New actuarial reports analyzing the city of Warwick’s liabilities for active and retired employee healthcare and the city’s four pension plans have split officials and financial watchdogs into two specific camps regarding what these figures mean in regards to the financial health of the city, with one side warning of impending doom and the other insisting on a less drastic stance.
All told, according to the two reports, prepared by GRS Retirement Consulting and Danziger & Markhoff LLP, the city faces about $352 million in unfunded OPEB (other post-employment benefits, meaning healthcare for employees who are retired or who will retire) liability and $331 million in pension liability for the fiscal year than ended in June of 2018.
“I think it’s important that we all understand there is a fiscal cliff,” said City Council President Steve Merolla during the hearing for the report on Monday night. “We can ignore it and go over it, or try and fix it together. But if you don’t acknowledge there’s a cliff, you can’t address the problem. And the question is how soon do you get to the cliff?”
“It’s important to have these conversations. Knowing helps you keep these costs under control,” said Michael D’Amico, principal of D’Amico consulting who was brought in as an executive assistant/consultant to Mayor Joseph Solomon in July. “But it’s important not to be overly alarmist either.”
So, is Warwick barreling towards a fiscal cliff and flirting with receivership down the road, or are such claims merely misinterpreting the data and causing false alarm?
What the report means for OPEB
To simplify this complex topic as accurately as possible, we must first understand what an actuarial report seeks to determine and what that means in the scope of Warwick’s unique situation. First, let’s break down what the city’s total unfunded liability for OPEB is, and what that actually means.
The important number outlined in the first sentence of this story – $352 million – is not to be interpreted as a bill that is due for the city to pay. It does not accrue interest like a large credit card bill would. Rather, as D’Amico explained, the figure is a cumulative, speculative figure that represents what the city would have to pay in order to satisfy the healthcare needs of every one of its 1,649 employees reflected in the report throughout the remainder of their lives. It is a number that spans 60 to 70 years’ worth of costs.
Obviously, it cannot be known for certain how much healthcare each of these employees will require, how long they will live or how much healthcare procedures will cost in year 2050 – so the report is inherently reliant on certain assumptions.
Most importantly, the report assumes that the trending cost of healthcare will decrease gradually over time from an average of 8 percent to an average of 5 percent year over year. Small deviations in this assumption create drastically different projections. For example, a one percent increase in that assumption turns the $352 million number into $406 million, while a 1 percent decrease in rates drops the projected net liability to $306 million.
While Merolla sees this assumption as problematic, stating on Wednesday that the school department recently experienced a 14 percent increase to health insurance and the municipal side has seen increases close to double digits in recent years, D’Amico sees it as a conservative estimate given the span of time encompassed by the report.
Another factor that generated disagreement between parties is the “discount rate” utilized within the calculation of the actuarial report. As D’Amico explained, federal standards that guide these reports mandate that municipalities assume a certain percentage of growth within funds set aside to build revenue towards paying down the overall healthcare liability, so that rating agencies and bond issuers can assess all municipalities on a level playing field based upon the same formula.
In this report’s case, it assumes Warwick is earning a 3 percent return on investment on funds set aside, which to Merolla and others, like council finance committee chairman Ed Ladouceur, is problematic for one very large reason – the city has set aside zero dollars to contribute towards its OPEB liability.
“When that 3 percent return doesn’t occur because I have no investments, what happens to my financial picture?” asked Ladouceur of Edward Echeverria, Senior Actuary at Danziger & Markhoff LLP, who presented the report for the city. “I don’t understand how that translates into an accurate financial picture.”
Merolla also argued that the true OPEB liability projection should reflect the fact that Warwick has no money set aside with which to earn a return. According to the report, if the discount rate were set at 0 percent, the unfunded liability would actually be about $90 million higher – totaling $442 million.
But D’Amico said this interpretation was problematic. In addition to being the means by which municipalities are evenly compared for bonding purposes, he said that the discount rate is an important factor that tries to conservatively assume the rate of inflation within the speculative formula.
He reasoned that a dollar in 2018 is not going to be worth the same value in 2070, just as a dollar in 1950 was worth significantly more than a dollar is worth today. By assuming a modest 3 percent “discount” to factor in prospective inflation, he argues that the number becomes more accurate since a majority of the assumed costs – and the city’s spending power with its dollars – must be factored and calculated decades down the line, during a time when today’s dollars will go farther than they do now.
Paying as you go versus setting up a fund
Another area of disagreement regarding the city’s liabilities stems from the notion of setting aside money each year – as is done for the city’s pension plans – for prospective retiree healthcare costs, versus paying one premium every year and “paying as you go,” which the city currently does.
Merolla and those who believe the OPEB liability number indicates much larger trouble looming for Warwick cite the actuarial opinion, as presented by Echeverria, that Warwick should be dedicating $34 million each year for the next 20 years to pay off this total liability, for healthcare alone. The city currently allocates zero dollars per year towards long-term OPEB costs.
