Like most employers in the public sector, Oakland County provides health care to its retired employees as part of the fringe benefit package. There is a cost to providing the fringe benefit (both currently and as the employee earns rights for future payments of retiree's health care bills). The cost of this benefit is a County liability, money that the County must pay in the future, even as the employee earns that right today. The monetary expression of the right is called the "actuarial accrued liability."
The liability is calculated by an actuary, a professional knowledgeable in these types of fringe benefits. After carefully considering various aspects of the fringe benefit and related assumptions, the actuary projects the future liability of the program giving the governmental entity an "actuarially accrued liability." Some of the related assumptions include -- healthcare inflation increases, life expectancy, the fringe benefit program details offered to the employee, etc.
How are retiree healthcare programs funded?
In most governmental entities, the entity does not address the actuarial accrued liability -- it is essentially ignored -- until the time a retiree's healthcare bill requires payment. Only the amounts to be paid are reflected in the budget, substantially understating the true cost of this fringe benefit. In doing so, the accrued liability grows each year and in many instances, has become a staggering liability for these governmental entities. This approach is called "pay-as-you-go" and is being phased out as required by recently issued accounting principles.
These governmental entities would only have to provide the public financial information on what they actually paid on behalf of the retirees healthcare programs, prior to this recent accounting principle change. Shortly, these entities will be faced with the public's scrutiny of the actuarial accrued liability (which will be significant) and the fact that no funds have been set aside to accommodate this liability. These governmental entities will be under significant budgetary pressures to resolve this fiscal dilemma.
Oakland County, however, has been setting funds in a trust account solely for the purpose of funding future retirees' healthcare bills when presented. This actuarially sound policy has allowed the County to have set aside $265 million as of the last actuarial report. While this is a substantial sum, it does not cover the County's actuarially accrued liability. The County is setting aside the annual required contributions on a prorata basis as specified by the actuary.
Because the County has been funding this fringe benefit on an actuarial basis over the past 20 years, it has placed the County in a very unique position to help sustain this costly benefit, while many other governmental units will be struggling to fund it. In the other governmental units, this will mean program and employee reductions in order to balance their budgets. In Oakland County's case, the cost of this program has already been calculated in the County's operating budget. However, in recent years, even Oakland County's operating budgets are being squeezed and programs/employee benefits are being adversely affected.
What is the actuarially accrued liability?
According to the actuary, the County has an estimated $752 million liability as of September 30, 2005. HOWEVER, the County has been advanced funding this benefit for over 20 years (something most governments haven't done). As a result of these efforts, the current estimated unfunded actuarially accrued liability is approximately $486 million as of September 30, 2005.
The actuary takes the unfunded liability and spreads the cost out over 30 years to calculate an annual required contribution or ARC, much like a homeowner's mortgage payment. The ARC is just like your house mortgage, it is the amount you must pay in order to cover the interest and the principal of the mortgage over time.
Specifically in this case, the ARC is the amount the County must contribute (or set aside) to the retiree health care system in order to have sufficient funds to pay the current and future cost for retiree health care.
How does this translate to a taxpayer obligation?
Funds to cover the ARC come from the County's general resources; primarily property taxes (as well as certain fees and third party payments such as grants). It is a cost of operating the County government just like salaries and wages, healthcare costs for active employees, supplies and heat/light/power for facilities.
So what is the business problem?
Because of a number of factors, including changed accounting and actuarial standards, increasing cost of providing health care to older individuals, life expectancies increasing, and changes instituted by the County to cap future retiree health care cost (closing the plan to new employees), the ARC has risen substantially over the last four years. The ARC for the fiscal year 2005 was $28 million, in 2006 it is $37.5 million, and for 2007 is $54.8 million, an increase of $17.3 million or 46% over last year alone. While most employees focus on the raise in their paychecks (which is expected to be 2% starting October 1, 2006), the cost increases to fund the retirees healthcare program will generate an 8% increase benefiting the employee (over and above the actual amount seen in employee paychecks).
What does that mean for County services?
Funds to pay the ARC and other County services come from the same sources; property taxes, fees, and grants. If more money is needed to pay the ARC, there is less for other services. The County is required to pass a balanced operating budget in accordance with State statutes. As such, these large increases in retirees' healthcare costs have taken its toll by squeezing out other program expansions, or in some cases, actually caused program reductions.
The fiscal year 2007 spending plan developed in connection with the 2006/2007 operating budgets passed in September 2005, anticipated a 23% increase in the cost of retiree healthcare representing $46 million to pay the ARC. However, this budgeted amount is almost $9 million less than the actual ARC as recommended by the actuary. Unless the County comes up with a different method to fund the ARC, there would have to be $9 million in service cuts for the 2007 fiscal year, beginning on October 1, 2006.
What is the County Executive's proposal to solve this budgetary dilemma?
The County Executive proposes to pay off the entire retiree health care liability at one time, thus eliminating the unfunded actuarially accrued liability. To do this, $500 million in taxable bonds have to be sold. The bond proceeds (the cash) would be placed in a retiree health care trust fund and will cover the entire liability. Selling bonds is the governments way of borrowing money.
