Proposition B - Retiree Health Care Reform

What it does

This proposed amendment to the San Francisco City Charter would limit how future City employees earn and receive retirement health benefits. The measure also includes an increase in the City’s pension formula. The purpose of the measure is to ensure that the City’s $4 billion unfunded liability for retiree health care does not grow, by limiting future payouts and by pre-funding the liability with payments from employees and the City.

The key changes to the City charter in Prop. B:

• For future City employees, it eliminates lifetime subsidized health care for retirees with only five years of experience, and increases the threshold for full vesting to 20 years of employment.
• It establishes a new contribution of 2 percent of gross salary for future employees to pay to pre-fund their retiree health costs. The City will match with a 1 percent contribution.
• It increases the pension for all current and future employees. The current maximum formula for most City workers is 2 percent of salary per year of service at age 60. The proposed change would increase pensions to a maximum of 2.3 percent of salary at age 62.
• It establishes a compounded cost-of-living adjustment for pension payments. Today, the cost-of-living adjustment each year is the same simple 2 percent of the original pension payment. The compounded growth means that the 2 percent growth is based on the prior year’s pension payment and grows each year.
• It imposes an 18-month wage freeze effective July 1, 2009 through Dec. 31, 2010.

How retiree health care and pensions work now

HEALTH CARE

Under existing policy, when employees with five or more years of service with the City retire, the City pays 100 percent of their health costs so long as the person is 55 years or older. The City also pays 50 percent of the health-care costs for the retiree’s domestic partner or spouse. The required five years of service may include years of service at another eligible California public entity such as the State of California, and the five years of service do not have to be served consecutively. Neither employees nor the City contribute to a fund to pay for the cost of retiree health care. Each year, the City pays the full cost of retiree health care directly out of its General Fund. Whereas in 2001 the City expended $17 million on retiree health care, in 2007 it expended $130 million on retiree health care, an increase of $113 million.

RETIREMENT

Under current policy, the City’s employees — except for those in public-safety departments — are eligible to receive retirement benefits at age 50. The amount of the retirement benefit varies according to the age at which the employee retires and the number of years of service; the older the employee at retirement and the longer the period of service, the higher the retirement payment.

Existing policy also dictates that retirees receive an annual cost-of-living adjustment equal to a maximum of 2 percent of the employee’s initial retirement payment. In years when the retirement system’s investment earnings exceed expected returns, the retirement system may pay employees a supplemental payment equal to 1 percent of their COLA.

Proposed changes under this measure

HEALTH CARE

The proposed measure will make no changes to the health care contributions and retiree care for current employees. It will make changes to the benefits of employees who start work for the City after Jan. 10, 2009. First, it will increase the number of years for which City employees must work before the City will pay 100 percent of their retiree health benefits. Under the proposed legislation, for employees hired after Jan. 10, 2009, the City would begin paying a percentage of the employee’s retiree health cost after 10 years of service, and would not pay for 100 percent of retiree health costs until retirees had completed 20 years of service.

The second change proposed by Proposition B is to establish a mandatory employee and employer contribution to future retiree health-care costs. The mandate would apply to all employees who start after Jan. 10, 2009. Employees would contribute 2 percent of their gross pay and the City would contribute 1 percent.

The proposed legislation would further reduce future retiree health costs by eliminating reciprocity benefits. For example, employees no longer would receive credits for years they worked for other public entities, and employees would be required to retire within 180 days of leaving City employment. Therefore, only consecutive years of service that end in retirement would count toward retiree health-benefit calculations.

The proposed legislation would pre-fund future retiree health costs by creating the Retiree Health Care Trust Fund. Like the City’s retirement fund, this fund would be financed by employee and employer contributions and would be administered by a board of trustees. This board would be known as the Retiree Health Care Board and would be composed of five trustees.

The Retiree Health Care Board would be responsible solely for administering the Retiree Health Care Trust Fund and would not be responsible for decisions regarding the level or type of health coverage offered by the City. The Health Service Board would continue to make those decisions.

The Retiree Health Care Trust Fund would be financed via payments from the City and from employees hired after Jan. 10, 2009. Under the proposed legislation, until the trust fund is fully funded, the City would pay an amount equal to 1 percent of each employee’s salary into it. In addition, employees hired on or after Jan. 10, 2009 would pay an amount not exceed 2 percent of their gross income into the trust fund. Once the Retiree Health Care Trust Fund is fully funded, ongoing costs would be split evenly between the City and employees hired after Jan. 10, 2009. Proponents expect that the contributions from the City and employees would fully fund future retiree health costs by 2031.

RETIREMENT

Under the Prop. B, employees who work beyond the age of 60 would receive enhanced retirement allowances.

The proposed legislation also would change the way cost-of-living adjustments are calculated as well as increase the supplemental COLA from 1 to 1.5 percent. Existing policy mandates a simple 2 percent COLA, which means COLA increases are the same each year — that is, they always are equal to 2 percent of the employee’s original retirement payment. Under the proposed legislation, COLAs would be calculated as a compound 2 percent adjustment, which means that each COLA would take into account all previous increases.

Why it is on the ballot

The City has a $4 billion unfunded retiree-health liability. Changes to the federal General Accounting Standard Board rules now require that public entities report all unfunded future liabilities. Consequently, the City now is required to report that it owes $4 billion in future retiree health costs and that it has no dedicated funding source. This situation is likely to negatively affect the City’s bond rating, making it more expensive for the City to borrow money. In addition, as the City’s workforce ages and employees retire in increasing numbers, the City’s future retiree health costs are likely to increase. As a result, a larger portion of the City’s budget will be dedicated to funding retiree health care and less discretionary funding will be available to fund City programs and priorities.

