Island governments face budget buster
Martha's Vineyard towns, Dukes County, Island school systems, and other agencies are beginning to grapple with a budget-busting liability: the health benefits they have promised to pay their employees after retirement.
A recent change in accounting standards requires all Massachusetts government retirement plans to show this unfunded liability on their balance sheets, though there is currently no state mandate to put aside money for the future, and no way short of a special act of the state legislature to effectively pool money to earn higher interest rates.
Local government officials are beginning to realize, however, that they are between a rock and a very hard place, financially. If they continue to pay for retirement benefits as they do now, they will face enormous liabilities in the decades to come. If they heed recommendations to begin putting money aside now, they will pay millions less over the long run, but face very large annual payments from already stretched operating budgets over the next 30 years.
The Dukes County Retirement Board, which administers retirement plans for Island towns and other public agencies, recently commissioned a study to assess the unfunded liability, and outline a way to pre-fund the retirement benefit costs. The results were an eye-popping wake-up call, and they come just as several Island towns are realizing the impact of slowing revenues, and dealing with the possibility of economic recession that could force budget constraints over the next several years.
The situation in town of Oak Bluffs exemplifies the health benefit liability faced by nearly every other town, school district, and independent agency in the state.
According to an actuarial study completed recently by Bucks Consultants of Boston, Oak Bluffs could erase their retiree health benefits liability by putting $7,118,127 in a trust fund that earns eight percent interest. That of course, is impractical in a town where that amount represents about one-third of the entire annual operating budget.
Instead, the study lays out a plan to fund the liability over 30 years, much like a mortgage.
If the town starts in fiscal year 2009, which begins July 1, 2008, the additional amount it would need to fund out of its operating budget is $596,403. This amount would increase by an estimated five percent each year for the next 30 years, when the fund would yield enough money to pay the expected cost of benefits for retired employees. The town would still have to pay for its active employees, but its liability for all the employees who will retire over the next 30 years, would be met.
If Oak Bluffs continues paying for the retirement benefits as it currently does, on a "pay-as-you-go" basis, it would contribute $209,690 this year for the post-retirement health benefits of people who currently work for the town. But according to the projections for rising benefit costs, the town will owe much more than that when those employees retire. Under the new accounting rules, it will have to show what it owes on financial statements. This year alone, the town would have to disclose it owes $1,683,078 to fund the cost of those future benefits.
"It's a big number," said Oak Bluffs Town administrator Michael Dutton. "That's what most people don't really understand, it's not a one year shot."
Mr. Dutton hopes to take the prudent approach for future debts, but he is also looking at slipping revenues, and growing budget demands right now. "I don't know if that's realistic, given the other budget constraints, but we're going to do something."
The six Island towns are facing a double exposure to the unfunded liability, because they indirectly pay for post-retirement health benefits for teachers and county employees, through assessments.
The Martha's Vineyard Regional High School (MVRHS) district is facing a $10.6 million liability. If the district begins to fund its liability this year, it would need to set aside an additional $452,613, and that amount would increase by approximately five percent annually for the next 30 years. The Up-Island Regional School District would need to save $236,409 this year, toward a liability of $4.4 million, and Dukes County would need $265,675 toward a liability of $5.6 million. The schools and the county pass those costs to each town proportionately.
While the town is not required to put this amount away, the new accounting standards do require that it show the future amount owed in its financial documents.
"Our mandate is to put this amount of money on the books," said Amy Tierney, business manager for the Martha's Vineyard Regional High School district. "It's not a mandate to fund the liability."
Rating agencies, such as Dun & Bradstreet, Standard & Poors, and others who assess the financial health of public and private organizations, may view this liability as a financial time bomb. If those agencies lower a bond rating, it could cost significantly more to borrow money for projects like libraries or public works.
Ms. Tierney says the Martha's Vineyard Regional High School district's bond ratings are very good, and she says the unfunded liability is not something that keeps her awake at night. "We have outstanding bonds for construction, we have bonds for buses, and we'll be bonding for the wastewater project," she said. "If it affects us a little bit, and it might, I don't think the dollars are big."
Daniel Sherman, the consultant who wrote the actuarial study, believes the reaction of credit rating agencies will be important for towns that borrow money to fund large capital projects. If credit ratings are already shaky, further downgrades could be significant.
"That will cost you real money," said Mr. Sherman. "That's where the rubber hits the road."
Just like a family budget, where money is put aside in a retirement fund, it makes sense to start saving early, because that money has a lot more time to collect interest. The longer savings are put off, the harder it is. Just like a family budget, it's tempting to pay for what you need now, and put off something you won't need until 20 or 30 years in the future.
Unlike a family budget, there is no 401k or IRA retirement plan for government agencies. The actuarial study assumes an eight percent return on money set aside for post-retirement health benefits. For a small community, that is a tricky proposition, because the amounts of money are not large enough to diversify the risk necessary to earn high returns.
While she does not see the unfunded liability issue as a crisis, West Tisbury treasurer Kathy Logue is concerned about the effect on her town's budget. "If you're not funded," said Ms. Logue, "it's going to be a lot harder. Later on, it's going to come back and bite you."
"It's fiscally wise," said Ms. Logue. "The problem right now is there is no good funding mechanism, or place to pool our dollars, where we could earn that kind of return on those dollars. At some point they may require that we fund it, and at that point, we hope to be well on our way to doing it."
Island financial administrators are working to map out a path for dealing with the unfunded liability. Many will meet next Monday to discuss the issues. While the state is moving to create ways for local retirement plans to pre-fund the amounts they will owe for post-retirement health benefits, the mechanism is not ready yet.
One idea is to create a fund for all the Island government and agencies facing an unfunded liability, where they could pool their money. Larger amounts of money are more likely to earn higher investment returns.
Only four Massachusetts communities have begun to address the unfunded health benefit liability. Through a special act of the legislature, Needham, Wellesley, Bedford, and Arlington have created special trust funds and started pre-funding their liability.
The public sector faced these issues two decades ago. Some corporations reacted by limiting, or even eliminating retirement benefits. Some municipalities are beginning to take a hard look at the benefits they offer.
"Many are addressing health care costs by increasing co-shares and deductibles," said Mr. Sherman. "When they do that, it reduces the cost [to the towns]. We're seeing a lot of that happening."
Mr. Sherman said there are many, many compelling reasons for Island towns to begin saving money to cover the costs they will owe when their employees retire. "There's only one compelling reason not to, and that's money," he said. "They don't have the money."