When the city of Glendale, Calif., created its employee healthcare benefits, it allowed retirees to remain on the plan while still paying the same premium as active employees. The active employees were essentially subsidizing the retirees’ premium. This “hidden subsidy” or “implicit subsidy” as it’s known, however, created a massive unfunded liability of $250 million. 

New reporting provisions mandated by the Governmental Accounting Standards Board spurred Glendale to take action. Released in June 2015, GASB statements 74 and 75 require government entities to report all unfunded Other Post-Employment Benefits liability as an expense on their financial statements.

“That creates a further financial burden,” says Steve Gedestad, municipality practice leader for Keenan & Associates, a private insurance brokerage headquartered in Torrance, Calif., that works with the city of Glendale. “This is causing more and more agencies to take a more serious look at what they are providing and how are they going to afford this, frankly, in the future.” 

Glendale, which has roughly 1,500 active employees and 700 retirees, wanted to address the issue without forcing retirees off of the city’s plan. Keenan redesigned the plan — which allows retirees to stay on it at an adjusted rate — and retirees also have the opportunity to purchase coverage via Keenan’s private exchanges. “It was important to provide that option,” says Glendale HR Director Matt Doyle.

The new plan, which the city approved in early October, permits retirees to stay on Glendale’s plan. However, they must pay the actual cost of their premium instead of the pooled rate. Retirees can also purchase coverage through Keenan’s pre-65 and Medicare exchanges. The changes are expected to reduce Glendale’s OPEB liability by more than $200 million.

The decision was not taken lightly, Doyle says. The retired city employees are more than just former co-workers, they’re friends, mentors and respected members of the community, he says. “I cannot overstate how difficult this was to do,” Doyle says. “But it was the right thing to do. We had to do it.”

To make the transition easier, Glendale is offering a temporary subsidy through December 2016 for those who choose to stay on the city’s plan. “We’ve done everything we could to soften the blow,” Doyle says. The city is also offering an ongoing subsidy for existing low-income retirees who stay on Glendale’s plan.

Overwhelming disappointment

The retirees were overwhelmingly disappointed when they first heard about the alterations to their medical plan, Doyle says. Many made the assumption the city was abandoning them. That’s understandable, he says, as most thought they would be able to remain on their current plan at their current rate for the rest of their lives. “We never made that promise,” Doyle says.

The city held multiple town hall meetings to explain the situation and provide education about the new private exchange alternatives. Now that retirees have had a chance to peruse those options, Doyle has been hearing that many people are surprised their medical costs have decreased. Even with the temporary subsidy, some retirees have found better options and dropped the city’s plan, he says.

The private exchange gives post-65 retirees more options than they had with Glendale’s plan, Gedestad says. “They’re appreciating that,” he says. Having more choice is needed in retirement to account for everything from finances to the amount of coverage to prescription drugs, Gedestad adds. “There’s a lot more variables when you’re retired as opposed to the canned plan.”

Educating the retirees about the new plan is crucial, Gedestad says. The population ranges from people in their 50s to their 80s, and effective communication involves disseminating information in a format that they will read, he says. Along with public meetings and mailings, the city has a webpage where all the information about the changes can be found. In addition, Keenan has licensed professionals to help answer questions, and retirees are directed to the same person each time they call to make the process more efficient, Gedestad says.

Also see: “States with the worst-funded pension programs.”

Retiree healthcare is in the same situation as America’s state-run pension programs, which had a $1 trillion shortfall as of 2013, Gedestad says. “The actual liabilities are as great on retiree health as they are on pensions, but a fraction of these retiree health liabilities have been funded,” he says. “It’s a real time bomb for public agencies, certainly in California.”

Also see: “States with the best-funded pension programs.”

It’s not limited to the Golden State. A look at 61 U.S. cities — the largest in each state plus those with populations exceeding 500,000 — found that the cities saved just 6% of the $126.2 billion needed for OPEB costs in fiscal year 2009, creating $118.2 billion in unfunded liabilities, according to the Pew Charitable Trusts.

“This is an issue around the country,” Gedestad says, especially for more industrialized states. “These liabilities can be significant, unless the agencies take a proactive view on what they’ve negotiated,” he adds. “Can they ultimately afford them? Is it a benefit that is sustainable?”

Glendale is an example that a city can address this issue without eliminating retiree health benefits, Doyle says. “People need to look at what we did as a model to make sure your unfunded liabilities are addressed,” he says. “This is something city governments all over the country have to take a serious look at.”

Increased interest in exchanges

Utilizing a private exchange for retiree health benefits for Medicare-eligible participants has been gaining popularity in recent years, says John Grosso, actuary and leader of the Aon Hewitt Retiree Task Force. “We continue to see aggressive evaluation and aggressive movement toward individual market-based retiree exchanges for post-65 retirees,” he says. “We continue to see plan sponsors looking for alternatives to the group insurance approach for folks who are eligible for Medicare, and specifically a private exchange that can help these retirees identify, evaluate and enroll in individual coverage.”

The interest in post-65 exchanges has been slowly and steadily increasing, and is now more of a mainstream solution, Grosso says. “You have many more plan sponsors, across the public and private sector and across industry, looking at this option as a viable, tested, proven benefits sourcing strategy.”

