While underfunded pensions are a problem, they pale in comparison to the underfunding of other post-employment benefits. These benefits are “comprehensive group medical, prescription drug, hearing, dental and vision coverages for retirees and beneficiaries,” according to the MPSERS annual actuarial valuation report for health benefits in 2010. Michigan provides health insurance coverage to MPSERS retirees in an amount that depends on the years of service they earned and when they were hired. At the maximum, the state pays 90 percent of the cost of the premium.
With these “other post-employment benefits” — frequently called “OPEB” — the state has not set money aside as the benefits are earned, as it has tried to do with pension benefits. Instead, it assesses additional contributions from MPSERS employers to pay for the bills of retirees as they come due — a “pay-as-you go” approach, rather than prepayment. In the Michigan Constitution, there is no requirement to prefund OPEB, as there is for pensions.
Under the state’s current policies, state actuaries project that the present value of all future payments for benefits already earned under the state’s current policies exceed the present value of the few state assets set aside for these benefits by between $16.7 billion and $27.6 billion.[*],  The magnitude of this gap is similar to the state’s $17.6 billion unfunded liability for MPSERS defined-benefit pension plan.
To cover the pay-as-you-go costs of providing other post-employment benefits in fiscal 2012 and fiscal 2013, the state is requiring school districts to pay to MPSERS amounts equivalent to 8.5 percent of payroll and 8.75 percent of payroll, respectively. In fiscal 2011, the state set aside $958.8 million to cover this benefit.
The state has latitude to change this benefit for current members and retirees alike. Unlike public employee pension benefits, these retirement benefits are not protected by the Michigan Constitution.[†] Moreover, retiree medical care is a benefit that is rarely afforded in the private-sector. In a 2010 Mackinac Center Policy Brief, actuary Richard C. Dreyfuss found that only three of a sample of 24 major Michigan private-sector employers provided this benefit to members. A key reason such benefits are uncommon is that once retirees get to age 65, they are entitled to Medicare benefits that cover a substantial portion of their health expenses.[‡]
Instead of levying substantial payments on schools and taxpayers for benefits that few private-sector taxpayers can afford, and rather than committing taxpayers and school districts to substantial long-term risk and financial expense, policymakers could scale back this benefit. The Legislature can use the savings to catch up on financing earned pension benefits, which, unlike OPEB, cannot be reduced under the Michigan Constitution.
The level of savings from this would depend on how much health care expenses increase in the future, how much legislators cut back this benefit and whether the reforms are applied to current retirees or to future ones only. In fiscal 2011, MPSERS employers paid $795 million to retiree medical care benefits. The first-year “transition cost” would be $360 million — nearly half of the 2011 retiree medical coverage payments.
This figure does not mean legislators would need to cut retiree medical costs in half, since reductions to retiree medical coverage would not have to net $360 million in savings each year. The “transition cost” for the amortization payments is lower in subsequent years, and the Legislature has already set aside $133 million that can be used to mitigate the upfront “transition costs.”
It is worth noting that the state has scaled retiree medical benefits back in the past. The state's 1996 reforms revised MSERS retiree benefits to require 30 years of service before an employee received 90 percent of a retiree’s health care premium, with employees earning 3 percent of the health care premium for each year of service. Previously, an employee was fully vested in retiree health benefits after just 10 years of service.
[*] Note that MSERS has a similar OPEB gap between assets set aside and benefits earned under the state’s current policies. Also note that the Legislature has closed the MSERS OPEB plan to new members as of Jan. 1, 2012. These MSERS members are instead offered a higher employer payment to their defined-contribution plan and a small deposit to a health reimbursement account upon retirement. Bethany Wicksall, “A Summary of House Bills 4701 and 4702 as Enacted,” (Michigan House Fiscal Agency, 2011), http://goo.gl/siUab (accessed March 4, 2012).
[†] In Studier v Michigan Public School Employees’ Retirement Board, the Michigan Supreme Court ruled that “health care benefits paid to public school retirees [do not] constitute ‘accrued financial benefits’ subject to protection from diminishment or impairment” under Article 9, Section 24, of the Michigan Constitution. Studier v Michigan Public School Employees’ Retirement Board, 472 Mich 642, A-1 (2005).
[‡] It should be noted that the most important determinant of health does not appear to be the expense of health insurance. See Robert H. Brook et al., “The Effect of Coinsurance on the Health of Adults: Results from the Rand Health Insurance Experiment,” (The RAND Corporation, 1984), http://www.rand.org/pubs/reports/2006/R3055.pdf (accessed Jan. 24, 2012). Thus, while retiree medical insurance benefits may reduce the financial risk attendant on paying for health care, the health benefits are likely inconsequential, especially given the availability of Medicare.