Blog Posts > Don’t Hit the OPEB Panic Button
May 25, 2010

Don’t Hit the OPEB Panic Button

Would you consider it a “crisis” if an accountant told you how much money you owe on your house? Apparently, that’s the rationale Phil Kabler used yesterday when he told people that our state’s $8 billion OPEB  (Other Post Employment Benefits = the state’s retiree health care subsidy for state and public school employees) liability is “the biggest financial crisis facing the state.”  While $8 billion is nothing to gawk at, the number needs context, a lot of context. The $8 billion is based on a shaky estimate and represents what the state would owe if every single vested public employee retired today and demanded the benefit. Furthermore, looking comparatively at other states, we don’t look too bad. According to the Pew Center on States, West Virginia has funded its OPEB liability better than 37 states (4%). Moreover, 22 states have put zero funds toward their OPEB obligations. That’s how concerned they are.

Fortunately for us, there is no “crisis” and the $8 billion figure is based on a misunderstanding of debt. However, what I am most afraid of is that the media and (some) lawmakers are using OPEB as a scare tactic or a red herring to cut future government investments and hurt public employees benefits.  Both of these actions will hurt our state’s economy and its people.  

 The OPEB story is not so simple, but I’ll give it a shot.  Many years ago, state employees and teachers were told that in exchange for pay increases that they “may” receive a retiree health care subsidy (based on salary and years worked) from PEIA once they hit age 55 (I say “may” because the state has no legal obligation to provide health care to retired public workers). This was ok until a bunch of accountants got together and “pronounced” that states need to report this on their balance sheet as a future liability (GASB 45 ) Once this happened, West Virginia went from a pay-as-you-go system to one where we started appropriating ($400 million to date) money into a trust fund to help pay the projected future liability of the entire benefit. So in one fell swoop our balance sheet (liability) changed, reflecting not what we need to pay out in the upcoming fiscal year, but what the state would have to pay if every vested public employee took the benefit today. From a transparency point of view, this makes sense because it is a perceived state liability. However, from a fiscal policy point of view, it gives the false impression that the state owes this money today and it cannot afford other public investments.

Let me explain. Unlike public pensions that are defined, the cost of OPEB plans are unknown. This is largely because we don’t know the present value of those future health care benefits payments in today’s dollars, so we have to make an estimate.To figure this out, the state hires actuaries that use a number of assumptions to calculate the OPEB liability at present value ($8 billion).  The main ingredient they use is projected future health care costs or medical inflation (others include discount rate changes based on assets, turnovers, mortality, and coverage lapse). (One problem with using this variable is that health spending cannot continue to rise at these alarming rates without damaging overall U.S. economic growth and security.)

Let’s get back to the mortgage analogy. Imagine that you owe the bank $150,000 on your home, a payment you’ve “promised” to make based on your net worth and salary. Would you stop putting away money for your kids college, stop making repairs to the house, and not buy a car because your accountant said your total unfunded liability is $150,000? Would you put money in an escrow account to pay for the $150,000 liability? Probably not, because you understand that the debt is “manageable” and that you could sell your home (analogous to reducing the state provided health care subsidy and buying out future retirees) or reduce other costs if you were unable to afford it. This is the same principle that should guide lawmakers about OPEB. As long as the state can afford to pay its share of OPEB, then it should do so and not worry too much about the total liability. If we can’t afford the payment in the future, then changes will have to be made.

The real reason lawmakers are concerned about the OPEB liability is that it has the “potential” to lower our state’s bond rating. A lower bond rating =  higher interest rate = more money that state has to pay to finance capital projects like schools. The power of the bond market to control policy decisions is immense and it can stifle the state’s ability to invest in things like infrastructure. As James Carville quipped back in 1993, “I used to think if there was reincarnation, I wanted to come back as the president or the pope or a .400 baseball hitter. But now I want to come back as the  bond market. You can intimidate everybody.”

If our state’s bond rating is the key concern of policymakers, then they shouldn’t be concerned. Last year, West Virginia’s bond rating was upgraded to AA . The truth is bond rating agencies have already considered the OPEB liability on state’s balance sheets and they don’t rank it as a critical factor in determining a state’s bond rating.

So, back to the problem of what to do. Kabler notes in the article that the Legislature is considering funding the liability for three years at $600 million so the fund can hit $1 billion – which would increase the discount rate (or investment return) and reduce the liability. This is a (somewhat) reasonable approach, but the real question should be: Do we invest $600 million in the stock market (trust fund) or do you investment the money in our future workforce that could yield even higher returns? One of the key problems in this debate is that too many legislators don’t recognize that spending money on education often yields greater revenue returns in the future than the stock market. 

As John Maynard Keynes said, “Once we allow ourselves to be disobedient to the test of an accountant’s profit, we have begun to change our civilization.”

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