Rising Health Care Costs Focus of New GAO Study

December 10, 2007

A Government Accountability Office (GAO) study suggests that state and local governments generally have enough funds set aside to meet their current pension and retiree health care benefit obligations.

But as retiree health care expenses rise, local and state governments may begin to experience funding shortfalls over the long-run, according to the study. GAO predicts that the cost of providing health care benefits to retirees will more than double as a percentage of salaries between 2006 and 2050. Municipalities that have not yet developed policies to deal with these shortfalls may be faced with the need to raise taxes, cut spending, or reduce benefits to meet their obligations, the study says.

Currently, state and local governments typically fund retiree health care costs as an operating expense on a pay-as-you-go basis, managing them together with active employee benefits. However, new Government Accounting Standards Board (GASB) 45 standards say that public employers can no longer report post-retirement health benefits on a pay-as-you-go basis.

Instead, they must account for and report the annual cost of other post-retirement benefits (OPEB) for current and future retirees. While public employers do not have to actually pre-fund OPEB benefits, the study cautions state and local governments that the challenge in meeting these obligations will be difficult if they don’t set aside funds for future retiree health care costs, the same as is done with pension plans.

The report says that without these efforts “tough choices lie ahead about whether and how to maintain the current level of pension benefits for future retirees. State and local governments may be forced to raise taxes, cut spending or reduce benefits in order to meet their obligations.”

The report also says because state and local government officials are in the early stages of estimating their unfunded liability for retiree health care, they have not fully developed strategies to respond to these costs. This report is a follow-up to letter issued over a year ago by Senators Grassley and Baucus in response to concerns about public pension plans being poorly funded.

A copy of the report can be found here.