WASHINGTON — The nation’s 10 largest cities are making some progress managing billions of dollars of unfunded liabilities for health care and non-pension other post-employment benefits, and could decide to issue OPEB bonds, similar to pension obligation bonds, as a way to deal with the growing burden, Standard & Poor’s said in a new report.
The report — “Largest Cities Show Mixed Progress in Meeting Their OPEB Liabilities” — pointed out that while OPEB funding bonds, would turn a “soft” liability, with a less distinct funding schedule, into a “hard” annual debt-service liability, they may also help municipalities level their payments.
Report co-author and analyst David Hitchcock said there are some incentives to issuing OPEB funding bonds because the liabilities burden governments and create budget difficulties.
However, it will not be clear whether municipalities are interested in issuing OPEB bonds until they release actuarial reports on their liabilities.
“As we see the liabilities actually being quantified, I wouldn’t be surprised if enterprising bankers would [try to get] cities or counties interested in issuing OPEB bonds,” Hitchcock said.
“Up to now, it’s been a non-issue because the liabilities haven’t been quantified. But as they are ... the possibility exists that cities may turn to OPEB bonds, especially since [OPEB liabilities] seem to be so underfunded.”
But while the 10 largest U.S. cities analyzed showed mixed progress in addressing their OPEB liabilities, those costs will continue to pressure their budgets for “some time to come,” the Standard & Poor’s report said.
“I think there’s no clear trend. Some cities seem to be addressing it and some cities seem to be ignoring it,” Hitchcock said.
Some cities have set up trust funds to pay their OPEB liabilities and some have not. The ones that have trust funds vary in terms of the extent to which they have funded them.
The report found that the actuarial assets in the trust funds that had been set up represented from 0% to 55% of the cities’ actuarial accrued OPEB liabilities.
OPEB unfunded actuarial accrued liability, or UAAL, ranged from 7% to 87% of total governmental expenditures in the cities’ most recent audited years, according to Standard & Poor’s.
Six of the 10 cities had not set up any trust fund to amortize their UAAL, and only two funded the full annual contribution necessary to keep the liability from growing.
“In our examination, funding of actual annual OPEB costs ranged from Chicago’s 17% to Los Angeles and Phoenix, which over-funded in order to add to their OPEB trust funds,” the report said.
Only Philadelphia has not released a public OPEB actuarial study to date, although the city has indicated actuarial results will be available for its fiscal 2008 audit.
Quantifying and disclosing OPEB liabilities, as required by the Governmental Accounting Standards Board’s Rule 45, may spur cities to more aggressively manage those liabilities over time, Standard & Poor’s said. Rule 45 requires governments to conduct actuarial valuations of their OPEB benefits, and the rule is being phased in, starting with the largest governments.
Managing OPEB liabilities is especially important because they may pose greater budget concerns in the future than pension liabilities, even though pension liabilities are larger, the report said.
Cities already generally include in their budgets their annual pension cost on an actuarial basis.
“However, most cities have yet to carve the true actuarial cost of OPEB out of their budgets, and by postponing true annual funding leave themselves open to a progressively larger UAAL,” the report said.
“We believe this level of unfunded liability should nevertheless be amortizable over time, if cities are willing to address the issue in the next few years, but could become progressively more difficult,” Standard & Poor’s said.
Some cities that have realized their OPEB costs are huge, such as Chicago, have cut post-retirement benefits. Chicago’s existing $1.3 billion UAAL will have to be paid down by 2013 under a legal settlement and will disappear after the city stops providing post-retirement medical benefits. The city has proposed using money from the lease of Midway Airport to pay the existing UAAL to avoid steeply increasing its pay-as-you-go OPEB payments through 2013.
Standard & Poor’s said it worries that some of the cities that began to at least partially fund OPEB trust funds to pay for future liabilities in fiscal 2007 and 2008 when the economy was strong, may no longer do so now that tax revenues have weakened due to the recession.
“We believe that the temptation to avoid funding OPEB trust funds, which are not legally mandated, may be strong,” the analysts wrote.
For example, New York City deposited $2.5 billion into its retiree health benefits trust during fiscal 2006 and 2007 to advance-fund future OPEB costs.
However, the city is now proposing to draw this fund down by $1.1 billion during the next three fiscal years to help balance its operating budget.
The draws will be used to contribute to yearly OPEB costs and are designed to free up budget resources to meet unanticipated increases in separate pension fund liabilities that have arisen due to the market downturn.