State and Local Health Plans for Active and Retired Public Employees

Robert Clark, and Olivia Mitchell, University of Pennsylvania and NBER

How Does Retiree Health Insurance Influence Public Sector Employee Saving?

Economic theory predicts that employer-provided retiree health insurance (RHI) benefits would be hypothesized to have a crowding-out effect on household wealth accumulation, not dissimilar to the effect reported elsewhere for employer pensions, Social Security, and Medicare. There is little, if any, similar research on the impacts of retiree health insurance per se. Accordingly, Clark and Mitchell utilize a unique data file on four baseline cohorts surveyed in the Health and Retirement Study (HRS), to explore how employer-provided retiree health insurance may influence net household wealth among public sector employees, where retiree healthcare benefits are still quite prevalent. The authors find that most full-time public sector employees anticipate having health plan retiree coverage, unlike many private sector workers, and that public sector employees covered by RHI have substantially less wealth than similar private sector employees without RHI. In particular, Federal workers had about $89,000 (21%) less net wealth and $100,000 (344%) less financial wealth than private sector employees lacking RHI; state/local workers with RHI accumulated about $80,000 (or 19%) less net wealth, and $83,000 (or 28%) less in financial wealth than their uninsured private sector counterparts. After controlling on socioeconomic status and differences in pension coverage, net household wealth for Federal employees is $82,000 less than workers without RHI, and the state/local difference in net wealth is $62,000.

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Sita Slavov, American Enterprise Institute, and John Shoven, Stanford University and NBER

The Role of Retiree Health Insurance in the Early Retirement of Public Sector Employees

Public sector employees often face strong early retirement incentives from their defined benefit pension plans. In addition the availability of retiree health insurance can facilitate early retirement. For most private sector workers with employer-provided health care coverage, the only way to maintain group coverage is to continue working until age 65, when they are eligible for Medicare. However, most government employees have access to retiree health coverage, which allows them to continue group coverage even after they stop working. Retiree health coverage eliminates the incentive to wait for age 65 to retire. Shoven and Slavov study the impact of retiree health coverage on job exit rates among public sector workers between the ages of 58 and 64. They find that for state and local government employees, retiree health coverage raises the probability of job exit by 9.3 percentage points (around 69 percent) at age 61, and by 13.0 percentage points (around 71 percent) at age 64. These effects are somewhat larger than for private sector employees. The authors find weaker evidence that more generous coverage (measured by the percentage of the premium paid by the employer) has a larger effect on retirement than less generous coverage.

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Robert Clark; Melinda Morrill, North Carolina State University; and David Vanderweide, North Carolina General Assembly

The Effects of Retiree Health Insurance Plan Characteristics on Retirees' Choice and Employers' Costs

Employers everywhere struggle to moderate the rate of growth of the cost of providing health insurance to active and retired employees. Although most private sector employers have eliminated retiree health insurance (RHI), the majority of public sector employers have, thus far, continued to offer RHI. Employers have adopted a variety of plan modifications to reduce employer costs and move retirees into less expensive plans. This raises two questions: do incentives produce the desired plan elections, and do these changes, along with cost shifting to retirees, produce the expected reductions in costs? Clark, Morrill, and Vanderweide examine a series of policy modifications implemented by the State of North Carolina State Health Plan. Using individual-level administrative data on retirees' plan choices, along with aggregated data on expenditures for retirees, the analysis estimates the effects of the introduction, and subsequent repeal, of a Comprehensive Wellness Initiative (CWI), increases in coinsurance and copayments, and the introduction of a premium on the choice of health plans by retired state employees. Over a third of non-Medicare eligible retirees shifted into the least generous plan. Although plan choices were significantly influenced by the plan changes, the effects on both current year costs and unfunded actuarially accrued liabilities (UAAL) were relatively modest for the CWI. Increases in the employee/retiree premiums did reduce long-term projected costs.

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Robert Novy-Marx, University of Rochester and NBER, and Joshua Rauh, Stanford University and NBER

Funding Soft Liabilities

Many state and local governments provide subsidized health insurance to retired public employees, but the legal protections that apply to state and local pension liabilities generally do not apply to these other post-employment benefits. Under current government accounting rules that give a role to expected returns on assets, states and local governments use discount rates that increase with the amount of pre-funding. In contrast, financial economics implies that, viewed from the perspective of taxpayers, cash flows should be discounted at rates that reflect their risk. Novy-Marx and Rauh estimate retiree health insurance liabilities from a taxpayer perspective for the state of California under different assumptions about the extent to which the benefits are subject to default. They analyze optimal funding strategy in a model in which risk-averse workers, who otherwise lack market exposure, demand wage premiums to compensate for the possibility of default on retiree medical benefits. More aggressive pre-funding reduces the option value of default, but also can reduce the wage premium that must be paid to workers. The model delivers an optimal funding strategy of pre-funding over 15-20 years.

