under the new federal health care reform law.
Issuing bonds to cover the liability is also now an option since passage of a new law last year. The law includes a number of restrictions on which local governments can borrow, but for some, like Oakland County, Mich., it will mean significant savings.
Oakland County was a pioneer when it issued $570 million of taxable certificates of participation in 2007 to fully fund its OPEB liability.
Now, with the new state law, the county plans to head to market later this year with the first of two tranches to refinance the COPs into bonds.
Since the 2007 borrowing, the triple-A rated county now has roughly $210 million more than its $814 million liability, due to strong investment growth, according to deputy county executive Robert Daddow.
“The long and the short of it is we’re overfunded — probably one of the only counties in the state and in the nation,” he said.
Oakland County plans to use the extra investment earnings to pay off some of the principal, he added.
By restructuring the certificates into bonds, cutting down the final maturity, and taking advantage of current low rates, the county expects to cut interest rates down to 3% from 6.2%.
The move could save as much as $100 million over the life of the debt. The county’s debt service on the COPs is $48.5 million a year.
Debt service on the bonds is expected to shrink to around $40 million. The county’s OPEB annual contribution would have been $60 million in 2007, the year it issued the debt, increasing over the next 10 years.