In fact, 78% of employers who currently sponsor post-65 retiree health benefits are either using or considering using a Medicare exchange, according to Towers Watson’s 2015 survey on retiree healthcare strategies.  

There are three main reasons plan sponsors are using exchanges for Medicare-eligible retirees, Grosso says. Those include:

1) Cost savings for the plan sponsor and retirees. “It’s clear that you can deliver the promised benefit at a lower cost in the individual market,” he says. That’s because of the “competition, the choice, the innovation, the federal subsidies, etc. —  the younger, healthier risk pools available in the individual market relative to any employer’s single plan, single risk pool approach. That savings opportunity has been facilitated by the Affordable Care Act.”

2) More choice. Exchanges give retirees more choice with respect to plan design and carriers, Grosso says, which “allows them to calibrate the benefit to best meet their specific healthcare and financial needs.”

3) Some reprieve for plan sponsors. Using an exchange allows plan sponsors to step away from traditional administrative commitments, which enables them to reallocate resources to other parts of the business, he says.

Grosso expects to see continued growth among Medicare-eligible participants. “We see the post-65 market as very stable with a long-term value proposition,” he says. “We expect this to be a very good opportunity for the foreseeable future.”

Pre-65 market much slower

Adoption in the pre-65 market is much slower, as the ACA’s individual market reforms only took effect two years ago, Grosso says. “The reason why the pre-65 movement is so much slower is because the market is so new,” he says. “It’s evolving, it’s volatile in places, there’s a political process and a political angle to this that affects the pre-65 market. Many plan sponsors are concerned about putting their retirees into this new market when it is not fully stabilized.”

The fair amount of instability in the pre-Medicare market is due to factors such as carriers changing the coverage they offer, models shifting from a PPO to an HMO and narrow networks, Grosso says. “The challenge is it can change so dramatically in certain locations year to year that it’s tough for a plan sponsor to really get comfortable moving folks in this environment,” he says. “I think we’re going to need to see a few years of stability here before we see massive movement on the pre-65 side.”

By 2017, more than half of employers (53%) “plan to reassess their approach to pre-Medicare retiree medical in light of new opportunities under healthcare reform,” Towers Watson found. Thirty-one percent of those will do it by 2016.

The impending Cadillac tax could encourage more plan sponsors to send early retirees to the public marketplace. “The excise tax can hit the pre-65 population pretty hard because it’s a higher-cost group,” Grosso says. “If and when the excise tax is implemented, that could create more momentum for movement out of the pre-65 group space and into the individual market. We’re all watching very carefully what’s happening with the political process around the excise tax because it’s not very popular.”

Also see: “Employer groups want more than a two-year delay of the Cadillac tax.”

Implementation of the tax has been delayed as part of a $1.1 trillion spending package President Obama signed into law Dec. 18. The bill included a two-year delay of the Cadillac tax.

No more ‘meaningful benefits’

While existing and new retirees have comprehensive, employer-subsidized health benefits, new employees aren’t so fortunate. “Most plan sponsors aren’t offering meaningful retiree healthcare benefits, if any, to a new hire,” Grosso says. “You tend to have different generations with respect to what plan sponsors do with their retiree medical strategy.”

Most plan sponsors are committed to continuing health benefits for current retirees, Grosso adds, “but they’re looking for ways to deliver that benefit more efficiently, which is where the retiree exchange can come in. We don’t see plan sponsors eliminating benefits for existing retirees.”

Prior to the ACA, plan sponsors lumped all of their retirees into one group, says Joe Murad, managing director, exchange solutions at Willis Towers Watson. “Employers had never distinguished between their pre- and post-65 retirees,” he says. “They just saw them as no longer employees that are contributing on a daily basis, but they still had an obligation to service those benefits for their previous effort.”

Addressing pre- and post-65 retirees as different groups can be advantageous for employers — but saving money isn’t the sole reason. “A lot of it was just separating and capping the liability and exposure, and they could do that through the individual market by providing access to dollars in lieu of the group plan through an HRA,” Murad says. “Those employers who wanted greater cost certainty, so they knew what was in their future, and they really wanted a lot of flexibility and choice for their retirees. That’s what the individual market affords them.

“And that’s whether you’re pre-65, post-65, part-time, seasonal employee,” he adds. “We have the capability to service them, and historically we couldn’t until the ACA legislation enabled us to do that for the [pre-65]. We were really limited to the post-65.”

Education is key

Education is also a critical side to retiree health benefits. “Retirees are all over the board, some are prepared for retiree healthcare needs, others aren’t,” says Grosso. “You have retirees in very different places.”

That’s why it’s essential for advisers to help retirees make the best selection and stretch their employer subsidy as far as possible, he says. “It’s something the private exchange is designed to do,” Grosso says. “Each retiree is in a different place with respect to their preparedness financially for what their obligations are going forward.”

While everyone varies, a trend has developed over the past decade. “The one consistent theme we’ve seen for 10 years is the plan adoption always blows the minds of the clients that we’re servicing,” Murad says. Most think that retirees will stay with their current plan. “It’s never the case,” he says. “There is significant adoption across the entire spectrum of plans because people are just generally different. When they are educated around those distinct differences, they benefit, and they select something that is more tailored to their needs.”

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