Paige Qin, Harvard University, and Michael Chernew, Harvard University and NBER

Compensating Wage Differentials and the Impact of Health Insurance in the Public Sector on Wages and Salary

Qin and Chernew explore how the expanding share of health-related costs in state budgets affects state public sector wages and hours worked. They examine the variation in health care spending at the state level, and its impact on the wages and hours of state and local government employees using individual-level micro data from the 1992–2011 Current Population Survey. The authors analyze the impact of state expenses on retiree health benefits on the wages of current state government employees using Pew Center data derived from states' Comprehensive Annual Financial Reports (CAFR). The results are consistent with a dollar-for-dollar trade-off between existing workers' wages and health insurance, though the findings identified from variation in state health care spending are very imprecise. The authors find little effect of health coverage on hours worked, though some models suggest coverage is associated with a decline in hours. Finally, holding contribution per employee and other retirement system characteristics constant, a more fully funded retiree health insurance system is associated with lower wages. A one percentage point increase in the percent funded - a measure of a state's retiree health benefits' permanent funding status - is associated with a 0.2 percent decline in hourly wages.

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Byron Lutz and Louise Sheiner, Federal Reserve Board

Examining the Whole Picture: Retiree Health Obligations and the Long-Term Budget Outlook for the State and Local Government Sector

While state and local government pension obligations have been analyzed in great detail, much less attention has been paid to the costs of the other major retiree benefits provided by these governments: retiree health insurance. Lutz and Sheiner use the information contained in the annual actuarial reports for state government retiree health plans to reverse engineer the cash flows underlying the liabilities given in the report, and then gross up these flows to account for local government workers. In this way, the authors can construct liability estimates which are consistent across governments in terms of the discount rate, actuarial method, and assumptions concerning medical cost inflation and mortality. They find that the total liability of state and local governments for the future provision of retiree health care exceeds $1 trillion. In some states, such as Illinois and Connecticut, the liability is over 100 percent of annual total revenues of the public sector. Relative to pension obligations discounted at the same rate, the authors find that unfunded retiree health care liabilities are one-half the size of unfunded pension obligations. They argue that using assumptions concerning the growth in health care costs that are more realistic than those employed by most states reduces the size of the liability in most cases. Pushing in the opposite direction, they find that using more realistic mortality assumptions increases the size of liability. The authors also place retiree health care obligations into context by examining the budget pressures associated with retiree health on a continuing, largely pay-as-you go basis. They find that the states, on average, could permanently fund their retiree health obligation by contributing an additional one-half percent of total revenue toward the benefit each year. Finally, the authors place the retiree health care problem in context by modeling the long-run structural budgets of state and local governments. The authors find that growth in Medicaid expenditures driven mostly by cost growth in medical care presents a substantially larger source of pressure than either pensions or retiree health care.

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Maria Fitzpatrick, Cornell University and NBER

Retiree Health Insurance for Public School Employees: Does It Affect Retirement and Mobility?

Despite the widespread provision of retiree health insurance for public sector workers, little attention has been paid to its effects on employee mobility and retirement. This is in stark contrast to the large literature on health-insurance-induced "job-lock" in the private sector. In this paper, Fitzpatrick uses the introduction of retiree health insurance for public school employees, in combination with administrative data on retirement and mobility of these employees, to identify the effects of retiree health insurance. As expected, the availability of health insurance for older workers that is not contingent on employment allows employees to retire earlier -- that is, not to wait for Medicare eligibility -- and increases job-to-job transitions.

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Jeffrey Clemens, University of California at San Diego and NBER, and David Cutler, Harvard University and NBER

Who Pays for Public Employee Health Costs?

Clemens and Cutler analyze the incidence of public employee health benefits. Because these benefits are negotiated through the political process, relevant labor market institutions deviate significantly from the competitive, private-sector benchmark. Empirically, the authors find that roughly 15 percent of the cost of recent benefit growth was passed on to school district employees through reductions in wages and salaries. Strong teachers' unions were associated with relatively strong linkages between benefit growth and growth in total compensation. Finally, the authors find that when economic conditions are poor, and public budgets are strained, benefit growth is more readily shifted back to public employees.