But if the County borrows money, doesnt the County have to pay it back?
That right! Annually, the County will have to pay back a portion of the bonds borrowed and interest; just like a mortgage. However in the public sector, it's called debt service. The County plans to pay the bonds off in 20 years. In fact, when the actuary calculated the current ARC of $54.8 million, he used the normal time now required to fund actuarially accrued liabilities -- or, 30 years. By borrowing, the County will actually be able to pay off the actuarially accrued liability 10 years sooner reducing the interest charges otherwise incurred.
But if we simply borrow to cover this liability, how does the County and the taxpayer gain?
Because of the Countys outstanding AAA bond rating, the County can sell the bonds (borrow the money) at about 5.5% interest rate. Since the retiree health care liability is something that the County pays off over the lives of the active employees and retirees, the County does not need all the borrowed funds to pay health care bills currently. Therefore the County will invest the bond proceeds (borrowed funds). Because this is a long term obligation, the County is not restricted by statutory investment policies and can invest the money in long term instruments (equities, bonds, etc.) and receive interest of 7.5% or greater. In the case of the Countys defined benefit (pension) plan, it has earned an average of 8.38% over the past 10 years time, even with the down market in the first part of this century. That difference of what the County sells the bonds at (5.5%) and what we invest the proceeds at (7.5%) is called "arbitrage" and represents new revenue to the County -- the roughly 2% earned above amounts paid in debt service on $500 million in bonds will help avoid program reductions cited above of roughly $9 million . This new revenue should amount to $145 million over the 20 year life of the bonds all to the benefit of County services and taxpayers.
Because the County has already built the ARC into its budgets, the savings noted above will manifest themselves in program reductions avoided. As can be seen in many governmental entities surrounding the County, they are struggling with the healthcare program (particularly that fringe benefit related to retirees) and will do so in years to come. Their fiscal problems will be felt in program and employee reductions and general program turmoil, because no amounts had been set aside in prior years -- and, they are facing the same healthcare increases as Oakland County has in the past several years. Unfortunately for them, however, their inability to fund the actuarially accrued liabilities will further exacerbate the fiscal problems over the next dozen years -- all while Oakland County has solved this very difficult fiscal problem.
So the gain to the County and the taxpayers is?...
Rather than funding a $54.8 million ARC payment, the County will fund a $44 million dollar debt service payment for 2007. Considering the County originally budgeted to spend $46 million on the ARC, as passed by the Board of Commissioners in September 2005, selling bonds means there is $9 million annually in services that can continue (difference between the ARC payment of $54.8 million and the $46 million ARC budget) and there is $2 million in flexibility to cover additional payments, should the cost of retiree health continue to rise faster than estimates.
Essentially, this is like refinancing your house because of more favorable interest rates. The County will use the excess earnings (difference between the anticipated 7.5% investment income and debt service at 5.5%) to avoid further program reductions otherwise required.
There are other benefits as well. Required ARC payments have increased substantially over the last three years, each year spiking at a new level. By selling the bonds, the County is locked into a specific debt service payment that will not change over the 20 years of the bonds. The County now knows what it has to budget for the ARC (now essentially the debt service payment). And the County can accomplish this without any tax increase, or change in our debt limits, or any other burden on the Countys taxpayers.
This proposal is not going to lead to a tax increase or other burden on the taxpayers?
That is correct!!! As stated above, the County budgeted $46 million annually to cover the expense of the ARC for the 2007 fiscal year. This amount is already built into the budget by use of the current property tax rate and property tax revenues. Since the debt service payment is less than the original budget, there is no need to increase taxes.
Also the County is limited by state law to borrow no more than 10% of it state equalized value. That means the debt limit for Oakland County is $7.3 billion. The current debt obligation of the County is $324 million. Oakland County is comparatively debt free!! This proposal would increase the County's debt obligation to $824 million; $6.5 billion below the legal limit. Further, in discussing this matter with the bond rating representatives, they are looking very favorably on this transaction in fiscally settling a problem for most other governmental entities.
Taxpayers will see no tax increase through this proposal and should see benefits!
Why the need for a legislative change?
The current state law (The Municipal Finance Act), dictates the process and types of debt instruments local governments can sell to receive cash. Although the Municipal Finance Act allows local governments to sell bonds to cover pension obligations, it does not allow the sale of bonds for retiree health care obligations.
The legislative change sought is a simple amendment to the Municipal Finance Act which will allow municipalities (including counties) to sell bonds to cover retiree healthcare cost. The change should not affect any budgetary matters of the State of Michigan and would allow other governmental units to avail themselves of this unique Oakland County program.
What happens if the state law isn't changed?
Under the current Municipal Finance Act, the County has the authority to sell "Treasury Certificates." These are like bonds, however they are more difficult to market, and therefore the interest rate the County will have to pay investors is higher than a bond interest rate. The more interest the County has to pay, the less money available to support other services. If the law is not changed the County would sell Treasury Certificates and work to adjust the annual budget accordingly. The difference would likely not affect reductions in current programs, but would reduce the overall savings in the proposed program.
