Recently adopted accounting  standards, however, require governments to change the way they account  for the cost of retiree health benefits, specifying that governments should  account for these costs on an accrual basis. Unfunded OPEB Liabilities for State and Local Governments Exceed $530 Billion

We found that the total reported unfunded liabilities for OPEB (which are  primarily retiree health benefits) for state and select local governments  exceed $530 billion. As variation between  studies’ totals shows, totaling unfunded OPEB liabilities across states and  local governments can be challenging. Approximately   35 percent of the governments for which we reviewed CAFRs—18 of   50 states and 13 of 39 local governments—reported having set aside at  least some assets for OPEB liabilities for one or more entities in the  government, as of their actuarial valuation. In addition, the ultimate cost of OPEB may significantly differ from  estimated OPEB liabilities because (1) the CAFRs we reviewed report data  that predate the market downturn and (2) significant uncertainties affect  the estimation of OPEB liabilities. Two significant  assumptions used in OPEB liability calculations are the discount rate and  the health care inflation rate. Some State and Local Governments Have Taken Actions to Address Retiree Health Liabilities through Prefunding and Making Benefit Changes

Some state and local governments have taken actions to address their  liabilities associated with retiree health benefits by setting aside assets in  order to prefund the liabilities and reducing these liabilities by changing  the structure of retiree health benefits. The CAFRs that we reviewed also  showed that the percentage of the OPEB liability funded—the funded  ratio—varied. Among the 10 selected governments whose actions we reviewed in more  detail, officials from the governments that were prefunding at least a  portion of their retiree health liability reported using irrevocable trusts. The governments we selected varied with regard to the source of funds  used to prefund their retiree health liabilities. The governments we selected also varied in how they determine the level  or amount to commit to prefunding their retiree health liabilities each  year. Some State and Local Governments Have Worked to Address Retiree Health Liabilities through Three Types of Benefit Changes

Another action some state and local governments have taken to address  their retiree health liabilities has been to change the structure of the health  benefits they offer retirees. While governments also make relatively  routine changes to the health benefits they offer retirees (such as changing  co-payments, deductibles, or covered benefits) that could affect their  liability, we identified three key types of changes our selected  governments have made to the structure of retiree health benefits:  changing the type of retiree health benefit plan, changing the level of the  government’s contribution toward retirees’ health insurance premiums,  and changing the eligibility requirements employees need to meet to  qualify for retiree health benefits. Level of government contribution: Some of the governments we  selected have changed the level of the contribution they provide toward  retiree health insurance premiums by reducing the amount or proportion  of health insurance premiums paid for by the government or by changing  how the level of contribution is calculated. Changes to the level of government contribution were the  most common benefit change reported by the governments we selected. As seen in table 2, in  some cases the selected governments made more than one change to their  retiree health benefit structures. The changes were most often applied to  newly hired employees or currently active employees. Health-Related Spending, Including OPEB Liabilities, Is Increasing State and Local Governments’ Fiscal Pressures

Unfunded OPEB liabilities on their own are large enough to represent a  fiscal pressure for state and local governments but are also likely to be  considered part of the broader fiscal challenge of managing increasing  health care costs. However, spending on state and local government retirees’ health  benefits is projected to more than double as a share of total operating  revenues by 2050, from 0.9 percent to 2.1 percent. GAO staff who made major contributions to this  report are listed in appendix V.

Appendix I: Supplemental Scope and Methodology for State and Local Government CAFR Review

To describe what is reported about state and local governments’ unfunded  other postemployment benefits (OPEB) liabilities, we reviewed the most  recent governmentwide comprehensive annual financial reports (CAFR),  as of June 30, 2009, for the states and selected local governments. We determined that the state and local government CAFR data were  sufficiently reliable for our purposes, which were to describe the total  unfunded OPEB liability reported; the total OPEB liability, assets, and  unfunded liability for each of the individual governments for which we  reviewed CAFRs; as well as the ranges of unfunded OPEB liabilities,  assets, and funded ratios reported.
Why GAO Did This Study

Accounting standards require governments to account for the costs of other postemployment benefits (OPEB)--the largest of which is typically retiree health benefits--when an employee earns the benefit. As such, governments are reporting their OPEB liabilities--the amount of the obligation to employees who have earned OPEB. As state and local governments have historically not funded retiree health benefits when the benefits are earned, much of their OPEB liability may be unfunded. Amid fiscal pressures facing governments, this has raised concerns about the actions the governments can take to address their OPEB liabilities. The Government Accountability Office (GAO) was asked to provide information on governments' retiree health liabilities. GAO described (1) what has been reported in state and local governments' comprehensive annual financial reports (CAFR) regarding OPEB liabilities, (2) actions state and local governments have taken to address retiree health liabilities, and (3) the overall fiscal pressures these governments face. GAO reviewed the CAFRs for 50 states and the 39 local governments with at least $2 billion in total revenue. GAO also reviewed the actions taken to address retiree health liabilities by 10 state and local governments, selected based on geography and variation in approaches to address their liability. Finally, GAO simulated the fiscal outlook for the state and local sector and projected health care costs for state and local retirees.

What GAO Found

The total unfunded OPEB liability reported in state and the largest local governments' CAFRs exceeds $530 billion. However, as variations between studies' totals show, totaling unfunded OPEB liabilities across governments is challenging for a number of reasons, including the way that governments disclose such data. The unfunded OPEB liabilities for states and local governments GAO reviewed varied widely in size. Most of these governments do not have any assets set aside to fund them. The total for unfunded OPEB liabilities is higher than $530 billion because GAO reviewed OPEB data in CAFRs for the 50 states and 39 large local governments but not data for all local governments or additional data reported in separate financial reports. Also, the CAFRs we reviewed report data that predate the market downturn. Finally, OPEB valuations are based on assumptions about the health care cost inflation rate and discount rates for assets, which also affect the size of the unfunded liability. Some state and local governments have taken actions to address liabilities associated with retiree health benefits by setting aside assets to prefund the liabilities before employees retire and reducing these liabilities by changing the structure of retiree health benefits. Approximately 35 percent of the 89 governments for which GAO reviewed CAFRs reported having set aside some assets for OPEB liabilities, but the percentage of the OPEB liability funded varied. Among the 10 selected governments whose actions GAO reviewed in more detail, officials from the governments that were prefunding at least a portion of their retiree health liability reported using irrevocable trusts. However, these governments varied with regard to the source of the money used to prefund their retiree health liabilities and how they determined the level or amount to commit to prefunding each year. To address their retiree health liabilities, the governments GAO selected made three key types of changes to their retiree health benefits: changes to the type of retiree health benefit plan, to the level of government contribution, and to the eligibility requirements employees need to meet to qualify for retiree health benefits. Changes to the level of government contribution, such as reductions to the amount or proportion of health insurance premiums paid for by the government, was the most common benefit change reported. Some of the selected governments made more than one change to their retiree health benefit structure. The changes were most often applied to the retiree health benefits of newly hired employees or currently active employees. State and local governments face unfunded OPEB liabilities and decisions about addressing liabilities amid increasing fiscal pressure. Assuming the continuation of current policies, by 2050 the size of the projected operating budget imbalance for the state and local government sector is 4.7 percent of gross domestic product, attributable largely to increases in health-related spending. Though Medicaid is the largest health-related expenditure, spending on state and local government retirees' health benefits is projected to more than double as a share of total operating revenues to 2.1 percent by 2050.