Objectively, the city pays a huge bill for healthcare for its employees. According to data gathered by former councilman and school committee member Bob Cushman – who helped establish the camp warning that the city is headed for financial disaster – the city’s net expense for healthcare for its employees (active and retired) has risen from about $12 million in 2004 to a proposed $22.3 million in FY2020.
The healthcare expense for retirees specifically has more than doubled from $4.8 million in 2004 to over $10.4 million as proposed for FY2020. As Merolla pointed out on Wednesday during a phone interview, the city now has more retired workers collecting benefits than it has active employees – a lot more, in fact, with a disparity of 711 active workers and 938 retired workers as of June 30, 2018, according to the report.
But D’Amico said he finds himself in the minority being of the belief that putting aside a separate pool of money for healthcare expenses could actually be detrimental for a municipality.
“Me personally, if I can pay $10 million per year in pay as you go, why would I not do that? Why would I choose to put away $35 [million]? It won’t save you money in the long run,” he said. D’Amico argued that the long-term OPEB costs should be viewed similarly to a mortgage assessment, where the overall cost of something looks overwhelmingly large, but is manageable in monthly installments over a long period of time.
D’Amico said that calculating any expense over a period of 60 to 70 years will look daunting, giving the example of projecting how much it would cost to run a police department for 70 years. “If I did the math, it would be scary. But we’re not forced to calculate that,” he said.
And that is an important point to note. Prior to the last year or so, municipalities did not have to report their overall OPEB liability. But now, under the Governmental Accounting Standard Board “GASB #75” reporting mandated requirements, municipalities like Warwick are seeing – for the first time – the total breadth of their promised benefits to all city employees, past and present, for the length of their lives.
However, D’Amico contends, merely seeing this number does not indicate that such liabilities are new, or any more of a cause for concern as he has seen.
“The problem hasn’t changed in the last 40 years, we just know it now and have it written down,” he said, adding that if somebody was forced to extrapolate retiree healthcare costs 30 years ago, the looming overall liability number would have been similarly daunting.
Healthcare handcuffing the city?
But Cushman argues that increasing healthcare expenses, along with the required pension contributions that must be made each year to keep on track with those plans (which in FY19 is projected to cost $33.8 million, and climbs to $39.4 million by 2023) equates to the city – which has historically and recently been forced to lean on rainy day funds and scale back projected infrastructure work in order to be able to fund the cash-strapped school department – running out of track in regards to being able to functionally run, as the costs will eventually envelope all other needs.
It’s an opinion that Merolla shares.
“We all want new schools, we all want new equipment, we want our roads repaved. We want our fields and recreational facilities to be improved. But we can’t do it because of the debt that’s been accumulated,” he said. “No one seems to grasp the severity of it.”
Backing up this point of view, Cushman showed another chart – which outlined that, of $61,237,885 in new city spending between 2004 and 2020, 86 percent of the money went to active and retired employee benefits (with retired employee benefits accounting for more than half). The 14 percent remaining ($8.3 million) has gone to everything else that makes the city run.
“We just inch closer and closer to the cliff every single year,” Cushman said on Tuesday.
D’Amico argued that, from the point of pensions at least, the city is making its contributions each year and while the contributions must increase each year for the near future, once the city hits 2026 it should see these contributions peak and begin to go down as the overall liability falls.
But for Cushman and Merolla, this too is overly-reliant on assumptions – primarily that the city will be able to continue to contribute 2.75 percent increases in its contributions and that it will continue to earn 6.9 percent return on its investments when the historical return has actually been 6.6 since 1997.
“If we hit a recession, the whole plan this guy [Joe Newton, actuary from GRS who presented the pension report on Monday night] has laid out is nonsense,” Cushman said.
“That money goes up every year that we have to contribute. That money has to come from some place,” Merolla said on Monday in regards to pension contributions. “It’s great to say that if you stay on track, you’ll pay your retiree costs. It’s another thing to say where you’re going to get the money from. What are you going to cut to make ends meet?”
D’Amico didn’t try to diminish the importance of actuarial reports, but offered that they should be used as a negotiating tool for future collective bargaining agreements rather than something to be used as evidence of a looming financial disaster.
“I think it informs your future labor negotiations knowing what these liabilities are in the future, and that you have to be more mindful of making these promises to your future retirees now that we have a truer interpretation of what these numbers mean,” he said. “This is why it’s important to understand these numbers and not ignore them.”
In fact, throughout this complex issue, the need to restructure benefits packages through future contractual agreements seems to be one area of mutual agreement.
“You can’t solve this with revenue. It’s in the design of the plans,” Merolla said Monday. “At some point you’re going to reach a point where, if we can’t negotiate these changes, then somebody else will come in – another branch of government – and fix it for us.”