Chapter 26: Controlling Retiree Health Costs: I’ve Got Some Bad News And Some Not So Bad News…

Originally published in “The Public Retirement Journal,” March-April 2016, and reprinted with permission.

So, here’s the bad news. Governor Jerry Brown referred to the State’s grossly underfunded pension and retiree health obligations in his 2016 State of the State address as “liabilities…so massive that it is tempting to ignore them.” The State’s unfunded retiree health obligation (well in excess of $65 billion) has now surpassed its unfunded pension obligations – and, more importantly, there is no statutory or administrative construct in place (like CalPERS) to force State agencies, cities and local governments to properly fund for these growing obligations. Sure, GASB 45 now forces government to “account for” these liabilities to acknowledge that they really exist; however, it does not by itself mandate funding of these obligations or efforts to control future costs.

None of this is really “new” news. Most of us have seen this coming for some time now. So, what’s the “not so bad news”? Depending on whether you are wearing the hat of someone charged with the responsibility of controlling these liabilities and costs, someone who may be adversely affected by a future reduction in retiree health benefits, or both, the not so bad news is that State agencies, cities and local governments have the tools needed to begin to control retiree health care costs and unfunded liabilities. The real question is whether they have the political skill and will to use them.

In the simplest terms, California law regarding “vested rights” of public employees does not protect retiree health benefits to the same extent that it currently protects pension benefits. With respect to public pension benefits, the courts judicially “imply” a contract (or a vested right) that generally arises when an individual is first hired, which prevents the employer/public agency from reducing or adversely modifying pension benefits unless the employer provides a simultaneous enhancement of pension benefits that is of comparable value. Not so with respect to retiree health benefits. Instead, the California courts recognize that public employers may, if they choose, provide their employees with vested rights to retiree health benefits; however, the extent to which they are protected or vested is strictly a matter of contract law. In other words, the courts have not inferred or presumed some immutable right arising upon hire, as they have in the pension arena.

Of course, things are never so simple. Contracts can be “expressed” – where the terms of the agreement are clearly determined from the written words of the contract, or they can be “implied” – where some or all of the terms of the agreement may be based on the conduct of the parties and, in some cases, relevant written communications outside of the contract.

There have been a number of significant court cases dealing with the rights of California public employees to vested retiree health benefits, most notably the series of federal and California rulings involving the dispute between the retired employees of Orange County and the County of Orange[i] that took over six years to resolve (REOC) and the intervening rulings involving the City of Redding[ii] (Redding). Without going into all of the messy details of these cases (something lawyers love to do), here are the major takeaways from REOC and Redding:

  • It is possible for public employees in California to obtain “vested” rights in their retiree health benefits.
  • Whether and when retiree health benefits become vested and protected against unilateral modification is a matter of “contractual analysis.” That is, what did the parties negotiate and agree upon?
  • A right to vested retiree health can arise by either implied or express contract.
  • In analyzing whether there is an express or implied contract to provide vested retiree health benefits, the courts will look at the employer’s legislative acts (i.e., resolutions, ordinances, and approved MOUs). If the parties’ intent to confer a contractual right to retiree health benefits is not explicit, the party asserting the right (i.e., the retirees) has a heavy burden to overcome.
  • To find a binding obligation to provide permanent retiree health benefits, the courts will look for resolutions, ordinances, or approved MOUs that:

Explicitly provide for health benefits in perpetuity;

Guarantee that the level of benefits will continue; and

Indicate that the benefit is a continuing obligation.

  • A long-term practice of providing a retiree health benefit is not, by itself, enough to create a vested retiree health benefit.
  • MOU language conferring retiree health benefits upon “each retiree and dependent…currently enrolled and for each retiree in the future” is enough to create vested retiree health benefits – potentially in perpetuity.

Let’s go beyond the legal takeaways and focus on what public employers need to understand about their retiree health benefits and what can be done with them.

  • In most cases, California public employers do not have the kind of language in their MOUs that was present in Redding. In other words, very few employers have contractual obligations to provide retiree health benefits beyond the terms of the current MOUs. Start immediately by having legal counsel look at your resolution/ordinance/MOU language.
  • Assuming that the employer is not constrained from making changes in existing retiree health benefits (or future retiree health benefits) by the terms of its contracts, there needs to be an honest assessment of:

The current and projected liabilities associated with retiree health, whether these liabilities (and the assumptions underlying them) are realistic, and how important it is for the employer to control overall benefit costs by reducing retiree health benefits.

The changes that might be available to reduce or control retiree health costs and liabilities (e.g., moving away from a defined benefit retiree health system to a defined contribution system that focuses on what employers can afford to contribute).

Whether there are other aspects of employees’ total compensation and benefits that can be negotiated or reduced in lieu of complete or immediate changes to retiree health.

  • Once the numbers have been reviewed and the issue of financial “sustainability” has at least been raised, there needs to be political discussion about the willingness of the employer and its governing board/council to take on this issue.
  • Again, assuming that there is the need and the will to make changes, there are a number of things that can be done to begin to control these costs and liabilities:
  • Even if the employer is a participating employer in CalPERS and subject to the Public Employees Medical and Hospital Care Act (PEMHCA) and its equal contribution rule, there are adjustments that can be made by using rate groups.[iii]
  • Apart from the use of rate groups, employers that are subject to PEMHCA may also be able to lower their mandatory equal contribution rate for both active employees and retirees and then make separate subsidies (outside of PEMHCA) through the use of a cafeteria plan for active employees and a health expense reimbursement arrangement for certain retirees.[iv]
  • Some employers such as the County of Sacramento have “re-characterized” their retiree health benefit subsidy as an ad hoc benefit that may or may not be conferred on employees. If this is done, there would be no contractual right, but there might be a benefit conferred if there is sufficient room in the budget.
  • If things are really bad, there is always bankruptcy. Based on the experiences of Vallejo, Detroit, Stockton and San Bernardino, literally hundreds of millions of dollars in retiree health obligations were eliminated as part of these bankruptcies.

Given the State of California’s law with respect to public employees’ retiree health benefits, there is bound to be continuing discussion and scrutiny as to what if anything can be done, or is being done, to control these multigenerational obligations.

[i] See Retired Employees Association Of Orange County, Inc., v. County Of Orange, 742 F. 3d 1137 (9th Cir. 2014) and Retired Emps. Ass’n of Orange County v. County of Orange, 52 Cal. 4th 1171 (Cal. 2011).

[ii] See International Brotherhood Of Electrical Workers, Local 1245, v. City Of Redding, 210 Cal. App. 4th 1114 (Cal. App. 3rd Dist., 2012); petition for review denied, 2013 Cal. LEXIS 462 (Cal. 2013).

[iii] See Chapter 12: When Treating Everyone The Same May Not Work – Working With PEMHCA’s Equal Contribution Rule, http://focusonpublicbenefits.com/?p=322

[iv] Id.

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