BY: LUCIUS McGEHEE, President, Argent Institutional Services
(318) 251.5851 | lmcgehee@argentfinancial.com
and ANN MARIE MILLS, SVP, Employee Benefits, Argent Trust
(318) 251-5800 | ammills@argenttrust.com
Lucius McGehee
Ann Marie Mills
The U.S. economy has improved dramatically since the Great Recession, yet state and local governments still face a significant threat to their fiscal well-being: the rising cost of other post-employment benefits (OPEB) liabilities.
OPEBs are categorized as employee benefits other than pensions that are received after employment ends. Other post-employment benefits include medical, dental, prescription medicines, disability, long-term healthcare, life insurance and other health benefits that are not part of a pension plan. The financial obligations that many state and local governments owe to cover these expenses is staggering.
A study by Pew Charitable Trusts estimates that in 2015 (the last year data was available) states had a mere $46 billion in assets to cover $692 billion in OPEB liabilities. Pew says the primary reason for the deficit is that “most states pay for retiree healthcare benefits on a pay-as-you-go basis,” meaning they’re paying the minimum amount owed each year and not whittling down the balance. In other words, they’re kicking the can down the road.
State and local governments that are not adequately addressing their unfunded liabilities put themselves at additional financial risk. Credit ratings agencies pay close attention to other post-employment benefits. An increase in liabilities could trigger a ratings downgrade, which could lead to higher borrowing rates on the debt issued to state and local governments.
State and government finance officials say it’s time to take action. In a May 2 opinion editorial in the Houston Chronicle, Houston Controller Chris Brown summed up the feeling of many finance officers, saying the city’s pay-as-you-go “approach to funding its OPEB obligation is unsustainable” and that “it’s clear something must be done.”
An excellent way to address this problem is to establish a pre-funded, irrevocable trust to pay for other post-employment benefits. Here are three key benefits to having an OPEB trust:
- Financial stability/responsibility: Creating a trust to pay for OPEB costs will appease the credit rating agencies and reassure key publics and constituencies that state and local governments are working to resolve unfunded liabilities. OPEB trust assets also are legally protected from outside creditors.
- Higher return on investment: An OPEB trust provides greater flexibility in how the fund’s assets are invested. Funds can be invested more like a state pension plan, which typically invests in a broad range of asset classes (stocks, bonds, real estate, private equity) with a long-term horizon that yields a higher return on investment than government or money-market securities. Conversely, pay-as-you-go payments typically are made from government general funds, which usually have strict limits on investment options (such as only being able to purchase risk-free securities like U.S. Treasuries) and earn a nominal return on investment.
- Best practice: Establishing an OPEB trust is considered a best practice by the Government Finance Officers Association (GFOA), an organization that represents public finance officials in the U.S. and Canada and has more than 19,400 members. GFOA has created a comprehensive document outlining the steps to establish an OPEB trust.
Creating a pre-funded OPEB trust isn’t without challenges. Government budgets are under pressure to fund everything from building new schools and hiring more police officers to fixing potholes and giving raises to employees. It will take a certain amount of political courage for legislators to approve a budget that reallocates funds from other projects to fund the trust. But government officials need to tackle the issue now and an OPEB trust is the best option to help ensure funds will always be available to pay for the benefits promised to retirees.
Argent offers a full line of services to assist local governments, including OPEB solutions, investment management of bond proceeds and surplus funds, and custody and escrow agent services. We would be honored to meet with you to discuss your OPEB needs. Contact Lucius McGehee to learn more.