The mayor and Supervisors Sean Elsbernd and Aaron Peskin sponsored this charter amendment. It received unanimous support from the Board of Supervisors to be placed onto the June ballot. Like all changes to the city charter, it requires a vote of the people.

The final version that will appear on the ballot is the result of a major compromise between the City and the many public-sector labor unions who also support the measure. Proposition B’s adjustments to the City’s pension formula are necessary components that secured the support of unions for the new requirement of employee payments for retiree health care.

Pros

Arguments for this measure:

• This is a timely and necessary measure that addresses the growing issue of how to pay for future retiree health costs. It establishes a fair and new system whereby both the City and future employees will pay to fund their retiree health costs.
• Because the City’s workforce is aging, retiree health costs are expected to increase even more quickly in the future, and we need to begin solving this issue now.
• The City would be taking an important step toward containing future retiree health costs, which likely would have a positive effect on the City’s bond rating and therefore reduce the City’s borrowing costs. In addition, pre-funding the City’s future retiree health-care liability would make San Francisco a pioneer in good governance.
• San Francisco offers one of the most generous retiree health systems in the region, but ranks second to last among regional public agencies in terms of retirement pension benefits. The proposed legislation requires the City to strike a delicate balance between reducing health benefits and increasing pension benefits.

Cons

Arguments against this measure:

• While the proposed legislation reduces the City’s future retiree health costs, it also establishes a permanent increase in pension payments. The actual costs of this increase are unknown and could be substantial for the City in perpetuity.
• Estimated costs and savings for the retiree health and pension plans are highly sensitive to actual hiring and retirement patterns, turnover in the current workforce, the number and demographic profile of new hires, and societal conditions such as the presence or absence of a national health-care system. If any of the assumptions made when calculating the costs and benefits of this measure were to change, the increased pension cost could actually exceed retiree health savings.
• While pre-funding retiree health benefits is likely to positively affect the City’s bond rating, increasing the City’s pension costs is likely to negatively affect credit analysts’ view of the City’s financial condition. Therefore, the net financial impact of this legislation is unknown.
• The proposed legislation creates a two-tier system that requires future City employees to participate in funding their own retiree health-care benefits, but requires little of existing City employees. Whereas future City employees will receive the benefit of pension enhancements but must partially fund their retiree health-care benefits, current City employees will benefit from pension enhancements without being required to make a financial contribution toward retiree health benefits. This measure greatly advantages existing employees at the expense of future ones.
• While the proposed legislation addresses the critical issue of funding the retiree health costs of future city employees, the legislation does nothing to resolve the existing $4 billion unfunded retiree health liability. This is because the current unfunded liability is based on the projected retiree health costs of existing City employees. Because of legal restrictions, it is not possible to reduce the expected level of City contribution to the health care for existing employees when they retire.

SPUR’s analysis

The City’s pension and health systems are highly technical policy arenas that require a great deal of expertise and patience to understand. In addition, both systems are highly politicized. The fact that we have a compromise measure on the June ballot that received both unanimous support from the Board of Supervisors and support from the public-sector unions is a testament to the importance of the issue and the effectiveness of the proponents.

Still, the measure combines an attempt to address the retiree health-care issue with an increase in pension benefits. By conflating these two independent issues, the measure loses some of its effectiveness. Given that the fiscal benefits of this measure are expected to emerge over the course of 30 years, it is likely that some of the assumptions made when the fiscal analysis was conducted are incorrect. Most importantly perhaps, it does not begin to address the current unfunded health liability, because it asks nothing of current employees. All costs and contributions will be borne by future employees and the City.

Proponents of the proposed legislation estimate that the City would save $49 million dollars by reducing and pre-funding the City’s future retiree health costs. However, these savings would emerge over time. In the short-term, due to pension enhancements, the proposed legislation likely would increase retirement expenditures. In the very short-term, these increases would be partially offset by the proposed 18-month wage freeze for non-safety employees that would begin July 1, 2009 and end June 30, 2010. Considering all factors, in the first 20 years of its implementation the proposed legislation is expected to cost $84 million annually, which represents a 3.55 percent payroll increase. After 20 years, when the effect of pension enhancements that encourage employees to work until age 60 — the age at which Medicaid coverage begins — is felt, the total cost of the proposed legislation would decrease to $27 million per year, resulting in a $35 million savings per year.

Still, this potential solution to the retiree health-care problem is the result of a unique confluence of political and economic circumstances and personalities that might not appear again. We believe that the charter amendment before the voters is the best possible policy reform we could have, given the current political environment. Lastly, many of the potential pitfalls in the proposed legislation can be addressed through future action by the City. Some of those suggested reforms:

• The City should create a separate funding scheme that would address how the City should finance the existing retiree health liability. One of the tough legal and political questions is how to get existing employees to help fund this outstanding liability. as opposed to saddling future employees with the entire burden of paying it off.
• Given the level of uncertainty regarding the assumptions and the length of time over which benefits are expected to accrue, SPUR recommends the City perform regular financial analyses that measure the financial impact of the proposed legislation.

Though far from perfect, Prop. B is an adequate solution to the unfunded retiree health liability.

SPUR recommends a “Yes” vote on Prop. B.