Ohio's largest public pension fund, the Public Employees Retirement System, is launching a preemptive strike to preserve retiree health benefits over the long term by scaling back on benefits now.
Without the benefit cuts, OPERS projected that it would exhaust its $11.3 billion healthcare fund by 2030. The system has a trust, unlike many governments that still do pay-go funding for other post-employment benefits, or OPEBs.
The pension system is funded by employee and employer contributions and investment returns. OPERS used to earmark a chunk of employer contributions for retiree health care but stopped doing so in 2018. Instead, all the contributions are plowed into pension benefits, which take priority over healthcare coverage. At the end of 2019, the pension fund held about $91 billion. As of Dec. 31, 2018, the latest fully audited information available, OPERS was 78% funded.
OPERS said in a statement that when it began considering changes to its healthcare coverage in mid-2018, the goal was to extend solvency of the $13 billion health care fund until could begin funding it again. The changes to OPERS health care coverage that the board of trustees approved in January have extended that solvency from 11 years to 18.75 years.
The changes, which take effect on January 1, 2022, will reduce state and local government unfunded OPEB liabilities by more than $6 billion, based on OPERS' actuarial assumptions.
Among the changes in benefit provisions enacted by the OPERS board, the system will provide a monthly stipend to retirees not yet eligible for Medicare to help offset their healthcare coverage costs, but will discontinue the OPERS-sponsored plan currently offered. OPERS will also reduce the monthly allowance it provides to Medicare-eligible retirees.
The reduction in benefits comes at the same time the board has asked the legislature to approve a cost of living adjustment freeze for retirees, allowing it to reduce a $24 billion unfunded liability. The measure is also calling for a freeze on OPERS management salaries and limit investment adviser fees.
After the healthcare cuts, OPERS projects it can extend its solvency to nearly 23 years and that includes the preliminary investment return that the system achieved for year-end 2019.
The changes are a credit positive for the state and the local governments that participate in OPERS because they lower unfunded OPEB liabilities, according to Moody’s Investors Service. The changes are consistent with what other states have done in a number of other situations for the health and strength of their pension systems or benefits to retirees, Moody's said. OPERS serves about 516,000 active and retired state employees, and manages assets totaling $87.8 billion, making it one of the largest pension funds in the country.
“OPERS pension is 78% funded — they are obviously not 80% or 90%, but they are certainly not 40% or 30%,” said Chapman Strategic Advisors managing director James Spiotto. “I think long term what they are doing is taking incremental steps for the solvency of the fund which is a prudent way of going. Obviously if things get better they won’t have to do anything, but if things get worse they can take further action.”
The reduction in benefits was approved on a 9-2 vote by the Ohio Public Employees Retirement System board in January after the board reported the health care trust fund didn't have the funding coming in to continue current healthcare coverage levels.
“There is no available funding for health care,” a report from the board said. “All of the employer contributions must be allocated to pension funding until that funding improves. Based on current projections, no funding will be available for health care for 15 or more years.”
Ohio OPEBs have a lower priority relative to pension in terms of statutory protections. The healthcare benefits of retirees are not statutory contract obligations, they are discretionary. The OPERS pension fund is used to pay pensions — more than $6 billion each year. At the end of 2019, the pension fund held about $91 billion.
“The way it has worked in recent years is that because of the underfunded status of the pension side, the board has directed the contributions that are coming in all toward pensions and not toward OPEBs,” Moody’s analyst Tom Aaron said. “So what that has done in order to keep the OPEB benefits flowing to the current retirees that has forced the system to use the assets that has accumulated to pay for those benefits on an ongoing basis.”
Spiotto said one thing to read into OPERS move is that it is on top of a situation, acting proactively and being smart about it.
“The fact that they are doing it at 78% funded could be a best practice or a wake-up call for others — that somebody that funded is making corrective changes because they can look down the road at projections and say we need to do something,” Spiotto said. “Clearly on the other side of this there are other states that are far less than 78% funded and the lesson is we should do it earlier rather than later. The hope that it turns around by itself, we have learned the lesson because we have economic downturns significant losses on investments, the hole could become bigger even if you try to dig out of it.”
According to OPERS, changes to the long-term assumed rate of return have a significant impact on the liabilities. In October 2018, OSPERS modified its long-term investment return assumption for pension to 7.2% from 7.5% based on changes in the market outlook. The change increased the pension liabilities by $3.4 billion.
About two-thirds of OPERS revenue from which benefits are paid is generated from investment returns. The remaining funding comes from employee and employer contributions. The system reports a total of $1.5 billion in member and $2.0 billion in employer contributions for the year ended December 31, 2018. Total net position is $94.1 billion as of Dec. 31, 2018.
“From what we have seen and what they have said is that these are a reaction to past investment losses in places where there investments have fallen short of what they had hoped for and potential future expectation of what investment markets will bring,” said David Draine, senior researcher with Pew Charitable Trusts.
Draine said that since Ohio follows a fixed-rate funding policy for both pensions and retiree health benefits it leaves a limited set of options for OPERS if it is committed to keeping contributions at 14% of payroll while trying to manage the volatility of investments markets.
“One thing they track is the amortization rate, they have this fixed funded policy and the fund looks at how many years will it take to pay it down based on that fixed contribution rate,” Draine said. “The 2018 numbers — and we know that there have been some bad investments between the 2018 reporting date and the 2019 reporting date — is over 30 years, which my understanding is that it is longer than what they want to be aiming for. Without changes they faced seeing pension debt grow.
“All of these pieces add up to telling them something about the trajectory of their system and what they saw is something they wanted to avoid.”
Aaron said that for the state government directly, unfunded liabilities are not outsized in any way. Ohio is above average in funding and certainly in much better shape at the moment than states like Kentucky, Connecticut and Illinois.
“What we have seen thus far as unfunded liabilities in these systems have grown the reaction has been to make an adjusted benefit — through either benefit cuts or benefit adjustments — but to leave government contributions rates alone,” Aaron said. “Unlike other systems where government contribution rates have risen dramatically in Ohio they have remained steady and instead relied on legal benefits flexibility to keep them relatively stable.”
Aaron said that the way that becomes a credit risk is if at some point the ability to continue curtailing benefits runs out — whether that be politically or legally on the pension side. “At that point if unfunded liabilities persist then the contribution rates may have to increase,” he said.
State Representative Diane Grendell, R-Chesterland, is working on a bill that would call for an investigation into approved reductions in healthcare benefits. Grendell has said she doesn't understand the need for the benefits reductions and is now proposing legislation that that would appoint a committee to investigate the cuts and produce a report with recommendations within six months.
Moody’s Investors Service rates Ohio Aa1. Fitch Ratings and S&P Global Ratings rate the state AA-plus. All assign stable outlooks.
